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The Real Value of Robinhood Markets
Let’s face it. Robinhood (NASDAQ:HOOD) is an easy company to hate.
Where else can you find a company that enabled billions of meme stock trades, only to pull the plug at the worst possible moment? Or what about an app that’s lost investors so much money that posting a 100% wipeout loss on Reddit’s r/WallStreetBets has become a badge of honor? Even Ian Fleming would have had trouble imagining a better Bond villain.
Yet, every Moonshot reader will know by now that there is such thing as “too cheap” — as long as a company is worth more than zero. And after many months of declining share prices, Robinhood finally seems to be getting to that point.
In today’s read, we’ll take a look at a company that combines Reddit trolls, cryptocurrency, options trading and memes into one massive Moonshot investment, and see what the firm is really worth.
Robinhood: Hero or Double-Oh-Zero?
When Robinhood launched its IPO last July, it was supposed to be a triumph for the young startup. Finally, a Silicon Valley tech firm was going to take on Wall Street at its own game.
“Robinhood Markets has been at the forefront of the democratization of finance,” a report from Bloomberg glowed. “In January, they did, nuking a bunch of hedge funds betting against GameStop in one of the greatest short squeezes of all time.”
But it didn’t take long for Robinhood to fall flat. A combination of trading blackouts, poor customer service and stinging investor losses would send HOOD on a one-way trip to the doghouse.
“Hello to the people from r/all! DO NOT use Robinhood!!” angry investors on Reddit complained. “Robinhood may seem like the quick and easy way to buy stocks but they are against you!”
Not since Idris Elba dropped out of the “next James Bond” race have I seen so many disappointed fans.
Yet here we are. HOOD shares are trading 82% below their all-time high. Shares are now worth their Series G valuation from 2020… It’s as if the 2021 meme stock frenzy never happened.
Diamond (Hands) Are Forever
Eventually, the tide will turn again. And that’s for one important reason:
Robinhood is phenomenal at acquiring new customers.
In the past nine months, Robinhood added 11 million new users with its $87 million advertising budget. Rival Charles Schwab (NYSE:SCHW), by comparison, spent four times as much and acquired only half the accounts.
The upstart trading app now sits among the top echelons of brokerages by customer footprint.
- Charles Schwab – 33 million customers (includes multiple accounts)
- Fidelity – 31 million
- Vanguard – 30 million
- Robinhood – 22 million
Of course, the average HOOD customer has a far smaller net worth. The average HOOD account has only $5,000, compared to Schwab’s $235,000.
But that will eventually change as younger investors continue to save. In July, CEO Vlad Tenev openly mulled plans to offer U.S. retirement accounts. And the firm’s slow march into greater crypto offerings is starting to bear fruit.
With proper stewardship, Robinhood will eventually look more like a traditional brokerage firm, presumably with high traditional brokerage profits too. Industry Returns on equity (ROE) typically hover at 15%, about 50% more than those earned by commercial banks.
If Robinhood makes it alive to the other side, it’s likely worth around $120 billion (or $140/share), a 750% upside from current levels.
Shaken and Stirred
But why isn’t HOOD at $140 per share today?
I’ve long written about Robinhood’s Payment for Order Flow (PFOF) shenanigans, where “free” trades come laced with hidden fees. (Your order for $160 GME shares might get filled at $160.50). And when HOOD hit $70, I was all too happy to recommend investors look elsewhere for gains. (Those who did would have saved themselves $7,800 on a $10,000 investment).
But there’s another deadly shark that’s been lurking beneath the surface: Robinhood’s legal liabilities.
Last week, FINRA awarded $29,461 to a 27-year-old investor who lost money during the app’s trading blackouts in January 2021. It’s among a series of cases that’s alleging a laundry list of complaints. Breach of contract… breach of good faith… negligence… fiduciary duty… unjust enrichment… and so on.
Here’s the rub. If FINRA opens the floodgates to more settlements, the $30,000 fine can quickly turn into a dollar value worthy of a Goldfinger heist.
No Time to Die
Here’s where a little knowledge of FINRA goes a long way.
FINRA is a Self-Regulating Organization (SRO) with an unusual reliance on arbitration. Complaints against financial organizations are submitted directly to FINRA and are done on an individual basis rather than by class-action. The U.S. Court system rarely gets involved.
In practice, that means fines are often incidental to other penalties. FINRA would sooner ban a firm from the securities business than bankrupt it through punitive fines.
That’s important to Robinhood. FINRA currently has a choice between 1) reining in Silicon Valley ambitions or 2) shutting down a brokerage that 22 million customers now rely on. It will almost certainly choose the former.
Meanwhile, the future of PFOF is a little murkier. Securites and Exchange Commission (SEC) Chairman Gary Gensler has openly considered outright bans of the practice, but has also acknowledged that these agreements “have made trading far cheaper and efficient than in prior decades.”
In October, the SEC also stopped short of blaming Robinhood or PFOF in its long-awaited report on the GameStop (NYSE:GME) saga. Its final decision on new rules is still up in the air.
For a company that generates 80% of its revenues from PFOF, these details matter. Only when the SEC begins to remove these uncertainties can HOOD start back on its climb to fair value. Under current conditions, I would put a $30 target price on the company’s stock, a 100% upside. If the SEC clears PFOF, my fair-value estimate rises to $45.
Robinhood’s Future: Die Another Day
Regular Moonshot readers will realize: Robinhood is starting to look like a Golden Rule stock. It’s a 1) high-quality business, that’s 2) selling at a steep discount and 3) starting to gain momentum again. Shares are already up 15% from their all-time-lows and analysts expect another 29% in revenue growth this year.
But Robinhood also has a hidden benefit:
Its buyout potential.
“When [HOOD] stock falls low enough, it will be acquired by one of the online brokerage giants,” notes investment strategist Jared Dillian. “Those accounts are worth something to somebody.”
The company is also making the right changes. Last Thursday, the company appointed Steve Quirk — a 35-year veteran from TD Ameritrade — as its chief brokerage officer. It’s also indicated that it plans to move investors toward plain-vanilla ETF investing.
“The recommended ETFs will give customers exposure to a diverse set of domestic and international equities as well as exposure to the U.S. bond market,” the company said on a website post.
Other former Silicon Valley startups from Google (NASDAQ:GOOG, NASDAQ:GOOGL) to Palantir (NYSE:PLTR) have walked this path before. Technology startups often start life focused on products, and only add top-notch sales and support teams once they start to mature. (Congressional lobbyists hiring come soon after).
Today, Robinhood is also starting that road to maturity. And with some luck, it will one day become the Wall Street hero it so wants to be.
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On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.