12 BARRON’S February 8, 2021
IntheWakeofGameStop,
ANewTestforRobinhood
T
he Super Bowl ad that
Robinhood is airing this
weekend doesn’t talk
much about stocks, and
maybe that’s for the better.
A surge in stock trading
by retail investors has put
the investing app in the spotlight,
and it’s likely to stay there for several
months. In the weeks ahead, the
company’s CEO, Vlad Tenev, is set
to testify before Congress, and after
that—perhaps as soon as the second
quarter—Robinhood is expected to
go public. The initial-public-offering
process will probably highlight Robin-
hood’s huge growth, but also the sig-
nificant risks it faces in trying to over-
turn decades of Wall Street norms.
Robinhood, founded in 2013, has
risen from plucky start-up to central
player in the broker wars, and it’s
now an important part of the plumb-
ing of the U.S. financial system. Its
basic innovation—commission-free
trading—has realigned the industry
and helped attract millions of new
Americans to stock investing.
Robinhood’s platform became the
central battlefield where retail traders
took on Wall Street during theGame-
Stop(ticker: GME) frenzy late last
month. But the company faltered at a
key moment, banning the buying of
GameStop,AMC Entertainment
(AMC), and several other stocks just
as retail investors were rushing in.
Other brokers imposed restrictions,
as well, but most continued to allow
stock trading. Robinhood said it was
suddenly forced to place more capital—
as much as 10 times normal levels—
with its clearinghouse as a safeguard
and couldn’t allow the high volume of
trading on its platform to continue. The
firm eventually eased those restric-
tions, and fully lifted them on Friday.
But not before GameStop lost 85% of
its value, a move that some investors
blamed on Robinhood’s restrictions.
Robinhood declined to comment
or make Tenev available to discuss the
IPO, its financial statistics, or the criti-
cisms of the company. In blog posts,
the company has dispelled rumors of
anything nefarious about the trading
limits, showing that volume was
“magnitudes higher than the norm.”
Robinhood hasn’t released recent
figures on the size of its customer base,
but last May, the company said it had
more than 13 million account holders.
Now, it probably has somewhere north
of 15 million. Data from web analytics
company SimilarWeb show that Robin-
hood’s app was downloaded more than
a million times in just two days at the
height of the GameStop frenzy, many
times more than competitors. It’s nar-
rowing the gap with industry leader
Charles Schwab(SCHW), which had
about 30 million active accounts at the
end of the fourth quarter.
The math isn’t all in Robinhood’s
favor, though. While Robinhood is the
growth leader, its clients have tended to
have much smaller balances than those
at rival brokers, with some estimating
that its average account size is below
$5,000. Clients of some larger competi-
tors tend to have more than $100,000.
Robinhood doesn’t release revenue
or profit numbers, but securities fil-
ings offer some hints. The company
is heavily dependent on what’s known
as payment for order flow, meaning
that Robinhood gets a share of the
money that market makers pocket
from the spread between the bid and
ask prices on assets they trade. In
2020, Robinhood made $687 million
from payment for order flow on stocks
and options trades. (It also makes
money on crypto trading, though its
filings don’t disclose those numbers.)
CFRA analyst Pauline Bell estimates
that about 80% of Robinhood’s reve-
nue comes from payment for order
flow, which would mean the company
had close to $1 billion in revenue in
- Analysts say they suspect the
company is unprofitable.
Robinhood’s last traditional round
of private fund raising valued the
company at $11.7 billion. Analysts
think the company could go public
for considerably more than the $
billion thatMorgan Stanley(MS)
paid to buy E*Trade last year.
To achieve that valuation, Robin-
hood will probably have to convince
investors that its revenue stream is
secure and consistent. Payment for
order flow, however, has come under
scrutiny. In December, Robinhood was
By AVI SALZMAN
As the trading platform considers
an IPO, the risks are mounting
Hot Trade
Robinhood’s
popularity soared
as retail investors
traded GameStop.
Estimated app
downloads
Source: SimilarWeb700 thousand600500400300200Jan. 3 Jan. 30tt1000forced by the Securities and Exchange
Commission to pay $65 million to set-
tle claims that it misled customers on
how it made money, even as it wasn’t
getting the best execution for them.
The company didn’t acknowledge
fault. It has said it has changed prac-
tices. Other brokers also make money
on payment for order flow—with the
exception of Fidelity—but it’s gener-
ally a much smaller percentage of
their revenue
ClearBridge Investments analyst
Miguel del Gallego, who covers finan-
cial companies, thinks payment for
order flow could see regulatory
changes, though he expects the
general practice to continue.
Options trading, which can involve
much larger risks than traditional stock
trading, is also likely to get more scru-
tiny. Robinhood made nearly two-
thirds of its payment-for-order-flow
revenue from options in the fourth
quarter, meaning that it could face out-
size risk from any regulatory changes.
Robinhood’s business model has
often raised questions about its align-
ment with customers. “The argument
can be made that its real end clients are
these high frequency traders who are
actually taking this information and
trading against what’s referred to as
uninformed investors,” Gallego said.
The company is now facing a back-
lash on social media. Some retail trad-
ers have lumped the company in with
the Wall Street bigwigs they despise.
In an interview on Reddit, billionaire
Mark Cuban wrote that Robinhood
“let you down in a big way” and he
suggested that traders find a “broker
with TRILLIONS OF DOLLARS in
assets on their balance sheet.”
A survey of some 10,000 investors
on social network StockTwits showed
that 40% of them were planning to
change brokers—and most of those
planning to switch were Robinhood
customers. Competitors aren’t lying
down. Schwab is having success at
attracting younger customers, with
about half of its new customers under
the age of 41. A majority of new cus-
tomers are signing up for trading tools
that help them create self-directed
accounts, the firm says, up from 20%
in 2016—a sign that Schwab is attract-
ing a newly emboldened generation of
traders who aren’t content to “set it
and forget it” with their accounts.
Robinhood faces another potential
risk once it goes public: As one person
wrote on Reddit last week: I “cant wait
to short Robinhood on Robinhood.”B Tiffany Hagler-Geard/Bloomberg