• Brett Schafer

Robinhood: Not So Deep Dive

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Show Notes

(Ryan) What they do: Robinhood is a commission-free brokerage platform, I believe the first. So, for anyone unfamiliar, the brokerage system for a long time required anyone that was buying or selling a security to pay a fee. So if I wanted to buy 10 shares of starbucks, I would pay $5 when I bought and when I sold. Robinhood cut that to zero and the way they did this is by rerouting trade orders to market makers, mainly Citadel (34% of all revenue).

Those market makers pay robinhood a fee in exchange for these orders which Robinhood calls a rebate. Once the market maker sees your order, it is able to buy it and sell it to you at a slightly higher price, making micropennies on every transaction. But they generate higher fees for their options transactions that they are selling. Marc Rubenstein found that while options accounted for only 2% of Robinhood’s AUM, it accounted for 47% of transaction revenue.

Robinhood is mobile first and also lets users buy and sell options as well as cryptocurrencies. And they use some of the same tools that their silicon valley peers like Facebook use in order to get users to use the app. They send push notifications when something goes up or down 5%. They make it feel a bit like a game by giving you a free stock right at the start. But they also make up some revenue from other sources as well.

Their Robinhood Gold subscription service, net interest income on margin lending and cash deposits, and some others. There are a few alternative ways they make money, but they’re smaller.

(Ryan) History: Founded in 2014 in Palo Alto by Baiju Bhatt and Vlad Tenev. The two were roommates at Stanford where Vlad studied mathematics and Baiju had degrees in physics and mathematics. But it looks like both of them knew how to write code, because once they graduated they moved to New York and sold trading software to hedge funds.

That’s where they realized that there was essentially this arbitrage opportunity and that commissions weren’t really necessary. So they moved back to the valley, where Robinhood is now headquartered and where they found their first $3 million seed round. They’ve had 11 total funding rounds, with the latest being more than a $3 billion convertible notes offering amidst the crisis last year since Robinhood needed to post collateral. That may have also encouraged the IPO since those lenders wanted to convert to stock.

(Brett) Industry/Landscape/Competition:

  1. Competitors include Vanguard, Charles Schwab/TD, Etrade, Coinbase, IBKR, other mobile-first trading apps

  2. Retail investing assets are $50 trillion according to the S-1. How much of that is reasonable for Robinhood to obtain? I’m not sure

  3. Crypto trading is hard to calculate, but Coinbase is doing $3 billion in sales (they have commissions though)

  4. 70% of Robinhood AUC is aged 18 to 40

  5. 68% of people aged 18 to 29 have no money invested in the market

(Ian) Management and Ownership:

  1. Vlad Tenev (ten-iv) is the co-founder and CEO

  2. The other co-founder (Baiju Bhatt) is the Chief Creative Officer

  3. Both stanford graduates

  4. Vlad had two other startups before Robinhood

  5. Estimated that both founders own a combined 20% of the company

  6. The design, roll-out and word of mouth marketing is impressive

  7. Read an article that they would test features at Stanford with college students before implementing. Kind of reminiscent of Tinder and Bumble

(Brett) Valuation:

  1. Ticker HOOD

  2. What valuation do we think it is going out at?

(Ryan) Earnings:

  1. In Q1 total net revenues was $522M, up 309% YoY

  2. Negative ~$1.5B in GAAP net income in the first quarter due to the change in fair value of their convertible notes.

  3. Largest opex is G&A, barely outpacing marketing

  4. Net cumulative funded accounts of 18M, up 150% YoY

  5. MAU’s was 17.7M, a little more than double year over year

  6. $80.1B in assets under custody, which backs out net margin balances.

  7. This puts the average account balance at just under $4,500

  8. Now I hate this metric but they have an adj. EBITDA margin of about 22% if you exclude primarily the convertible notes fair value change.

(Ian) Balance sheet and liquidity:

  1. Cash of $1.4B

  2. $4B in convertibles, should be thought of as dilutive equity at this point

  3. Should check out the plumbing of the investments. Some cash on the balance sheet is held for investors and they generate some interest on the cash

  4. Others more qualified

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Anecdotal Evidence:

  1. (Ryan) Started there thanks to free commissions. Then moved to Schwab pretty early on. I kept a little bit of money in there in case I essentially ever want to gamble.

  2. (Brett) Hate the app. Once Brewster/others opened our eyes to their tactics I have gotten angry at the company.

  3. (Ian) Transferred all of my assets off of it about a year ago. Schwab paid the fee. Only had opened it because of the free commissions. Glad they forced the hand of the big guys

Future growth opportunities:

  1. (Ryan) Honestly sports gambling. You’ve got an incredible UI/UX, no one can argue with that, noe just accept your stigma as a casino, rebrand and start letting people gamble across all different types of markets. Or a cash wallet with boosts like the Cash App. Honestly just copy the cash app.

  2. (Brett) Turning into a bank. Lots of language that makes it feel like they want to do that eventually. Extremely crowded space though.

  3. (Ian) Adding retirement accounts. Young people should be opening Roths. This would really help to democratize finance.

Highlights and lowlights:

  1. (Ryan) Highlights: They really have some organic marketing and a bit of a network effect. Unfortunately, this is basically the go-to app for first time investors. Also it’s fair to assume that they could be a pretty high margin business if they really peeled back some of their expenses. Lowlights: I really am not a fan of the CEO. And growth of the entire platform hinges on market sentiment. It’s not recurring revenue no matter how addictive they make it.

  2. (Brett) Highlights: Clear leader in its niche of finance, strong unit economics, infrastructure/operations look to be in a better spot. Lowlights: don’t trust management, feels like a business that is impossible to predict, reliance on crypto (Dogecoin specifically) and options for revenue, exploiting customers doesn’t feel sustainable

  3. (Ian) Highlights: Initial brand building (though this has taken a major hit, design, and foresight to no commission-free was a viable business model. I do like the line “We are all investors.” Just not the platform to spread that message. Lowlights: Options, due to the spread, are a significant portion of revenue. Active users declining. I would worry that this might be problematic if regulation ramps up. Also, no retirement accounts or custodial etc. It’s possible that I would still be using Robinhood had I been able to set up a roth there.

Bull case:

  1. (Ryan) I’m overthinking the downside risks/negatives of the business and this continues to be the go-to place for first-time investors. If those first-time investors continues to stick around for their lifetime then this could be a good investment pending a somewhat fair valuation.

  2. (Brett) Everyone turns into a degenerate gambler and nothing matters anymore (jk). If they go out at a market cap of $50 billion, I think you need to be expecting AUC to get to $1 trillion with the same amount of trading activity/take rate they currently have.

  3. (Ian) Adding more account types, features, diversifying revenue and and becoming the FI for younger generations. Just worry that there is a lot of competition, SoFi, Square, Paypal, etc.

Bear case:

  1. (Ryan) Any number of the legal proceedings result in big losses financially. Gamblers get bored with the market and trading activity/proliferation of new traders shrinks with less viral stuff to talk about.

  2. (Brett) A bear market. If investing ever becomes unfun again (idk if it will), then investors in Robinhood would lose lots of money.

  3. (Ian) The cynic in me says that order flow is about to decrease as we come out of covid and stimulus money. IPOing at the perfect time, etc., more people move to established brokers

*Our Thursday episodes are sponsored by Quartr. Quartr is democratizing investor relations by bridging the gap between companies and stakeholders. Download on the App Store or Google Play Store today.

Disclosure: The authors and podcast guests are not financial advisors. Brett Schafer and Ryan Henderson are portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this podcast.

#HOOD #Robinhood

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