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“Compound interest is the eighth wonder of the world.” - Albert Einstein
To all the Time Investors,
Traditional banks and investing platforms are prime for disruption. Based on CBInsights research, Fintech companies represent about 17% of all unicorns around the world, with companies like Stripe and Square. This environment reveals a clear message: people want to have frictionless participation in financial services and markets. Today we will break down Robinhood ($HOOD), the fintech company that wants to become the go-to app for money.
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📖What is Robinhood?
Robinhood is a stock-trading, investing tech company that provides everyone commission-free trading. The company is proud to have created an intuitive platform that makes investing easy.
The company’s mission and vision: The company’s mission is to democratize finance for all. Their vision is to become the most trusted, lowest-cost, and most culturally relevant money app worldwide. They simply want to allow everyone to participate in the financial system regardless of wealth, income, or background.
Customer Landscape and Partnerships:
Users:
Net Cumulative Funded Accounts: Q1 2021: 18.0M (151%) | FY 2020: 12.5M (143%)
Monthly Active Users (MAU): Q1 2021: 17.7M (106%) | FY 2020: 11.7M (172%)
Average Revenue Per User (ARPU): Q1 2021: $137 (65%) | FY 2020: $109 (65%)
Cohort Annual Revenue: 2017 Cohort returned $130M (7.6x) in revenue in 4 years | 2018 Cohort returned $186M (4.2x) in revenue in 3 years | 2019 Cohort returned $175M (3.9x) in revenue in 2 years | 2020 Cohort returned $326M (1.0x)
> 50% of users are first-time investors
> 80% of user were mainly acquired through the Robinhood Referral Program and the remainder organically
Referral Program cost $57M in 2021 (56% of marketing expense) and $26M in 2020 (37% of marketing expense)
The referral program awards free shares upon bank linking rather than account approval (share price ranging from $2.50 to $225)
CAC has steadily declined by 60% from $53 in 2019 to $20 in 2020 and now $15 in 2021
Robinhood states most of the investors buy and hold investors
70% of assets under custody came from ages 18-40
Tripled the number of women using the platform
Claims diverse user base: 9% are African Americans | 16% Hispanic |
65% have credit scores of prime or better and 65% have a debt to income ratios of less than 20%
50% of internal Robinhood surveys responded that the application helped motivate to save money
Contract Customers:
Market Makers: Revenue from market makers represented 75% of total revenue in 2020 and 81% in 2021
Q1 2021: Citadel Securities (27%), Susquehanna International Group (12%), Tai Mo Shan (11%), Wolverine Holdings (9%), All others represented about 22%
Financial Performance (Growth, Margins, Debt, Profit):
Revenue: Q1 2021: $522M (309% YoY) | FY 2020: $959M (245% YoY)
Net Income: Q1 2021: -$1.4B | FY 2020: $7M (Breakeven)
Loss in 2021 was driven by $1.4B in convertible note (considered a liability) that had to be raised (GameStop Party)
Assets Under Custody: Q1 2021: $81B (3.2x) | FY 2020: $63B (4.5x)
Q1 2021: 80% - Equities | 14% Crypto | 9% Cash | 3% Options | -6% Customer Margin Balance
FY 2020: 84% - Equities | 6% Crypto | 13% Cash | 3% Options | -6% Customer Margin Balance
Cash: $4.7B
Team DNA and Culture:
The company is founder-led by Vladimir Tenev and Baiju Bhatt. Their executive team is composed of leaders from CapitalG, Amazon, Facebook, Google, and former SEC Commissioner.
In Glassdoor, the company received a 4.4-star review with 87% approval to recommend to a friend and 88% approval of CEO (pool of 266 reviews)
The company is planning to increase its engineering team by 20%, customer service by 20%, and regulatory and compliance by 30%
Review Comments: Pros: “Company culture is open and friendly” | Cons: “Growing pains have definitely been real”
📈Market Opportunity
The stock market is defined as one of the greatest inventions in the capital markets to increase wealth. Historically the S&P 500 has produced on average a 10-13% annual return. But many Americans experienced limited or no access at all in the wealth generation process by the markets. With finance technology, the barriers that once existed preventing ordinary citizens from access are deteriorating rapidly. Realizing this some market dynamics are evolving:
2019 Pew Research Survey revealed that 60% of Americans do not have investments outside of their retirement accounts
2020 Gallop Poll revealed 68% of young adults (18-29) have no money invested
2020 Harris Poll revealed two-thirds of Americans would consider financial products from technology platforms
Retail Investing represents about 20% of all American households.
30% of Retail Investors place orders using a mobile app and 59% for participants at age 18-34 – FINRA survey.
The company reports from insights by Charles Schwab that U.S. retail investors have total assets of $50 trillion. With over half of the retail investors revealing Robinhood as their first brokerage account, a strong market share is inevitable. Additionally, the crypto market is currently valued at $1.3T (with Bitcoin representing about 46% of the market cap). As young retail investors are open to the developing ecosystem, the ability to access crypto investments is crucial. Simultaneously, the opportunity to offer FDIC ensured cash management solutions like traditional banks opens additional market opportunities. There are over $1 trillion in brokered deposits in the U.S and $3.6 trillion in credit card purchase volumes as well. Robinhood is positioned to operate in an ecosystem that is ripe for disruption.
👨💻What are the Strategic Resources?
Product Portfolio:
Technology Platform: the company has a proprietary ordering system that can evaluate past user orders and automatically route orders to market makers. The company claims that this ensures users have the best prices. The company also implements a self-clearing system that clears and settles trades across stocks, ETFs, and options. In addition, their machine learning platform enhances fraud detection and curates a personal, relevant newsfeed for users regarding equities and cryptocurrencies. To continue to enhance this platform Robinhood has a team of 550 engineers (26% of their workforce).
The platform offers some key critical features as well for users:
Investing Solutions: Invest in commission-free stocks, ETFs, options, fractional shares, recurring investment functionality, and IPO access.
Robinhood Crypto: Invest in seven different cryptocurrencies (Bitcoin, Bitcoin Cash, Bitcoin SV, Dogecoin, Ethereum, Ethereum Classic and Litecoin). Currently, users cannot deposit or withdraw fiat and cryptocurrencies directly from the Robinhood Crypto subsidiary.
Robinhood Gold: Monthly subscription service that offers instant access to deposits ($5k-$50k), stock research, access to investing in margin (eligibility criteria need to be met). Currently, there are 1.4 million customers subscribed.
Cash Management: Users can earn interest on cash account and currently there are 3.4M debit cardholders (MasterCard partnership). They have removed traditional bank fees (minimum balances, overdraft, and transfer).
Learning & Education Solutions: The company offers educational tools and resources like the podcast, newsfeeds, and a learning library of articles and tutorials.
To protect its assets the company has 55 issued patents, three pending design patents, and their Cash Management product card designs. Technology and development expenditures represent about 22% of their revenue.
💪Key Strategic Moats
Product Design: Design is at the center of Robinhood, creating a platform that is intuitive, informative, and aesthetically familiar. In 2020, half of all new investing and trading app downloads were driven by Robinhood.
Brand: When you think of Robinhood, you immediately associate retail investors and zero-commission trading. Investing is now socially relevant among younger generations due to Robinhood. 80% of newly funded accounts joined the platform through their referral program, which signifies brand relevance.
Scale: The company offers a variety of services ranging from news, watch lists, ability to manage cash balances, invest, and manage personal portfolios. Users on average visited the app nearly seven times a day. With this scalability, the company has 3.4M debit cardholders, 11 million users that have used fractional trades, and 32 million subscribers to their newsletter and podcast, and 7 million views on their Robinhood Learn initiative.
Team: The team is founder-led with experienced executive leadership, strong culture, and an overall positive work environment. The team strongly believes that the financial system should be accessed by all.
🧬Business Model and Growth
When you follow the breadcrumbs, three distinct revenue streams define Robinhood’s business model:
Transaction-based revenue: Represented about 75% of total revenue in 2020 and 81% in Q1 of 2021. Essentially, when a user puts in an order for a trade (equities, options, cryptocurrencies), Robinhood uses their ordering system to route orders to market makers to execute and they in return receive a fee. This strategy is called payment for order flow (“PFOF”). Similarly, on the crypto trades, it’s called a “transaction rebate”. Let us dig a little deeper and understand some facts about the fee structures:
Equities: Fee is a fixed percentage based on the difference between the quoted bid and ask (spread)
Options: Fee is on a per-contract basis
Cryptocurrencies: Fee is a fixed percentage on the order size of the transaction
*Majority of this revenue is also mainly driven by options (~47%), equities (~32%), cryptocurrencies (~20%),
*The fee structure is identical across all market makers and Robinhood states that they route orders to market makers that they believe offer the best execution and in the cryptocurrency space the best competitive price.
Net interest revenue: Represented about 18% in 2020 and 11% in Q1 2021 of total revenue. The company earns interest by lending securities, margin loans, cash balance.
Robinhood Gold Membership: Represented about 6% in 2020 and 8% in Q1 2021 of total revenue. To get access to margin investing and additional privileges, you must be a subscriber.
The company also intends to deploy the following growth strategies:
User Acquisition: The Referral Program was successful and will expand to deliberate marketing resources to acquire users. Uniquely, Robinhood is intending to allocate 35% of its IPO shares to retailers.
User Support: Resources will be deployed to increase customer support (“add the human touch”)
Product Innovation: The company intends to evolve its product to potentially including all aspects of financial management and services such as (loans, and mortgage services, etc.)
International Expansion: The Credit Suisse Research Institute estimates that total global wealth is estimated at over $250 trillion. Asian and European expansion are necessary.
Investor Facts:
Investors: DST Global, Ribbit Capital, New Enterprise Associates, Index Ventures
Stock Price across the various fundraises: Series A: $0.19 | Series G: $18.6 (100x return) | Potential Valuation at $40B
Class A shares: One vote | Class B shares: 10 votes
🤯Key Insights for Time Investors:
⚠️Key Critical Risks
Revenue Risk: Majority of the revenue generated by Robinhood comes from payment of order flows. This is highly driven by option trading, which is one of the riskiest forms of trades to make as an investor. A reduction in spreads between the bid and ask price, reduction in trading activity, and any regulation regarding the relationship with market makers can severely impact 81% of the company’s revenue. Additionally, a substantial driver for growth in Q1 was driven by cryptocurrency trading, and more specifically Dogecoin, which represented 34% of the cryptocurrency transaction-based revenue.
Brand Degradation: There has been a wave of negative media coverage as well as litigation/settlements with government entities regarding the Robinhood practices, “gamification” of investing, and operational outages.
December 2019: Robinhood settled with a $1.2M fine for noncompliance with best execution practices with FINRA, a self-regulatory organization.
December 2020: Robinhood paid $65M to SEC for an investigation into best execution and PFOF practices.
More recently, FINRA fined Robinhood ~$70M for the systematic outages, misleading communication, and trading practices (this is the largest penalty from FINRA)
There are a host of other class actions in play as well.
Competition: The ecosystem is also extremely competitive with incumbents like Charles Schwab (32M accounts), Fidelity (83M accounts), E-Trade (7M accounts), and TD Ameritrade (11M accounts). In the space, Consolidation is occurring to secure market share. Similarly, new entrants like Etoro (20M), Webull, and Public are in direct competition.
Government Regulations: The GameStop/Meme stock fiesta has certainly raised the flag causing government regulatory bodies to increase their focus. Payment of order flows is on the table with the potential legislation that is recently introduced to completely prohibit the practice. In addition, Gary Gensler, Chairman of the SEC, has proposed key focus on the following concepts: 1) PFOF 2) Gamification 3) Disclosures under trading restrictions 4) Margin requirement sufficiency 5) Managing liquidity risk 6) Mobile-app features such as rewards, push notification.
Robinhood, spawned from the idea of democratizing finance and with a grandiose vision of becoming the go-to app for money! This idea is very addictive, especially when it involves the traditional story of Wall Street. When I think about Wall Street and the narratives that have circulated across for years, three words come to mind: wealth, fraud, and privilege. Keeping this in mind, any company that delivers a message of enabling anyone regardless of wealth, income, or background can suddenly become extremely popular.
Robinhood began with a splash introducing a simple, beautiful, and intuitive design for any user regardless of their experience. They did a great job removing friction caused by learning a new technology platform. Once you get approved and funds are deposited, you can immediately start investing and trading. To continue with this success, they pioneered a “commission-free” trading business model that took the industry by surprise causing all the incumbents to follow suit in 2019. They coupled this strategy with a stock referral program and BOOM you have significant growth. In eight years, they added 18M users with funded accounts and in the first quarter of 2021, they attracted 5.5M users. This is explosive and a success that the company should take pride in. From a brand perspective, Robinhood has associated itself with retail investing and if interests are high in participating in the markets, they will remain a strong player.
But this growth and brand awareness has not come without any costs. If a Wall Street Soap Opera were to be made, Robinhood would be the theme. First, to achieve their “commission-free trading” on the front-end to the user, they must generate a substantial amount of revenue through a controversial practice known as the payment of order flow. Now this strategy, incentivizes high volume trading specifically regarding options (as shown in the S-1 filing), and the routing to market makers for a fee raises questions on whether that is truly in the best interest of the user and whether it gets you the best market price. This practice is banned in some countries due to the conflict of interest. The CFA institute published a paper summarizing the ban in the U.K. for the sole purpose of the incentive of maximizing fees from selling order flows. This practice has attracted a $65M fine from the SEC and in 2020 and $1.2M fine in 2019 from FINRA. Legislation in the U.S. is also being created to potentially ban this practice. This would be terrible news for Robinhood in the short-term. Second, the concept of gamification has hit some scrutiny as well. Young untrained users are practically gambling on the app (reported minimum average seven times daily visit per user). Now Robinhood claims they want to enable their “customers” to become long-term investors and take greater control of their finances. But the behavior by users tells a different story. Now, I know we are all adults and if we can buy alcohol, gamble in casinos, why not the stock market. This is where the conflict resides. A casino is a casino and its common knowledge that you do not enter a casino with the expectation of creating wealth. Robinhood on the other hand claims to be that trusted brand that empowers you to build wealth, which is walking a fine line based on what’s actually happening. Finally, there is a problem with transparency with Robinhood. The outages during the GameStop and Meme stock rally created a bad taste in many retail investors (including myself). Restricting trades during the period of increased volatility created outrage and 50 class suits. While there are mechanics behind why that tactic was necessary, Robinhood lacks proper “user” support to communicate transparently. This event resulted in the largest fine by FINRA, amounting to $70M.
As a Time, Investor, it is important to understand Robinhood holistically. As a fintech company, they are performing quite well, and they have made investing easier for everyone. However, there are serious regulatory and brand issues that Robinhood needs to navigate to truly democratize finance and become “the most trusted, lowest cost, and most culturally-relevant money app worldwide”. In my opinion, the fact that Robinhood is still here and widely used with all the negative media attention, reveals how unique their product design is and how resilient their brand is as well. As a long-term public investor, I would personally wait and see how everything develops over the next two years. Now, I do wish I were part of the seed round or Series A round in Robinhood, which for those who participated will exceed a 100x return (congratulations!). I am personally curious to see how Robinhood evolves in the public eye and hopefully, they can accomplish their mission and vision regarding investing and money.
Stay curious!
-Igli G. Laçi
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Additional resources and sources I used for all the Time Investors
This Week in Startups - Emergency Pod! Robinhood files to go public: S-1 breakdown
How Robinhood Transformed Retail Trading Ahead of Its IPO | WSJ
Robinhood files for Nasdaq IPO at what's expected to be a $40B valuation (update)
Should You Invest In Robinhood’s IPO? - Finimize
Payment of Over Flow - United Kingdom - CFA Institute
Disclaimer: The companies mentioned in my newsletter are not investment advice. This is simply information researched to help you learn about industries and various public companies