Analyst Insight: Robinhood's Not So Merry Men
In July of last year, Robinhood made its market debut in the thralls of the meme stock saga. While it is now abundantly clear this was an IPO of opportunity, there were certainly early signs hidden within its S-1 and brought to light by Rory in his First Look. He labeled Robinhood as a company “dealing with something of an existential crisis”, highlighting its branding as a brokerage of the people while simultaneously taking advantage of them. Not to mention, the company’s obscene dependence upon Dogecoin.
In its latest quarter, these characteristics remain prominent and they’re starting to put a damper on revenue.
In all fairness to Robinhood, it would be hard to improve from Q1 2021, when newbies flooded the market and cryptocurrencies popped up like weeds. This has meant all comparable stats look pretty dismal, but there are larger, more troublesome trends hidden beneath. Most of these can be best shown in graphs:
Firstly, account growth has been practically flat since Q2 2021. In that time, Robinhood has only added 300,000 funded accounts.
It’s tempting to explain this away as a mere pull forward — maybe everyone who wanted a brokerage account got one — but other financial firms continue to pull in new users at a steady rate. Charles Schwab added 1.3 million new brokerage accounts in the same period.
I would argue this demonstrates that the casino-like investing that Robinhood is famous for and has encouraged is beginning to fall out of favor. Just yesterday, Morgan Stanley calculated that meme-stock traders had lost all the money they made in the frenzy. Maybe those still interested in investing are looking for more measured, experienced players, like Schwab or Vanguard.
When it comes to the users Robinhood already has, things don’t look great either:
For the third quarter in a row, monthly active users have declined.
Just for clarity, Robinhood defines a Monthly Active User as a “unique user who makes a debit card transaction, or who transitions between two different screens on a mobile device or loads a page in a web browser while logged into their account, at any point during the relevant month.”
A consistent decrease in MAUs takes an especially nasty toll on Robinhood’s revenue because of how it likes to make money.
Robinhood makes the vast majority of its revenue through a practice called payment for order flow (PFOF). This process is pretty complicated, but in layman’s terms, Robinhood gets paid by wholesalers (like Citadel Securities or KCG) to bring your trades to them. This includes stocks, options, and crypto. Essentially, Robinhood is getting paid a finder’s fee.
This isn’t unusual in the industry, it's exactly how Vanguard or Charles Schwab do it and it makes commission-free trading possible. However, Robinhood is particularly good at it for reasons that seem a bit suspicious.
According to Spencer Jakab, the Editor of the ‘Heard on the Street’ column in The Wall Street Journal, Citadel paid Robinhood $0.62 for each options contract traded last year compared with only $0.35 for Charles Schwab customers. It’s believed this is because Robinhood users have a history of taking out far riskier options, so their business is worth more to wholesalers.
In order for Robinhood to continue to grow ARPU, it would need to continue to encourage risky, constant trading and products like options, buying on margin, or crypto. There’s not much money to be made in buy-and-hold trades.
Alphacution Research Conservatory showed that in the first quarter of 2020, Robinhood customers, in comparison with customers at Charles Schwab, traded a staggering 40 times the number of shares per dollar held in their accounts and a stunning 88 times the number of options contracts.
As inflation has taken hold, lockdowns have eased, and excitement has dried up, traders seem less interested in taking the plunge. Hence, why ARPU has declined and its overall revenue with it.
In response to all these stats, Robinhood would appear to be pivoting, but in two different directions.
On the one hand, it’s creating more traditional products such as IRAs and Roth IRAs. Tax-advantaged retirement accounts are often the most popular products for Robinhood’s competitors and are a great way to lock in a customer for a very long period of time. More than half of Robinhood’s users opened their first brokerage account on the platform, and the median customer age is 31 years old. That’s a wealth of potential long-term customers.
However, it’s not easy to make money from them so, in contrast, Robinhood continues to pursue ways to improve its gamified trading. Including extended hours (with the promise to eventually allow 24-hour trading) and consistently adding new cryptocurrencies.
To me, these tactics double down on how Robinhood already dubiously generates revenue and does little to lessen the company’s risk profile. It seems like a short-term attempt to level the ship.
If we take a look at a breakdown of transaction-based revenues, we can see that Robinhood continues to generate the vast majority of its income from options and crypto, its equity revenue is actually declining.
Management seems eager to label Robinhood as the great equalizer which can serve investors of any kind and will stabilize with maturity. In actuality, it’s still dependent upon novices treating the stock market like a casino.
That’s not the kind of business I’m interested in.
One final note worth mentioning: it's rumored that payment for order flow (PFOF) may face greater regulatory scrutiny in the future, which would take a sizable bite out of Robinhood’s revenue. While it would be upsetting to day traders, many critics suggest restoring a modest transaction fee or tax for trading to create more friction and prevent novices from jumping in headfirst and trading so consistently.
This, combined with the current macro conditions, makes me want to give Robinhood a wide berth.