Robinhood goes public with controversial earnings model

Just imagine: Randstad would go public again. And the accompanying prospectus describes a legal ban on agency work as a potential risk to the company. Not very realistic, because having to warn about a fundamental threat to your business model does not come across well.

Yet it is this choice that the potential investor in a newcomer to the American stock exchange now faces. And this time the risk is a lot more realistic. Investment platform Robinhood will most likely be listed on the Nasdaq from next Thursday. It seems to be a great success. Analysts expect Robinhood to be valued at about $35 billion (almost 30 billion euros). But danger lurks around the corner.

Robinhood is a company that has been around for a relatively short time – since 2013. The name, a reference to the British fictional folk hero and freebooter who stole from the rich and gave to the poor, does not come out of the blue. The American founders Vladimir Tenev and Baiju Bhatt were disturbed by the closed nature of the financial world. In their view, it was mainly accessible to wealthy insiders. They wanted to make investing possible for everyone.

They developed an app that allows investors to buy financial products such as stocks and options in just a few clicks. What makes it extra accessible: investors can also buy parts of shares. With just a few dollars, an app user can already invest in a company. They are also presented – à la Netflix – with companies in which investing may be interesting. “Did you just buy Apple? Maybe Facebook is for you too.’

Bored Investors

Read more about gamification here: As soon as investing becomes a game, the risks quickly disappear

Thanks in part to the corona crisis, the platform has the wind in its sails. Bored youngsters turned to Robinhood and started investing with savings. Sometimes they even took out a loan for it. Until recently, anyone who made a purchase via the app was shown confetti on his screen to celebrate the investment. Robinhood ended that after much criticism. It would lead to gamification: investing as a game. Young people in particular would not pay enough attention to the fact that investing entails risks: losing your money is also an option.

Uninformed buying led to the suicide of an American in his twenties last year. Among other things, this Alex Kearns bought options, a transaction that forces the purchase or sale of shares at a predetermined price at an agreed time. At one point, he suddenly saw a negative investment balance of $730,000 (620,000 euros) in his Robinhood account – money that he did not have. In a panic, he contacted Robinhood’s helpdesk, but they, except for an automatically sent e-mail, were not at home – with the drama as a result. After legal wrangling, Robinhood settled with the next of kin for an undisclosed amount.

Business model prohibited

Which also contributes to addiction: the platform does not charge a commission for the purchase of securities. So getting started is easy. Free investing was unusual for a long time. Anyone who instructed a trader to buy shares or options paid for them.

Robinhood makes money in a different way: by passing on buy orders to another party. For every assignment it moves through, Robinhood gets a fee. The party making the actual purchase for the customer makes money by acquiring the stock at a lower price. The margin between the purchase and sale price is the profit for that exporting party.

This practice has been widely criticized. In fact, the investor does not pay the most favorable price this way. The Netherlands and the United Kingdom already have a ban on transferring orders against commission. The US stock market watchdog SEC is now also looking at this payment for order flow (PFOF).

SEC executive Gary Gensler articulated the risk in May: “Many Robinhood users bear the cost of purchasing at a worse price. These costs may even be higher than what they saved by not having to pay a commission.”

The prospectus that made investors enthusiastic about investing in Robinhood itself warns of a possible ban on PFOF. If that happens, investment platforms will no longer be allowed to channel orders from customers to parties that make the actual purchase. Anyone who is instructed to buy certain shares must then really carry out that transaction themselves.

A PFOF ban could become a major problem for Robinhood. Based on the information a company must provide if it wants to go public, this case showed how much Robinhood depends on it: 81 percent of its revenue comes from transferring assignments.

Analysts therefore wonder whether a valuation of 35 billion euros for the investment app is not on the high side. It is not due to income and growth prospects so far: thanks to the bored at home, turnover grew by 245 percent last year to 959 million dollars (815 million euros), with a profit of 7.4 million dollars. In the first quarter of this year, the company already had a turnover of 522 million dollars.

Also read: Reddit users boost share of game store chain to hack hedge funds

bother big capital

That turnover jump was also due to the hype surrounding the share of games seller Gamestop. Hedge funds speculated at the beginning of this year through options on a price decline. On the internet forum Reddit, users called on users to buy Gamestop shares, in order to thwart the ‘big capital’. As a result, the price rose and the hedge funds made large losses. They had to buy the shares much more expensive than they expected.

The young Reddit users placed massive orders via Robinhood, among others, until the platform suddenly stopped trading on January 28 after the explosive price increase of Gamestop. The measure soon led to rumors of a conflict of interests between Robinhood and Citadel, the largest party that actually purchases investment products for the platform. At the same time, Citadel can count a large number of hedge funds among its clients. It was suggested that Robinhood shut down trading under pressure from Citadel and its major clients. Robinhood has always denied that.

It even led to two sworn enemies in American politics coming to an agreement. Democratic Rep. Alexandria Ocasio-Cortez and Republican Ted Cruz thought the companies should come and explain exactly what had happened. PFOF has been prominent on the radar of politicians and regulators ever since.

The most important question for potential investors is therefore whether Robinhood’s business model is future-proof. Will you be able to invest commission-free in the future, and how many investors will be left if that is not the case? Charlie Munger, second man at Warren Buffett’s investment vehicle Berkshire Hathaway, is certainly not putting any money into it. He spoke early this year of a new bubble. “The human greed and aggression of the traders creates these kinds of bubbles once in a while. Wise people will stay away from it.”

source https://pledgetimes.com/robinhood-goes-public-with-controversial-earnings-model/