Sometimes an analyst makes a lucky guess.
This comes to mind in considering my July column urging investors to avoid buying the shares that Robinhood Markets offered at its IPO.
Since July 26, those shares have soared from $35 to peak at $85 during its first week of trading before plunging 78% — opening December 27 at around $19 a share.
While the reasons I cited for avoiding this stock were valid, the biggest problem for investors remains Robinhood’s heavy dependence on crypto trading. With 7.04% of Robinhood’s shares sold short, I would continue to steer clear of this stock.
Robinhood’s Terrible Third Quarter Financial Report
In general, each quarter investors benefit if a company grows faster than Wall Street expects and raises its forecast above the consensus.
By that logic, it is no wonder Robinhood stock has fallen so much in the wake of its latest earnings report. According to CNBC, Robinhood stock fell after its third quarter revenue fell “way short of expectations on lighter crypto trading.” More specifically, Robinhood’s crypto revenue plunged 78% from the second quarter to $51 million in the September-ending quarter.
This took the wind out of Robinhood’s total revenue which rose 35% from the year before but at $365 million fell 18% short of the Refinitiv estimate.
Measures of customer activity were down from the previous quarter. How so?
- Net cumulative accounts dropped 4% to 22.4 million,
- Monthly active users fell 11% to 18.9 million; and
- Average revenue per user decreased by 36% to $65.
Robinhood’s net loss $2.06 was 50% worse than the Refinitiv estimate.
Robinhood issued a glum forecast. It told investors to look for “seasonal headwinds and lower retail trading” to be the big features in its results for the December 2021-ending quarter. It guided investors to expect revenue no greater than $325 million with 660,000 new accounts added, according to CNBC.
Robinhood was not perturbed by these results. Robinhood CFO Jason Warnick told CNBC, “Q2 was kind of one of those idiosyncratic market events where there’s this massive interest specifically in doge. We love it when those moments happen. It’s a great way to bring a lot of new customers onto the platform.”
Why I Argued To Avoid Robinhood’s IPO
Investors who are licking their wounds could have avoided the pain by resisting the urge to invest in Robinhood. In July, I cited three reasons to avoid the stock:
- Risk of a regulatory crackdown on its revenues — 81% of which came from routing orders to market makers. As I wrote, so-called payment for order flow — routing customers’ trades to trading firms — including Citadel Securities that accounted for 34% of its 2020 revenue — enables market makers to execute the trades and profit off the spread between the bid and the ask. SEC chair Gary Gensler has expressed concern that such payment for order flow could be a conflict of interest for Robinhood.
- Big fines paid after its dodgy treatment of users. I was bothered by the big gap between Robinhood’s values — such as “safety first” — and its actions. Robinhood paid a $57 million find plus $12.6 million interest to the Financial Industry Regulatory Authority (FINRA). According to Robinhood’s website, the company negligently communicated false and misleading information to its customers. I see its reputation for mistreating customers as a long-term threat to its growth.
- Uncertain sources of future revenue growth. Robinhood clearly hopes it can sell more to its existing customers. Hugh Tallents, a management consultant who surveyed more than 1,000 brokerage account customers told Barron’s that the average Robinhood customer keeps “play money” there and will not move their financial life to a company that he said has been “mired in scandal for a long-time.” The decline in third quarter customer activity suggests that cross-selling is a dream that may be difficult to achieve.
Where Robinhood Stock Is Headed
While things look gloomy for Robinhood investors, its relatively low stock price means it could benefit from faster-than-expected growth.
Sadly. meaningful revenue growth from new offerings is hard to envision. Nonetheless, the Wall Street Journal sees “big opportunity to turn newbies into fully-fledged trading, banking, crypto and retirement customers.”
Specifically, the Journal wrote that 25% of funded accounts — or 5.5 million customers now use Robinhood’s cash management product; over a million people have signed up for its yet-to-be delivered crypto wallet, and “Robinhood also plans to offer tax-advantaged retirement accounts in the future,” noted the Journal.
Sadly for Robinhood, its initially compelling offer of fee-free stock and ETF trading has been easy for better-established rivals to replicate. As TheStreet.com pointed out, Charles Schwab and Fidelity have followed suit. And they are massive institutions that offer customers more investment products.
The result is that Robinhood is a relative pipsqueak when it comes to assets under management (AUM). As TheStreet.com pointed out, Schwab’s AUM per customer are 75 times more than Robinhood’s $4,000.
Schwab’s reputation has earned it those higher account balances. While Robinhood could change its conduct to reinforce the noble values inherent in its name, I doubt that will happen under its current management.
I see two possible factors that could boost Robinhood’s stock: a return to booming cryptocurrency trading volumes and the possibility that its shares could drop so much that a larger institution would acquire the company.