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Will This IPO Be the Ultimate Reddit Stock?

By Jamal Carnette, CFA - Feb 26, 2021 at 11:38AM

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Hint: Wall Street Bets uses it...but will they buy the stock?

The financial story of the year did not start in lower Manhattan or in the wealthy enclaves of Greenwich Connecticut, but rather on Wall Street Bets-a NSFW chatroom on Reddit. The on-again, off-again meme stock trading frenzy has captured the attention of retail investors, Wall Street, and even Washington politicians.

That's understandable, as many young investors have gotten rich investing in these stocks. De facto GameStop leader Keith Gill, aka Roaring Kitty, posted he made $7.8 million from the stock...and the stock has nearly tripled since then!

It's unlikely the GameStop saga would have occurred without Robinhood as the brokerage's screenshots have become ubiquitous on Wall Street Bets. Still, the company faces a host of high-profile skeptics like Berkshire Hathaway's Charlie Munger and even from users due to its actions during the trading frenzy.

Despite the recent negative press, all intentions are the company's IPO is still on track and user growth is stronger than ever. Here's the bull and bear case for Robinhood stock before it goes public.

Sign the has a hashtag and the acronym "YOLO"

Image source: Getty Images

Robinhood has a strong bull case

Robinhood started with an audacious goal to democratize finance and it appears to be succeeding. Citadel Securities found retail traders accounted for nearly a quarter of stock market activity during pandemic-related trading, up from 10% a decade ago. Nearly 13 million retail traders are doing so on Robinhood with more than $20 billion in assets under management.

Even better, it is estimated nearly 80% of all Robinhood users are under the age of 35, a demographic that has been traditionally difficult for financial service providers to reach but are in the firmly in their earning and saving prime versus the Baby Boomer cohort that are in the spend and asset-transfer part of their financial lifecycle.

If Robinhood can maintain these relationships as this demographic begins to seriously plan their financial future, opportunities for further monetization from additional products and services will soon follow.

Risks abound and should be monitored

Like all stocks, Robinhood has risks. Particularly noteworthy for the trading site is reputation and regulatory risk, most notably due to its reliance on payment for order flow (PFOF). PFOF will vary over time, but it is estimated anywhere from 40% to 50% of Robinhood's total revenue was from PFOF.

It's no denying Robinhood suffered reputational harm when it was revealed Citadel Securities was the main buyer of Robinhood's order flow and took a position in a hedge fund shorting Reddit favorite GameStop. A Fortune poll found 56% of Robinhood users stated they were considering leaving the app.

Robinhood's value proposition in this highly competitive industry was predicated upon the fact it offered commission-free trades to investors, which was only possible due to the PFOF arrangement, along with a low-cost structure where it spends less than competitors on features like customer support and services like education.

The PFOF model appears to be under scrutiny. Robinhood was fined $65 million from the SEC related to this arrangement, which the enforcement agency noting "unusually high payment for order flow rates" and "inferior trade prices." At the same time, competitors have slashed equity commissions to zero, which negates Robinhood's key value factor, while offering more robust customer support, products, and educational content.

If the GameStop congressional hearing is of any indication, look for more scrutiny. It's apparent Robinhood is Washington's crosshairs for the time being and it won't take an outright ban on PFOF to hurt its business model and competitive positioning.

Final take

Robinhood is a high-growth company that is succeeding with a key demographic. However, finance is a highly regulated industry and any changes to its PFOF revenue could significantly imperil the stock's business model.

 

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Stocks Mentioned

Berkshire Hathaway Inc. Stock Quote
Berkshire Hathaway Inc.
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