Robinhood Markets, the controversial online brokerage that popularized free stock trades, finally filed its IPO paperwork on July 1. It hasn't set a date for its public debut yet, but it plans to "democratize" the process by offering 20%-35% of its IPO shares directly to its own users.
Some investors likely balk at the notion of investing in Robinhood after its missteps earlier this year. The platform limited trades in hot "meme stocks" like GameStop (GME -3.94%) during the Reddit-fueled short squeeze in late January, which sparked allegations of outside interference from its private backers.
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The debacle also highlighted the fact that Robinhood's "free" trades were actually funded by selling its order flows to market makers and high-frequency trading (HFT) firms. So instead of buying stocks on a public exchange, Robinhood sells orders to firms that profit from the bid-ask spread.
Robinhood isn't the only brokerage to use this model, but its starring role in the meme stock madness, its gamification of stock trades, and a user's suicide related to a complex options trade last June all caused investors, analysts, and regulators to turn against the platform.
Those headwinds might make Robinhood seem like a terrible IPO to invest in. However, I believe it's still more promising than many other recent tech IPOs -- and I'd be willing to buy it, for four simple reasons.
1. It's disruptive
At the end of March, Robinhood's number of funded accounts soared 150% year-over-year and 44% quarter-over-quarter to 18 million. Its monthly active users (MAUs) jumped 106% year-over-year and 51% quarter-over-quarter to 17.7 million , which suggests most of its users are actively trading stocks instead of passively holding them.
Most of Robinhood's users are Gen Zers and Millennials. At the end of March, roughly 70% of its AUC (assets under custody) came from users between the ages of 18 to 40, with a median age of just 31. At the end of 2020, it tripled its number of female users year-over-year.
Those numbers strongly indicate Robinhood is becoming the default trading app for younger and first-time investors. That disruptive potential is tough to ignore, and should alarm traditional brokerages.
2. It's growing like a weed
Robinhood's revenue skyrocketed 245% to $958.8 million in 2020. Three-quarters of that total came from transaction-based revenue, including its aforementioned payments for order flows (PFOF). The rest mainly came from interest payments on its margin loans and security lending, as well as subscription fees for its premium tier, Robinhood Gold.
Robinhood's transaction-based revenue soared 322% during the year, while its interest-based revenue increased 151%. Its average revenue per user (ARPU) rose 66% to $108.9. It also squeezed out a net profit of $7.4 million, compared to a loss of $106.6 million in 2019.
In the first quarter of 2021, its revenue jumped 303% year-over-year to $522.2 million, as its transaction and interest revenues rose 340% and 160%, respectively. Its ARPU rose 65% year-over-year to $137.
But it also incurred a net loss of $1.44 billion, compared to a loss of $52.5 million a year earlier, due to an increase in the fair value of its convertible notes and warrant liabilities. A large portion of those charges were related to new convertible notes it issued after the January short squeeze to stay solvent.
But excluding those charges and other one-time charges, it generated a positive adjusted EBITDA of $115 million during the quarter, compared to a loss of $47 million a year ago.
3. It's a cryptocurrency play
Robinhood also offers free cryptocurrency trades. Its cryptocurrency AUC rose from $414.7 million in 2019 to $3.53 billion in 2020, and skyrocketed to $11.6 billion in the first quarter of 2021.
During the first quarter, it generated 17% of its total revenue from cryptocurrency transactions, compared to just 4% in the fourth quarter of 2020. More than a third of that revenue came from Dogecoin (DOGE -1.34%), one of its seven supported cryptocurrencies.
Robinhood's growing dependence on cryptocurrencies, particularly newer ones like Dogecoin, could be a double-edged sword. However, it also makes Robinhood a more diverse and exciting cryptocurrency play than Square (SQ 1.68%), which only backs Bitcoin (BTC 0.40%), and a safer cryptocurrency play than Coinbase (COIN 7.04%), which relies entirely on the volatile cryptocurrency market.
4. The controversies will fade away
Robinhood is experiencing lots of growing pains. It was recently fined $70 million by FINRA (the Financial Industry Regulatory Authority) over its inability to fill customers' orders during the Reddit-fueled trading frenzy and other shortcomings, and it faces additional lawsuits and potential regulations.
However, I believe Robinhood can eventually overcome these challenges. If it does, its reputation for "democratizing" finance, simplifying investing, and disrupting traditional financial institutions could shine through, and make it one of the market's most exciting fintech stocks.
The key takeaways
I'm not saying I'll buy Robinhood's IPO right away. If its initial valuation is too rich, I'll wait for a pullback before nibbling on some shares. But it could still be the most exciting tech IPO of July if it arrives within the next two weeks -- and investors who focus on its fundamentals instead of its controversies might just realize it's a great long-term investment.
