Robinhood Markets' (HOOD) July debut as a public company marked the height of growth. The initial public offering's hype was fueled by meme stocks and Dogecoin account openings paired with frenetic options and crypto trading. However, reality has set in, and this episodic trading activity has fallen off dramatically.
Even so, Robinhood's shares are hovering only a few points below the $38 IPO price even though a recent earnings disappointment cut growth projections significantly. The stock, still valued as a high-growth disruptor, will likely see revenues decline in the first half of 2022.
Third-quarter revenue fell considerably, coming in at $365 million vs. Wall Street expectations of $425 million and down sequentially from $565 million. Guidance for the current quarter is even lower, "no greater than $325 million." The current run rate of revenues, extrapolating from this past quarter, has the unprofitable company trading at 20x sales with a market cap of $30 billion, almost one-third of its client's assets of $95 billion.
The market may be forgiving to the stock price due to the small float of publicly traded shares, a dynamic soon to change. On Dec. 1 the float will increase substantially as about 569 million shares become free to trade from a lock-up expiration. Although the unlock date is well-telegraphed, the stock doesn't seem adequately discounted to absorb the potential deluge of shares that can come to market. A smaller expiration on Wednesday of only 49 million shares helped push the stock lower by 6%.
The relatively small float has allowed one institutional buyer, ARK Invest, to dominate the tape. It has accumulated close to $100 million of the stock since earnings and now own more than $500 million of Robinhood shares.
Even after revenue missed expectations by more than 15%, many analysts remain bullish. J.P. Morgan stands alone as the only firm with an underperform rating, along with a $26 target. It notes that a business model based on serving small accounts for transaction-based revenue only works when activity levels are elevated, but is one that "other brokers have determined is volatile and valued less than recurring and predictable fee-based revenue driven by customer assets." This key observation leaves open the question of why Robinhood's premium valuation has stayed intact. It's clear that strong markets alone are not a driver of revenues; episodic high activity trading is needed, which Wall Street can easily dismiss as a one-off.
Last quarter, Robinhood's crypto revenue was down 78%. Investors can hope the company capitalizes on the next viral coin trading frenzy since Dogecoin trading composed a sizable percent of crypto revenue. However, Robinhood's management seems restrained, unwilling to approve new coins owing to the regulatory risks of allowing customers access to various crypto assets.
Securities and Exchange Commission Chairman Gary Gensler has brought new scrutiny to Robinhood's business model. Any regulatory change in how payment for order flow works would disproportionately hurt Robinhood's revenues due to its heavy reliance on this practice. A recent $70 million fine imposed on Robinhood by the Financial Industry Regulatory Authority (FINRA) for various violations, plus a hack of one-third of its users, will also add to regulatory supervision aside from the potential reputational damage.
Customer acquisition costs have been minimal for Robinhood, benefiting from word-of-mouth and ease of customer onboarding. Yet the path forward for customer growth may be more difficult as aggressive upstarts such as SoFi (SOFI) tread into Robinhood's territory with a more expansive suite of offerings. Although Robinhood has touted recent IPO access for customers, in the latest hot IPO only SoFi obtained an allocation of Rivian Automotive (RIVN) shares exclusively for retail (read my column on Rivian here).
Robinhood undoubtedly will evolve to find new sources of revenue. A crypto wallet is in the works, and the company has aspirations to leverage its customer base to create a financial hub. But the company will probably need years of product enhancements to gain traction to diversify away from a transaction-based business model. In the interim, growth will be idiosyncratic -- event-driven and hard to predict quarter to quarter. Investors may wear thin of the stock due to the hard-to-grasp valuation, lack of profitability and uncertain monetization drivers.
In weeks to come, expect an overhang in Robinhood's stock when shares become free to trade. With the growth outlook vastly diminished and a regulatory cloud over the business model, the stock looks far overpriced at a valuation hard to defend.
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