Robinhood is going public – should you invest?

Online stockbroking app Robinhood is going public, but it may already be bracing itself for a lacklustre start.

Robinhood is due to trade later today under the symbol “HOOD” on the Nasdaq exchange, marking the seventh biggest public listing (also known as an initial public offering, or IPO) to take place on a US exchange in 2021. It is looking to raise $2.1bn.

On Wednesday the company sold 55 million shares at $38 each. That is at the low end of the range of $38-$42 it was targeting, and gives it a market valuation of around $33bn

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It is clear from the price Robinhood opted for that investors are probably not scrambling to buy into the company. But, as Bloomberg puts it: “a lower price in the IPO could allow more room for the “first-day pop” craved by investors when the stock begins trading Thursday.”

Robinhood’s co-founders, Vlad Tenev (who is also the firm’s chief executive and creative officer) and Baiju Bhatt will between them hold most of the voter power and rights in the company.

But what is Robinhood?

Robinhood was set up in 2013 and is a middle man, a broker-dealer which allows private investors to buy and sell shares. But it is a unique middle-man: it is backed by the US Securities and Exchange Commission and by FINRA, which is part of the Securities Investor Protection Corporation.

It revolutionised the brokerage industry and gave birth to mobile share trading, making it much more convenient, particularly for amateur investors, to purchase derivatives, something which was difficult until a few years ago.

It also pioneered the zero-fee business model. Normally, broker-dealers earn money by setting a commission in the form of direct fees to customers. This often deterred investors from buying stocks, but Robinhood’s business model – known as “payment for order flow” (PFOF) – allowed Robinhood to make money by charging market makers in return for directing customers’ trades to their trading desks. This paved the way for other brokerages to embrace the business model and slash fees.

The zero-feel model has helped several day-traders enter the market and is at the heart of the retail market frenzy that started last year as amateur investors – many using their government stimulus cheques – flocked to the app to make money during heights of market volatility, punting on “meme” stocks such as GameStop.

But the company was criticised during the meme stock frenzy earlier in January this year, when several retail investors came together on forums such as “wallstreetbets” on the social media platform Reddit.

The flurry in trading in those meme stocks triggered higher deposit limits at its clearing house. This led to a ten times higher deposit requirement for the broker’s equities trading.

Robinhood had to get emergency funding and put curbs on a number of volatile stocks.

Robinhood was then forced to raise billions of dollars from its backers to prevent liquidity problems.

Another sore spot relating to that episode was the fact Robinhood blocked the purchases of stocks such as AMC, Gamestop and others just after the Reddit-sparked rallies. It told its clients they would still be able to close out positions in many of these volatile stocks but could not buy any additional stocks. Robinhood’s critics said this amounted to market manipulation.

But despite the negative publicity, Robinhood remains a strong growth stock, and has raised $5.6bn via 23 separate funding rounds since it was founded, according to Crunchbase.

For retail investors, Robinhood’s IPO may be particularly attractive as it is making just over a third of its shares available to buy directly through the app. This is rare for IPOs, which normally put aside reserve shares for institutional buyers.

So should you invest?

Forbes doesn’t recommend it, and says: “With its rapid growth slowing down, investors should be concerned about talk of a regulatory crackdown on major components of its revenue.”

The SEC is also exploring the trade in meme cryptocurrency dogecoin, which has risen by almost 6000% in the last year without any fundamental reason or value. Depending on the outcome, it could hurt Robinhood because of its reliance on cryptocurrency revenue as dogecoin alone accounts for 6% of Robinhood’s revenue, reports CNBC.

Robinhood is also prone to further regulations on its PFOF revenue model. While it accounted for 81% of Robinhood’s revenue in the past quarter, SEC Chairman Gary Gensler is scrutinising the model due to potential conflict it poses to brokers.

It also still faces 50 class action legal cases from the GameStop saga, 15 cases from application outages in March of last year as well as cases stemming from its PFOF model.

So if your risk appetite is big, then by all means invest in Robinhood. But as The Motley Fool puts it, while it remains uncertain how badly these lawsuits could harm Robinhood, “they do add another layer of risk to anyone thinking of investing in the company”.