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Saturday, November 26, 2022
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‘Little guy’ may feel sharp pain from Robinhood’s IPO arrow

The people at Robinhood made IPO history this past week when they reserved an unheard-of chunk of its initial public offering, around 35 percent, for the trading app’s small-investor clients.  

And if you’ve been listening to company honchos and its soon-to-be mega-rich CEO Vlad Tenev, this is what “democratizing” Wall Street is all about — letting its clients, the littlest of the little-guy investors, cash in on a hot IPO like those big, nasty hedge funds have been doing for decades.

Power to the people, right? I’m not so sure. In fact, there’s a strong counternarrative bouncing around Wall Street circles that Vlad’s supposed noblesse oblige is anything but — and yet another example of when something looks too good to be true, it usually is. 

Tenev positions himself as a fellow following in the footsteps of his company’s namesake, stealing from those rich Wall Street-types, and giving stuff to us poors, even as he’s setting himself up to be the latest 30-something billionaire tapping into the high-finance wealth machine. 

He created Robinhood eight years ago as a way for average people to trade easily and seamlessly just like the big guys on Wall Street, and with no commission. The company became a cultural touchstone during the pandemic lockdowns, when many people had nothing better to do with their time than trade stocks.

What his loyal customers might not fully appreciate is that they trade for free only because the firm sells client trades to brokers who then match the buyers and sellers, a practice known as “payment for order flow.” 

Nothing illegal about that (at least not yet), nor immoral, in my opinion. But let’s drop the sanctimonious BS: This “empowering the little guy” is doing a lot to enrich Wall Street’s ruling class.

Once you get past the myth of Robinhood’s eleemosynary foundations, you can see that the IPO stunt is hardly the stuff that democratization is made of. 

Most IPOs want shares to be placed with large institutional investors that hold them for the long haul. They are diversified mutual funds, and asset managers that can withstand the vicissitudes of any nascent company’s fortunes that play out in hopefully rising share prices over a period of time, usually years.

But Robinhood isn’t getting a lot of interest from those investors, I hear. The big asset-management firms are not Robinhood’s customers, and have no allegiance to the product. They’re looking hard at potential user growth during market downturns, and regulatory risks. 

While the Robinhood trading-app exponentially grew from thousands of “little guys” playing around with meme stocks like GameStop, its business model is not sustainable at all.
While the Robinhood trading-app exponentially grew from thousands of “little guys” playing around with meme stocks like GameStop, its business model is not sustainable at all.
Christopher Sadowski

And I am told they didn’t like what they saw. Many were so skeptical about the business model that they decided they wouldn’t participate in the offering and might just short shares, betting they can make money when the shares fall in price as they did Thursday, dipping below the $38 IPO point.

As one large institutional investor told me, “Robinhood’s business model is mezzo morto.” (Translation: Half dead.) 

So Tenev makes a good show of giving his shares to the “little guy,” when the little guy probably didn’t have much of a choice. 

To become profitable, Robinhood needs retail trading to grow exponentially like it did during pandemic lockdowns. Its competitors, discount brokers like Charles Schwab, E*Trade, etc., are extremely profitable. A big reason why is they have commercial banks and other lines of business that allow them to make money under more adverse market conditions. 

Something simple like the Fed having to start raising interest rates because of non-transitory inflation will hurt Robinhood’s growth. The minute the Fed moves rates higher, it’s likely you can kiss goodbye to much of the meme-stock and crypto trading that is behind Robinhood’s amazing 200 percent surge in user growth in just the past several years (18 million customers at last count compared to just 6 million at the end of 2018).

To be fair, during the company’s road show, executives furtively conceded (in between a fair amount of chest pounding about customer growth, etc.) that they are open to making changes as soon as the IPO is complete. They seemed to acknowledge that they need to rely less on payment for order flow, which accounts for around 75 percent of the company’s revenues, because, after all, Gary Gensler, chair of the Securities and Exchange Commission, isn’t a big fan of the practice. 

So maybe Robinhood will at some point diversify its way into profitability and into large investors’ good graces. Robinhood executives have strongly hinted that they, too, could get into the payment-for-order-flow business by matching their own orders and skimming the difference in the bid-ask spread on stocks the way other market makers do. 

Robinhood could also use some of that $2 billion in IPO cash to buy a bank, a business that generally makes money when interest rates rise (and markets tumble) because banks charge more when they lend and are slow to raise rates on savings and checking accounts.

Lots of maybes for a company pushing the narrative that it’s poised for tremendous overnight growth while democratizing Wall Street.


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