(Note: This story has been updated to correctly identify Robinhood’s clearing firm. It is Citadel Securities.)
When the stock market bubble burst in 2022, Robinhood HOOD was one of the hardest-hit companies, dropping almost 90% from its all-time highs. The most obvious reason was that Robinhood was a newly IPOed company and deeply unprofitable. The rise in interest rates and the overall sentiment against growth stocks were a major turn-off to panicked investors. Moreover, its fundamental business model seemed on the verge of collapse. Today, however, having recently achieved its first profitable quarter, could Robinhood be in position for a turnaround?
Historically, Robinhood’s revenue is almost entirely payment for order flow. The saying that there is no such thing as a free lunch is very much true for Robinhood. In order to offer commission-free trading and remain a viable business, Robinhood routes orders to market makers and receives a small commission from those companies (the major one being Citadel Securities).
The trouble with this model is that it comes with what can only be described as a huge conflict of interest; its own best interests are diametrically opposed to its customers’. Robinhood needs its users to trade at large volumes to stay profitable. But retail investors — often unsophisticated — are statistically shown to obtain worse results when trading more. It’s no surprise then that most Robinhood users are losing money. And those who chased speculative stocks, as was common among Robinhood’s user base, did terribly in 2022, with many watching their balances fall to zero.
As a result, MAU (monthly active users) declined over 40% since their peak and never recovered. With retail investors bearing heavy losses, trading volume might take years to come back. Moreover, because of the predatory nature of payment order flow, the SEC is even considering an outright ban on the practice, making it critical for Robinhood to quickly find other ways to capitalize on its brand and community, and diversify its revenue streams.
Retirement to The Rescue?
In the past year, Robinhood has been significantly expanding its retirement account business. The company recognizes that many young people — gig workers, freelancers, often between jobs — lack corporate retirement plans. It appears to have been a good call: Since launching the product in January, Robinhood has already accumulated over $1 billion in retirement assets, which account holders then invest. The company offers a contribution match that bears a penalty for early withdrawal.
As a whole, Robinhood’s financials are dramatically improving. Driven by rising rates, the company’s income from loans to margin traders now makes up over 50% of Robinhood’s revenue. With many observers now speculating that interest rates will remain high for an extended time period, Robinhood is in a more sustainable position.
Due to the growing interest income and prudent cost-cutting, the company reported $25 million in net income in the last quarter. Revenue is returning to its pandemic highs, even with reduced expenses. With management’s focus on profitability, the stock could be a reliable generator of free cash flow while still achieving impressive growth by catering to the needs of new generations.
Robinhood has certainly made a remarkable transition in its business model. With a price-to-sales ratio of in the 5x range — many times lower than its high of 21.61x — the stock clearly has room to grow. At the same, with investor perceptions still broadly negative, now might be the time to take a second look.
