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Robinhood takes E*Trade lessons almost to heart

5 minute read

The Robinhood App is displayed on a screen in this photo illustration January 29, 2021. REUTERS/Brendan McDermid/Illustration

NEW YORK, July 23 (Reuters Breakingviews) - Robinhood Markets has made playing the stock markets easy. Pinpointing the digital broker’s own value is anything but. Next week Robinhood will sell shares to investors in an initial public offering that puts its price tag at $33 billion. The problem is that Robinhood’s business, and valuation, is jacked up by the speculative fervor of the moment, which may not last. Investors have seen this tale before.

Predicting Robinhood’s future is hard because it has grown dramatically and suddenly, driven by an explosion of disposable income and speculation by retail investors, many of them first-timers who were cooped up by Covid-19. As the company’s customer accounts doubled to 22.5 million over the past year and punters loaded up on everything from GameStop (GME.N) shares to Dogecoin, its revenue almost tripled, hitting $1.7 billion in the 12 months to June 30.

The first question for a would-be Robinhood owner is how much that top line can continue to grow. Robinhood’s own underwriter Goldman Sachs (GS.N) offers one answer. In a presentation for a deal involving rival eToro in March, the Wall Street bank presented data suggesting “high-growth fintech” firms were on track to expand revenue by 35% annually over the next couple of years. By that logic, the online prodigy founded by Vlad Tenev might have $3 billion in revenue by 2023.

Next comes the question of how to value that income stream. With slower-growing brokerages like Interactive Brokers (IBKR.O) trading at around 13 times their estimated revenue a couple of years from now, the $33 billion valuation looks reasonable. Look instead at Lemonade (LMND.N), an app that does for insurance what Tenev has done for stock trading and is valued at more than 20 times, and Robinhood’s valuation looks modest by today’s standards.

But what about tomorrow’s? If the future rhymes with the past, Robinhood investors might be in for a shock. With valuations elevated across the board, the company is a double bet on continued stock-market exuberance.

A similar problem befell dot-com-era forebear E*Trade Financial. Back in the late 1990s, E*Trade threw the staid world of investing into disarray by making online trading accessible to all. Its revenue doubled year after year; a Super Bowl ad in 2000 centered on the charmless refrain “he’s got money coming out the wazoo!” At its peak in early 1999, E*Trade was valued at more than 30 times its estimated sales, according to Datastream.

E*Trade did indeed change stock trading, just as Robinhood has. Both have left customers with money coming out the wazoo. But E*Trade’s valuation fell precipitously when the market turned. Not only did its number of average daily trades almost halve between 2000 and 2002, but investors also started valuing the company’s profit more conservatively, even though revenue kept growing.

Meanwhile, competition bit: The commissions E*Trade made from share trades fell from around $20 in the mid-1990s to $11 by 2003. E*Trade sold itself to Morgan Stanley (MS.N) in 2020 for five times its forecast sales, at a $13 billion price slightly below its value back in 1999, according to Datastream. In a historical echo, it was Ken Griffin’s Citadel, whose market-making affiliate Citadel Securities provides a third of Robinhood’s revenue, that bailed out E*Trade in 2007 after a bad bet on subprime mortgages, and later grumbled that the company had “squandered” a phenomenal franchise.

The three threats of falling markets, declining revenue per customer trade and heightened competition could be pointed at Robinhood in due course too. True, Robinhood has some attributes E*Trade didn’t. Its success lies partly in clever shepherding of users through smart design and game-like interactivity – skills that it could apply to other areas of personal finance when stock-trading mania subsides. The asset-light Robinhood is unlikely to follow E*Trade’s foray into traditional banking and mortgages.

On the other hand, Tenev’s firm faces some new pitfalls of its own making. Its IPO filing details a plethora of lawsuits and regulatory investigations. And the armies of irascible online forum-going investors who have pumped up shares on its platform – and complained when it had to halt trading of some so-called meme stocks – are unlike anything E*Trade contended with. Even if Robinhood’s future doesn’t resemble E*Trade’s past, its debut valuation might not be so conservative after all.

Follow @johnsfoley on Twitter

CONTEXT NEWS

- Robinhood Markets expects to price its shares between $38 and $42 in its initial public offering, giving it a valuation at the midpoint of that range of $33 billion. The price is likely to be set on July 28, and the stock would start trading the following day.

- The digital brokerage estimated its revenue for the second quarter of 2021 would be around $560 million, roughly double the level of a year earlier, with around $81 million of EBITDA.

- Robinhood has benefited from a surge in retail stock trading, and the performance of some specific stocks and cryptocurrencies popular with its 22.5 million account holders. The firm’s total client assets hit $102 billion at the end of June, it estimated in a July 19 filing, compared with $33 billion a year earlier.

(This item has been corrected in the eighth paragraph to distinguish between Ken Griffin’s hedge fund Citadel and its affiliated market maker Citadel Securities.)

Editing by Rob Cox and Amanda Gomez

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