Robinhood filing shows huge growth in controversial revenue stream
Robinhood had a tumultuous first quarter that led its CEO to testify before Congress, but it is becoming clear that it was also an extremely lucrative time for the company.
A federal securities deposit shows that Robinhood was paid $ 331 million by market makers who executed stock and option orders for the broker’s clients in the first quarter, when the
the frenzy took hold of the market. This is an increase from the $ 91 million in the first quarter of 2020.
This type of income, known as payment for order flow, has become a more important way for brokers to make money now that they no longer charge commissions on every trade. Robinhood does not publish all of its income or expense figures, so deposits are the clearest window into its operations. They show Robinhood is on track to generate over $ 1 billion in revenue this year and possibly over $ 2 billion if that level of activity continues.
That said, most other brokers expect business activity to slow in the second half of the year as Covid-19 declines in the developed world and economies open up more. “All brokers are predicting that the current peak in trading is unsustainable,” said Pauline Bell, CFRA analyst.
The securities filing shows that while trading activity remained high throughout the quarter, it fell in March after peaking in February. In February, the order flow payment was $ 121 million, up from $ 97 million in March.
A trade slowdown could dampen Robinhood’s growth rate and force it to find new ways to make money. The company has already confidentially filed for an initial public offering. It is expected to start trading in the second quarter if regulators give it the green light.
A portion of the convertible debt that the company sold can be converted into equity at a valuation of $ 30 billion. A startup with $ 2 billion in revenue and a path to strong profits could potentially meet or exceed this valuation in today’s market. But one that relies too much on a feverish trading environment could falter if trade slows for the rest of the year.
“The $ 40 billion question is whether the volume will go down,” Bell said, referring to a valuation of up to $ 40 billion for Robinhood.
Robinhood was in the spotlight in the first quarter as users flocked to the platform to bet on GameStop (ticker: GME) and other social media-driven stocks. He closed trading in some stocks because he faced additional capital calls from his clearing house. Users criticized the move for stalling the GameStop rally and costing them money, and leading investors like Mark Cuban have encouraged new traders to look elsewhere for better capitalized brokers. CEO Vlad Tenev testified before Congress to explain that the company had no choice but to temporarily shut down.
But not all of the turmoil seemed to hurt the business much. Its app has been downloaded millions of times during the GameStop Frenzy. “To them, it seems like there is no bad press,” Bell said.
However, payment for the order flow is under closer scrutiny and “bad press” could plague Robinhood. Basically, Robinhood routes its orders to high frequency trading companies that match buyers and sellers and profit from the spread between the buy and sell price. Market makers then reimburse a portion of this spread to the broker.
The practice is legal, but it has become controversial because the “cost” to the client is not as straightforward as it was when brokers were charging fees for commissions. That said, clients probably get better deals under the current system than when they paid commissions every time they bought a stock. Brokers are supposed to get the best possible price on a trade, and they say they get better prices for clients than they would get by going directly to an exchange to trade.
Payment for order flow is also controversial as it provides an incentive for brokers to encourage active trading. Clients who hold stocks for months are not as lucrative for Robinhood as those who do dozens of trades per month, earning brokerage commissions with every trade. Studies have shown that novice traders who actively buy and sell tend to lag behind the market. Critics say Robinhood uses visual cues in its app to encourage active trading, to the detriment of its user base.
Warren Buffett said over the weekend that what Robinhood is doing is not illegal or even immoral, but that they “take advantage of the gambling instincts of society, and that is not admirable”.
Robinhood responded that it does not encourage trading and that most of its users buy and hold for the long term. The company jumped at Buffett’s statement, arguing that the critics of the company are just wealthy people who don’t want outsiders to take advantage of the market. Robinhood same post a blog post in response, saying that “people are fed up with the Warren Buffetts and Charlie Mungers of the world acting like they’re the only investment oracles.”
Whether or not the payment for the flow of orders ends up attracting more attention from Congress or regulators, it could potentially pose a business problem for Robinhood. The company said it makes more than half of its money from order flow payment, far more than brokers like
(SCHW), which makes a higher percentage on other activities, such as lending customer deposits.
Some analysts estimate Robinhood’s number to be well over 50%. Bell, for example, estimates the number to be closer to 70-75%, although this is down from its previous call of 80%.
Using these assumptions, it is possible to derive a rough estimate of Robinhood’s revenue, although it is important to note what is not covered by the disclosures of payments for the order flow. The deposit does not include crypto trading, while Robinhood makes money from crypto trading in the same way that he profits from stock trading. The company said 9.5 million customers traded cryptos on Robinhood Crypto in the first quarter of 2021, up from 1.7 million in the fourth quarter of 2020. Even excluding cryptos, Robinhood likely made more than $ 400 million in the past. first trimester, after including money. made from enhanced services like Robinhood Gold.
The question now is whether the company can maintain this pace while improving services and revenue streams. With the IPO likely just around the corner, Wall Street will soon have an opportunity to bet on the company’s odds.
Write to Avi Salzman at [email protected]