How Robinhood’s fairy tale started to unravel

Few companies embodied the market mania of the past two years quite like Robinhood.

The flashy online brokerage ushered in an investing revolution at the start of the Covid-19 pandemic that, for the first time in decades, made trading cool. Robinhood’s easy-to-use interface hooked millions of Americans on buying and selling stocks, options and cryptocurrencies. A raging bull market helped turn many newbie investors’ trades into wins.

Good times for customers meant good times for Robinhood. The more customers traded, the more revenue Robinhood raked in. By last summer, it boasted more than 22 million funded customer accounts, had opened offices around the country and was preparing for an initial public offering of its stock.

Then the party ended.

In the span of less than a year, Robinhood has seen many of its successes fade. Its monthly active user count dropped 25% in the first quarter from last year’s quarterly peak, while revenue fell even faster, down 47%. Its stock this week fell to a record low and is trading 81% below its July IPO price. The company has shifted its focus from rapid growth to cost-cutting, laying off 9% of its staff earlier this year.

Robinhood has also found itself on a collision course with regulators after Securities and Exchange Commission chair Gary Gensler last week outlined a revamp of trading rules that could threaten part of its business model.

READ UK crackdown on risky trading threatens meme-stock platforms

“You had a perfect storm that fuelled the rise and attention around Robinhood,” said Paul Rowady, director of research for Alphacution Research Conservatory, a market research and advisory firm. Now, he said, “You’ve had the opposite occur over the past year.”

Few on Wall Street expected the boom times at brokerages to last forever. But Robinhood has been hit harder than most. Current and former employees, customers and analysts said the forces that built Robinhood — most notably, a flourishing bull market and investors’ delight in speculative trading — are the ones that now threaten its core business as stocks and cryptocurrencies decline. Where, some said, does Robinhood go from here?

‘Insane growth’

Robinhood chief brokerage officer Steve Quirk said in an interview that the company’s explosive growth in 2020 and 2021 had consumed many resources that otherwise would have been invested in longer-term projects, but it had a “healthy” pipeline of new product launches in the works. The company this year has extended pre- and post-market trading hours and launched products including a new debit card, while executives have said Robinhood is working on adding new retirement accounts. Those kinds of features, Quirk said, will allow Robinhood to grow with existing customers and generate revenues.

“How can we build for our customers and in doing so, make us a more evenly distributed revenue firm?” he said.

Millions of Americans flocked to Robinhood to try their hands at navigating the market volatility at the onset of the Covid-19 pandemic. They relished in trading securities both big and small, on fundamentals and just for fun. Later, users chased meme stocks like GameStop and AMC higher and binged on bullish options bets. Robinhood users’ embrace of dogecoin, a cryptocurrency started as a joke, was so fervent that it briefly crashed the brokerage’s app last year.

Robinhood makes the bulk of its revenue by sending its customers’ orders for stocks, options and crypto to high-speed trading firms that pay for the right to execute them. The practice, known as payment for order flow, makes it possible for brokers to let their customers buy and sell stocks without paying commissions, a feature Robinhood pioneered before it was imitated by others. Robinhood came to rely more heavily on that revenue than other brokers.

Capturing those small payments from high-speed trading firms on millions of customer orders started to add up. By the second quarter of last year — Robinhood’s best, according to public filings — it reported $565m in revenue — 80% of which came from routing customers’ stock, options and crypto orders. The company booked nearly $145m in revenue tied to dogecoin trading in last year’s second quarter, roughly 25% of its total revenue that period and more than what it made from stock trading.

Robinhood also ramped up hiring to keep up with demand. “It just felt like everyone’s job was to keep the ship running,” said Josh Cockrell, a former software engineer at Robinhood who said he left the company earlier this year. “It was just insane growth with customers and demands on the servers.”

Robinhood’s weekly all-hands meetings, led by co-founders Vlad Tenev and Baiju Bhatt and broadcast company wide, were often filled with charts showcasing the company’s growth. Teams would share progress on various projects using a “red,” “yellow,” and “green” colour system, according to some of the former employees, who said they relished surprise virtual visits from celebrities including Jared Leto and Ashton Kutcher.

Many employees also received generous stock compensation packages that would have produced a big payday had the stock soared after the IPO. Some gathered in New York City’s financial district on 29 July, 2021, the day Robinhood made its public debut. Tenev and Bhatt posed for pictures in front of a sign reading, “Welcome to the new Wall Street.”

READ Berkshire Hathaway’s Charlie Munger hits out at Robinhood again

Robinhood’s shares closed down more than 8% from its IPO price that day. It would be the first of many rough days for the stock.

Even before the recent selloff in markets, cracks in the company’s growth were starting to show. The number of new funded accounts and active users on the platform had spiked dramatically during meme stock and dogecoin rallies in the early part of 2021, but by the second half of last year the number of monthly active users started to drop as the speculative fervor in the markets slowed.

As Robinhood’s stock sagged, some of the former employees said they heard questions at all-hands meetings about whether Robinhood would roll out new product lines and what the plan was as growth slowed, according to people who attended these meetings. These people said they also heard Robinhood questioned at these meetings about why the company didn’t offer customers the ability to trade buzzier digital tokens such as Shiba Inu. Robinhood added Shiba Inu this April.

Quirk, Robinhood’s chief brokerage officer, said the company is moving forward with new ventures. This year, Robinhood has rolled out a feature that makes it easier for customers to transfer their digital currencies, as well as a new debit card that allows users to roundup transactions to the nearest dollar and use that additional money to invest. In April, Robinhood also unveiled an agreement to acquire Ziglu, a UK-based cryptoasset firm; the deal will allow Robinhood to expand internationally.

“By building out all these needs [for clients], there are revenues associated with those,” Quirk said.

On the company’s most recent earnings call in April, Robinhood’s chief executive said the company was “playing offence and charging ahead” while also paying more attention to expenses. At an all-hands meeting on 16 June, Tenev didn’t rule out the possibility of more layoffs, according to people briefed on the meeting.

Takeover talk

Some investors are still willing to make bets on Robinhood’s future. In May, one of the biggest names in cryptocurrencies unveiled a roughly $648m investment in Robinhood in exchange for 7.6% of the company’s Class A shares. That man, Sam Bankman-Fried, is the billionaire founder of cryptocurrency exchange FTX.

He said in an interview that the investment was mostly driven by the stock’s depressed valuation and his expectations that the company could rebound.

READ Robinhood stake acquired by FTX founder Sam Bankman-Fried

“There is a really plausible world in which it has a huge comeback,” he said, citing Robinhood’s potential to expand its menu of services and international reach.

He also said his company was also open to partnerships with Robinhood; FTX has been adding stock-trading capabilities to its popular app and Robinhood has been expanding its crypto offerings.

For months, market watchers have speculated that Robinhood could be a takeover target due to the change in the company’s fortunes and a more competitive industry. Rivals TD Ameritrade and E*Trade have already found new parent companies in Charles Schwab and Morgan Stanley, respectively.

Any outside investor, including Bankman-Fried, would have a tough time mounting an aggressive takeover bid for Robinhood or demanding changes to its business because of a dual-class share structure that gives the majority of voting control to Robinhood’s co-founders.

Quirk said Robinhood’s co-founders are dedicated to the company’s mission and committed to building the company with people internally.

New hurdles in DC

The company’s current regulatory headaches began with the same GameStop frenzy that lured millions of traders to Robinhood. After the surge in meme-stock trading, the SEC launched a yearlong review of the stock market’s plumbing, with a particular focus on the handling of individual investors’ trades.

Sending customer orders to high-speed trading firms — the way Robinhood makes most of its money — is controversial. Its critics, including Gensler, say the practice is riddled with conflicts of interest and has fuelled the dominance of a few big firms that handle the bulk of small investors’ orders. Robinhood has said that routing orders to high-speed traders benefits investors because it gives them better prices than they would get if their orders were sent to stock exchanges.

Last week the SEC chairman outlined a set of proposals that amount to a big shake-up of the current system. One of Gensler’s key ideas is to send investors’ orders to buy and sell stocks into auctions where firms compete to execute them. Other elements of the package involve reducing the minimum price increments of stocks on exchanges and mitigating the conflicts of interest posed by payment for order flow.

READ Robinhood shares fall on SEC’s warning of possible restrictions on payment for order flow

Quirk, the Robinhood executive, said it was too early to tell how the proposals would impact the company’s business. But analysts say the proposals could potentially curb the profits of market makers that execute Robinhood’s trades, leading them to reduce the payments they make for Robinhood’s order flow.

In the first three months of the year, 12% of Robinhood’s revenue came from selling order flow for stocks, the area covered by Gensler’s proposals. The SEC hasn’t indicated that it plans to review payment for order flow in options, a far bigger moneymaker for Robinhood.

Robinhood could find ways to make money even if the SEC limits payment for order flow. Jason Warnick, the company’s finance chief, has suggested that such a ban could spur Robinhood to “internalise” trades–matching buyers and sellers itself, rather than sending their orders to high-speed traders for execution.

Many analysts and executives at brokerages and trading firms expect Gensler’s proposals to be challenged in court. They argue that the stock market works well for small investors and the overhaul isn’t necessary. The SEC declined to comment.

“American retail investors enjoy one of the most efficient, low cost investing environments in history,” Robinhood chief legal officer Dan Gallagher said in a statement. “We look forward to reviewing the Commission’s eventual rule proposal and engaging with the SEC.”

Write to Caitlin McCabe at [email protected], Gunjan Banerji at [email protected] and Alexander Osipovich at [email protected]

This article was published by Dow Jones Newswires, a fellow Dow Jones Group service

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