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Why I ignored the Robinhood IPO

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The Robinhood (NASDAQ: HOOD) IPO was one of the most highly anticipated of 2021. But its initial stock offering at $38 a share did not live up to the hype, falling 8% to $35 by the market close on Monday. Yet the share price has since recovered. Even so, I think this weak opening was fairly predictable. It originally planned to IPO earlier this year, but repeatedly pushed the date back because of financial setbacks and negative publicity. I suspect the share price could fall again soon.

Risky business model

Robinhood generates 80% of its revenue from Payment For Order Flow (PFOF). As a brokerage, Robinhood is paid for client orders by a specific market maker. This makes its commission-free trading model possible. Market makers are companies that buy and sell stocks at a publicly quoted price. A conflict of interest arises because investors want to buy and sell stocks from their brokerage at the best price, while market makers make their profits by buying and selling stocks to brokerages at a premium.

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In December 2019, Robinhood was fined $1.25m by FINRA for failing to provide the best price for clients. The US regulator is currently scrutinising the fairness of PFOF. The UK has already banned the practice and it is limited across Europe. If PFOF is banned or limited in the US, Robinhood’s business model could unravel.

It is worth noting the upsides too, of course. In March 2021 it recorded 18m users, up more than 150% compared to its 7.3m users in March 2020. It projects an additional 4.5m users in the second quarter of 2021. And unlike many IPOs, Robinhood was profitable last year, making $7.45m profit from $959m in revenue.

Robinhood IPO’s rocky road

Robinhood suffered from negative press in 2021. Two system-wide outages in March stopped investors from trading. Many lost money and some filed lawsuits against the company. In June, 20-year-old Alexander Kearns committed suicide after seeing a misleading negative balance of $730,000 in his trading account. 

Then there was the Q1 GameStop debacle that cost the company $1.4bn. Major hedge funds made bets that GameStop’s share price would fall — a practice known as shorting. Millions of young retail investors, many of them Robinhood clients, bought shares in GameStop, driving up the price. As the price rocketed, hedge funds were forced to close their short positions for horrendous losses. As this was happening, Robinhood was compelled to restrict trading of GameStop in order to meet collateral requirements. This led to a steep drop in GameStop’s share price, leading to a class action lawsuit against Robinhood.

The publicity was so bad that Google had to delete over 100,000 one star reviews from its Play store. Google chose to delete the reviews because they believed it was a coordinated attack against Robinhood. To me, it seems just as likely that Robinhood’s investors felt that leaving poor reviews was the best way to express their dissatisfaction.

Then the Robinhood IPO was delayed by an SEC investigation into its cryptocurrency arm. It expects to pay a $30m fine because of a New York State probe into poor cryptocurrency Anti Money Laundering practices. In addition, it will soon face stiffer competition from larger competitors including Fidelity and Charles Schwab

With competitor eToro’s IPO coming up later this year, it’s all too much for me. I’m staying away.

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Charles Archer has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of investment advice. Bitcoin and other cryptocurrencies are highly speculative and volatile assets, which carry several risks, including the total loss of any monies invested. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

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