Chit Chat Stocks - Robinhood (HOOD) | Not So Deep Dive

Episode Date: July 22, 2021

Robinhood is a commission-free stock trading and investing platform. The company has gained significant traction over the last few years and is planning to go public. Listen in as Ian, Brett, and Ryan go through the history, financials, and future prospects of Robinhood. Enjoy the show! Our Thursday Deep Dives are sponsored by Quartr, the new way of doing company research. Access conference calls, presentations, transcripts, and more for FREE on your mobile device. Download Quartr on the App Store here: https://apps.apple.com/us/app/quartr-investor-relations/id1552412128  Download Quartr on the Google Play Store here: https://play.google.com/store/apps/details?id=se.quartr.android  Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Interested in more of Ian’s work? Follow him on Twitter: https://twitter.com/IanGrayLive  Rather watch us on video? Subscribe to our YouTube channel: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ  Contact us: [e-mail]  Timestamps Company Background | (2:22) Industry | (9:49) Management & Ownership | (12:24) Earnings | (15:58) Balance Sheet | (19:39) Valuation Game | (22:40) Our Analysis | (24:23) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. All right, welcome in. This is the Thursday Deep Dive episode. We have Ian Gray on the show, as always, and we're talking a fun stock today. One of the most controversial companies in the

world right now, possibly the most controversial. I don't think I'm using that term lightly. uh it is robin hood ian you said you just switched over from robin hood to schwab uh what was your experience like i guess maybe one minute to tidbit to start things up what was your experience like using robin and they're excited to talk about yeah i'm excited to talk about it i think it was um you know as everybody talks about it's a great user user interface and um pretty impressive what they've done but we'll dive into that all right and ryan do you want to introduce the company and talk about our flagship sponsor quarter yep so quarter is one of our new sponsors they are the investor relations app i guess what i call them i don't know if they call themselves that

but basically you can get conference calls investor presentations transcripts earnings report all from this one app i think it might be the first app to do this but either way it's really convenient it's going to totally change up my earnings season and they're officially on android right now. So now yours as well. Yep. Just downloaded it. Got to really help out my earnings season. Keep updated on the companies I own. Very easy. And it's free. So it's great. Yep. 100% free. They also have companies from all over the place. So I think it's 12 markets that they include today and they're adding more throughout the year. You can also request companies and they prioritize requested companies. There's a lot more in store for the back half of

the year, apparently. So check them out on Twitter. It's at quarter underscore app and quarter is spelled without an e so it's q u a r t r go ahead and check them out uh but i'll go ahead and dive right into robin hood it's kind of a household name at this point but for i guess anyone that doesn't know it's commission free brokerage platform and i believe it was the first i might be getting that wrong but the brokerage system for a long time i'll kind of go through the background of why this was started uh you used to have to pay a fee when you bought or sold a security. Let's say I wanted to buy five shares of Starbucks or 10 shares of Starbucks, it would be a $5, at least on Schwab is what it was. It'd be $5 to purchase that trade order, and then it

would be $5 on the back end when you sold it. I guess there was some friction in that process because people wanted to get rid of the commissions, but it also encouraged people to, when they bought, do it in size as opposed to being able to do it with small amounts of money. So Robinhood's goal or what they did was they came in and they cut that to zero and they made money, I guess, in a different way, which is payment for order flow. And so basically the way that works is when you submit an order, a trade order, you want to buy something, they reroute that order. So they send that order to what are called market makers, which is primarily Citadel,

which accounts for 34% of all Robinhood's revenue. and then uh citadel and correct me if i'm wrong buys buys that whatever that security is sells it to you at a fractionally higher price uh it's unknown what they do but they they don't pay robinhood for no reason so i'm assuming you know you gotta assume they're making money off of this okay so i guess whatever they're doing in between your order they're making some sort of money they want those orders uh and then they give robinhood a rebate or a fee in compensation for that order flow. And so, Ian, you got something? I was just going to add something there. So the money, at least as I understand it, the money's made on the spread. So in any transaction,

there's a bid and an ask spread about who's paying, like how much the seller's willing to sell it for and how much the buyer's willing to buy it for. And on Robinhood, unlike some of these other brokerages, that spread is larger. And so they're able to get sellers to sell their shares a little bit lower and then sell them to large chunks of those to buyers at a little bit higher and so then some of their customers basically are able to take that difference and make money immediately on it because they're able to buy it at a um at a lower price than it's like trading for in the market basically slightly lower but on large amounts of money it makes a difference buy it at a lower price and then sell it immediately for a higher price and they're

kind of they're the market makers on making that transaction work and because of robin hood's clientele they're able to have a spread that's a little bit bigger than normal what are you saying about robin hood's clientele there well i'm just you know unlike unlike institutions that care about large blocks of money um and you know a cent here there a basis point here there actually makes a difference um for many of robin hood's users the difference between you know 613 a share and 612 a share doesn't really matter because you're transacting a few shares that makes sense And I think, though, I don't know if I have it here, but the average revenue per user number for 2020 was, I believe, was like $137. That's trading 12-month Q1, yeah.

Okay, so I'm curious. Do you think users are saving more money being on Robinhood? Well, if they're going to be that active of traders, yeah, because those $5 fees would add up if they're trading every day. But would they trade every day with the $5 commissions? I don't know. I think it's a bit apples and oranges. Average revenue per user, $137. Average account size, less than $4,500.

So that's a small percentage of the assets. It's a solid take rate. But they also make money not just through equities. They also allow users to buy or sell options contracts, cryptocurrencies, and options actually is more lucrative for them. So Mark Regenstein found this, that while options only accounted for 2% of Robinhood's assets under management, it accounted for 47% of transaction revenue. Bit of a dangerous incentive there, but we can get into that later. And then Robinhood is mobile first, so I don't even know if they have, I don't know if you can trade. They got web, they got web, yeah.

But basically, that's how they really carved into this market and got a lot of first-time investors. it was kind of so easy so intuitive and i mean they really do have quite the good user interface user experience um and they really are a bit like their silicon valley tech peers they use a lot of the same sort of good for rob it's a good user interface for rob yeah i find that differently later but they use a lot of the same sort of tricks with uh to draw people into the app so push notifications is one way they do that whenever something goes uh i think up or down five percent you might have to opt into this but they send you a push notification and they do uh make the experience of buying and selling stock feel a bit like a game and they get a lot of crap for

that calling it gamification but it's like you get a free stock it pops out of a present and there's confetti um if you want if you think a stock's gonna go up you hit the up button and they offer you a bunch of out of the money call options uh and vice versa so that's well it's the infinite what's the class what was it called the free money what was it called it was an infinite leverage trick yeah that was a bit of a blip on their part um that's all we've solved that they also have some other revenue sources as well though so they have robin hood gold which is their subscription service i think it's five dollars a month i'm not sure what exactly you get i think better margin rates maybe access to better margins stuff like that there was some

access to more research that they do as well yeah and then they have net interest income on margin lending, as well as cash deposits that are in there. And there's, I think, a few other ways they make money, but most of it comes from transaction revenue. I think it was around 75% in 2020. Yep. But I'll get into the history a little bit. So it was founded in 2014 in Palo Alto by Baiju Bhatt and Vlad Tenev. So the two were roommates at Stanford where Vlad studied mathematics and Baiju had degrees in physics and mathematics. I believe both of them knew how to code because after they graduated, they moved to Wall Street or New York and started selling trading software to hedge funds.

And that's where they kind of realized that there's essentially this back-end way that a lot of these brokerage services are making money by rerouting their orders. So commissions weren't really that necessary. They kind of saw that opportunity. They moved back to Silicon Valley, where Robinhood is now headquartered, and they founded the company on a first $3 million seed round. They've had 11 total funding rounds since then with the latest being more than a $3 billion convertible notes offering, I think less than a year ago now. That would have been during the

GameStop stuff. So yeah. Yeah. And that was basically the post collateral for their users. For the clearinghouse. What do they call them? The DF? I don't know. Whoever's above. T plus two. The T plus two people. It's the clearinghouse. I forget their name. But yeah, they made them post through doing collateral, which- So they borrowed it from their investors. and i believe that's part of part of what the incentive is to go public is because uh those lenders that gave them the convertibles uh are hoping for an ipo so they can convert that to stock and i assume they got a pretty good deal there i think it was a 30 discount to i'm blanking on whatever the fair value they had at the time that's pretty good um all the industry

competition competitors are well known if you're an investor you likely either use robin hood or one of the competitors and if you don't and you're using like morgan stanley congrats you probably shouldn't be listening to our show. But that includes Vanguard, Charles Schwab, and TD Ameritrade, who are together now. They're one company. There's E-Trade, which I believe is actually owned by Morgan Stanley. Not sure if that's gone through. Coinbase is a competitor. Ryan did hit on it earlier, but Robinhood has a big crypto market, which we'll get into probably in highlights, lowlights, future growth opportunities. IBKR, which is Interactive Brokers, is another competitor. And then there's a lot of smaller mobile-first trading apps.

But Robinhood has really, they probably have 90. I mean, they're the clear market leader in this mobile trading apps. No one, I mean, there used to be Webull, which was W-E-Bull. That's totally fallen off now. Robinhood's the clear leader of these. They're really competing against Schwab, Vanguard, Fidelity. I'm freaking Fidelity too. They're the legacy solutions.

And Cash App. Oh, Cash App as well. To be honest, I have the Cash App for the credit, the debit card. It's weak. they're they're investing i mean robin hood stuff it's improving it's pretty weak from like the what not like just from the options you have like you can you can only now just start doing dividend reinvestments on robin hood cash app is significantly significantly weaker i guess though there's other ones like m1 finance that's kind of an interesting startup too

and there's public and common stock public right uh yeah there was another one where you common stock no maybe it's like a sound oh oh there was that was that united kingdom one yeah okay so uh getting more to the industry retail investing assets are at 50 trillion dollars according to the s1 so quite large um how much of that is reasonable for robin hood to attain like a lot of it might be 401k is a lot of the fidelity so i'm not really sure um crypto trading is hard to calculate but just looking at coinbase coinbase is doing about three billion dollars in sales right now. They have commissions. So it's unclear whether that's kind of a year margin is my opportunity thing for Robinhood, but we'll see. 70% of Robinhood's AUC, which is

assets under custody, that's kind of how much money is deposited with them, is aged 18 to 40. So 70% of their customers are within that 18 to 40 age gap. And then 68% of people aged 18 to 29 have no money invested in the market whatsoever. So the reason I put that in there is it shows the opportunity that Robinhood still has ahead of itself to acquire more customers. Um, all right, Ian, you want to hit management and ownership? Yep. So the CEO of this company is roaring kitty. I mean, uh, Vlad Tenev, um, you guys saw that picture, right? You know, the you throw on a headband and Vlad Tenev turns into roaring kitty.

They look suspiciously alike. Yeah. Also look like the John wick character. Yeah. What's his name? I forget. Uh, Keanu Reeves. Yeah. Yeah. Yeah. I can see that. But no, Vlad Tenev is the co-founder and CEO. Baju Bhatt is the creative, sorry, the chief creative officer, which is kind of interesting. I don't know that any other financial institution in the world has a chief creative officer. I could be wrong about that, but. They also don't have monetizable users.

All right, whatever, sorry. But, but anyways, the, I think the creative officer title is actually as much as I kind of would like to give him a hard time about that. I think it's actually a good thing for Robinhood given how much they depend on their user interface and creating a seamless environment for people to, um, get introduced to investing. And I think that that is one of the things that Robinhood has done a great job of is actually creating a, for better or for worse, create an app that is easy for people to use easy

for people to at least understand investing at a baseline level. Um, and they've just people, people like the interface on those part, especially people who aren't coming from the traditional investing world. Both of them, as we mentioned, are Stanford graduates. I think from what I read, Vlad had two other startups before Robinhood. So he's kind of was looks like he was kind of trying to test out this startup world for a little while. And then it's estimated that both founders have a combined 20% of the company. So pretty high insider ownership that is subject to change with the IPO. We'll have to check on that as kind of some more numbers come out and they probably file in an amended s1 and provide some more color for

that i'd say the last thing i'll say about management and ownership there's been a lot of controversy over the last couple years about or especially the last year about vlad and and some of the tactics they've used and also um the whole game stop saga and and all that type of stuff but one thing i will say in their favor is that the design the rollout and the word of mouth marketing is very impressive and the way that they're able to gain this big following um i was reading an article that when they were first starting um they had an office across from stanford and they would go test they'd like be trying out a new feature and they'd go take the app out and go test it with students at stanford to see whether they liked it or not um it's kind

of reminiscent to me of tinder and bumble that we've talked about in the past and how they would you know how they really targeted those college students and tried to get feedback from college students and create those even college student events and stuff and it just it seems like they've done a good job of getting a lot of good um data from people basically going out and just seeing do customers like this and trying to find that product market fit um and it's really been a good silicon valley story in that sense but um definitely some questions with management especially in the last year the referral program was very smart i believe a lot of people i believe i yeah i can that's how i got ryan to download it i was like hey get this they're gonna give me a

free stock it may have been chesapeake energy like everyone else got and then you immediately sell it for three bucks but that into anticipation they're like one in 200 of these people get apple shares and you're like oh oh my god uh it turns out you just get you get a penny stock but they can't really and yeah what are you gonna do uh we can't so this is a pre-ideal company so we're going to play the valuation guessing game before the second half. So Ryan, you can keep up with me. Yeah. So their Q1 total net revenues was $522 million. That was up 309% year over year. They had negative a billion and a half in gap net income for the first quarter due to the change in fair value of the convertible notes. God, what an investment by those people, whoever did it.

Yeah, but I guess if you X that out and all other costs, their adjusted EBITDA margin is about 22%. There is, I think we can all agree that theoretically at scale, this could be a very profitable business. It's pretty asset light. Yeah, I'd say their operations costs could be, that's something I was looking at that could, you know, they're having to beef up that customer support. We'll see. which which is probably worth the investment and then they have yeah general and administrative is the largest operating expense uh it's barely outpacing marketing which to their uh to them it's worked that marketing spend really has and if their average rep if it costs them a

and a share of chesapeake energy in order to get 137 in revenue per user a year uh it's definitely worth the expense but their net cumulative funded accounts was 18 million that was up 150 year over year although i guess the amount of accounts that i thought were just kind of barely funded and just idle i like how they didn't fund it because now mine like i don't count in that anymore you know i mean they could have yeah kind of said i was an active user just because i don't have any money in there anymore, but I can't do this. Yeah. They have monthly active users of 17.7 million. And that's a little more than doubled year over year. So very few that are funded and not active users. And then they have 80.1 billion in assets under custody,

which backs out the net margin balances. So this puts the average account balance at just under $4,500. I think we asked a year ago what we thought the average account balance was for Robinhood over and under $5,000. I think we said under. Yeah, at the end, we were right. Good, good. Well, I mean, hey, back then it would have been a lot worse too. Yeah, I guess the markets probably helped with that. But earnings overall, I mean, they're growing like a weed. This is a company that really embodies the phrase, move fast and break things. yeah almost break the markets uh break the financial world but q1 should be mentioned

q1 ended in march and april may june there's some pretty little boring yeah but within certain parts of it crypto was super uh hot i guess is the best way to describe it very volatile there and they've been making more and more money off dogecoin which we get into and then i think q1 q2 could even be a better number for them and i don't know how much crypto can be i don't know crazy too in q2 i don't know the presence of wall street bets has been so influential in relative success as long as there's these micro bubbles and the virality feature of like oh this is the stock we all have to get in on volatility is their friend yeah because honestly it's not it's really not all that different than the old way of uh of brokering like the incentive is for

people to transact it's just a backdoor path to do it yeah yeah there's no different yeah we say the incentives are kind of mixed but they've always been mixed if it's if it's someone that doesn't make money on that interesting all right balance sheet quick you want to hit that in yeah i'll hit this quickly first real quick um just to your point about q1 we've already actually started to see some decline in monthly active users um in february and march of q1 um still up like from where they were year over year but down from they reached a peak in uh january of 2021 kind of in that robin hood bubble um and that was for both well for let's see yeah for both daily and monthly active users um so it'll be interesting to see when if they do go public and q2 results come

out to see how much that continued to drop i have to assume that it continued to drop coming out of it but we can get more into that later um as far as the balance sheet they've got about 1.4 billion dollars in cash on the balance sheet and then they have some other kind of restricted cash um on the balance sheet and so part of that's due to caps that they're holding for their uh for the accounts on robin hood but then there's also some cash uh related to some of like their liabilities that they have to hold on the balance sheet. So they've got a few different buckets of cash on the balance sheet,

but it looks like about $1.4 billion that they can kind of do whatever they want with. As we were talking about earlier, they had that convertible note offering, which is over $4 billion. In my mind, that should just be thought of as dilutive equity at this point. That's going to convert to shares

and it's going to be dilution, basically. So that's kind of the story on the balance sheet. you should check and do some more research. And there's been some people who've put out some good reports following the whole GameStop story about the plumbing and how all these investments work together and where money goes and what the chain of custody is and all those types of things. I know that there's some good threads on Twitter and probably also some good articles and sub stack things. And so I'm not going to get into all of that right now. But that's something to consider when looking at this because their balance sheet is dependent on how

all that money flows and how long it takes for the money to flow from one entity to another. Like I said, others are more qualified to speak on that. So if you're interested, go do some research there. And the other thing is like if they get to the point where they have whatever 50 million monthly active users and they have to post collateral for some of these what they call 10 Sigma events, like that balance sheet really starts to matter or else they might have to raise like we saw in January. yeah i mean before and when they used to have the um in 2020 when they had their app just shut down man that was brutal i can't imagine what it was like it was shut down remember when um you know when it stopped working oh i don't remember that right you guys remember that remember when the app was shut down you know i mean you couldn't trade in 2020 and this was during march i believe

and in different times when uh they just couldn't get orders through yeah but either way let's wrap up the first half with the valuation guessing game so what do we think is it is going to come out at uh yeah i'm gonna say 25 billion they raised money at about 11 12 billion in 2020 um 25 billion would be about 25 times revenue i think sofi is trading at like 30 times revenue right now oh dude that's a discount yeah that's a discount but i i don't know it'll be interesting to see but i'm gonna guess somewhere 20 25 billion all right i think it gets a meme stock valuation i i know they're giving shares to robin hood users and that that sounds great but you know that they're like we give them to them they're gonna do their dirty work you know what i mean

i could see a world which they halt trading of robin hood on robin hood yeah that'd be i mean that would be a side to see be fun to watch um so i could see it being north of 40 billion so it's an estimate what do you what are clothes for i mean first day clothes are open like not like nothing random weird spike what do you mean you know what i mean like clothes like what you know yeah i could genuinely see this getting like 30 times sales which is probably what like 40 billion i guess yeah when i was doing an article on them S&P Global said at least 30 billion

from what they're hearing probably more. And that's unbelievable. I'd say, I think it's going to be 40 billion. Yeah. I mean,

there's been rumors of 50, but I think that was probably the one that the company dropped themselves. There's always that one where you're like, everyone's like,

oh, that's insane. You know, like you guys, guys, like sources are saying Robinhood's going to go public at 50 billion

and like, well, that's probably just Robinhood themselves. All right, let's hit the ad break and then we're going to discuss what we like,

don't like about Robinhood. business. This episode is brought to you by La Quinta by Wyndham. Here you are miles from home and ready to start your vacation. Good thing you're staying at La Quinta by Wyndham. They have free high-speed Wi-Fi to stream all your favorite movies. And in the morning, get fresh waffles with their free bright side breakfast or squeeze in a workout at their fitness center. Either way, you're ready to conquer the day. Tonight, La Quinta. Tomorrow, you triumph. Book your stay at LQ.com. This episode is brought to you by KPMG. As a business leader, how can you innovate, build trust, and move forward in a digital era? KPMG can help by bringing together the right

talent and technologies, generating insights that spark opportunities. To explore their thinking, visit reed.kpmg.us slash opportunities all right welcome back next up is anecdotal evidence this one should be fun here uh we've all had anecdotal evidence of robin hood and what are your thoughts yep so my experience with robin hood started about a year after i started investing i think um i came across it and i already had a little account at schwab but i thought hey if i can get money transferred immediately and uh commission free because at the time this Schwab commissions were actually, I think like 12 or 13 bucks a share. So when I'm buying little tranches of, you know, $200 things, right. That's like, you know, if you count it on both sides,

it's, it's, uh, 10% of my, of my initial equity. So I was like, man, if I can get on Robinhood and not have to pay those commissions, I'd love to do that and be able to buy one stock at a time and diversify faster and all that type of stuff. Um, then, you know, obviously Schwab dropped to commission free and I went, well, why am I on Robinhood anymore? Because I actually, you know, I didn't, I think the user interface is good, but it wasn't what I was looking for. I wanted some more tools and some more data. And, um, and then also I wanted some, like I wanted to open a Roth. And so I opened all those types of things with Schwab and then eventually still have my little Robin hood account over there. And, uh, that's the gambling account, you know, you gotta

scratch the edge with the gambling account. Yeah. And eventually I was like, you know what, I just want all this at Schwab. And so I think Robin hood charges an $85 fee to transfer your assets out um really i called schwab and i said hey if i transfer these out um like will you cover the fee and they said yeah we'll cover the fee and so so i transferred it over schwab covered the fee um and uh so now i'm all 100 in schwab yeah schwab customer support is one of the best in the financial industry i love them uh ryan yeah i mean everyone's got their own experience with Robinhood I think people our age at least or their own uh I guess take on it I started there most people do I mean the commission free is such well at the time it was such an edge because

young people just don't have much money to play with and so but I moved to Schwab pretty early on I guess uh I think there's still a little bit of money in my account and it's pretty much just like fun gambling money i guess like if i ever wanted to buy some crazy out of the money options on some random just hunch that's the place to do it but i i honestly think it's a very very small it might be gone now a contract might have expired worthless yeah them uh i think you have this in your notes forcing the hand of the big guys is nice uh from an investor's perspective love how they're doing that now um but me personally i really hate it i hate that i'm not gonna mince words here it makes me upset seeing it uh how my friends use it uh like once

we talked to bill brewster and kind of opened our eyes even further to the tactics they're using got pretty angry at the company um that's the slot machine tactics the notification tactics um and then the just the green and red stuff is so i mean when you're everything is good your whole page is green and it's like a magical cartoon and then when it's red it looks like i don't know it's just a little midnight you know yeah it's it's it's mind-blowing that they it feels like robin hood themselves don't notice or at least that's the narrative that they put out what's going on yeah it's kind of like with i mean it's kind of like with youtube and uh facebook like i don't know we didn't know

that nazi stuff was there like i don't know guys like in that we'll fix it in that finra 70 million dollar fine or 75 whatever it was there was 10 000 customer complaints that they like didn't disclose with whoever that regulating body was. Yeah. Oh, the track record of acting, um, ethically. Yeah. Or maybe like conservatively, you know what I mean? Not risk averse. They seem to take a lot of risk. Uh, you know, I wouldn't expect that as a, you know, to be risk averse as a shareholder going forward. Um, all right. Future growth opportunities and what are your thoughts here? Yeah, this is going to tie in a little bit with some of your concern so i think one of the future growth opportunities is um adding retirement accounts

the or other types of accounts because really young people that's what young people should be doing um and that's part of the reason like so when i first started i had an account with schwab like i said and then i opened an account with robin hood and then i needed to open a retirement i wanted to open a roth ira and i probably would have opened it on robin hood if the option had been there and my assets might still be with robin hood maybe not because of some option stuff i wanted to do, but, um, they might still be with Robin hood. Had I been able to open that Roth IRA, but I wasn't able to. And so I moved everything over to swap. Um, they, this is kind of the point that touches on your concerns. They, they call themselves,

or they've started doing these marketing campaigns where they say, um, everybody is investors, right? We are all investors. And that's a, I, that's a great theme because I actually, I do believe that that we're all investors, but the problem is, is they're reinforcing behavior. that's turning everybody into gamblers right and i think doing things you know if they could actually help all these young people open up roth iras then i'd be 100 on board like then then yeah we are all investors and you're helping us and that's what here's my thing kind of a pie in the sky question but as a society do you want robin hood to be a roth custodian where because the The idea behind Roth IRAs

is that the average American can build a retirement tax-free if that retirement account blows up at 30 and you're allowed to trade out of the money options without any collateral. Do you really want them?

Yeah, that's interesting. That's interesting. That comes back to Robin's business tactics. Maybe just don't allow options transactions within a Roth. There already are restrictions on on some of the types of transit the you can still do some options with within a roth but like some of the more advanced strategies aren't are not allowed not allowed okay um i would what

makes me concerned about management's integrity is that they launched crypto back in 2017 when the company was probably had two percent of the employees they do now and that seems really hard to do uh or maybe it's 2018 i can't remember uh they didn't have at a time they didn't have dividend reinvestment, Roth IRA, or regular IRA, that seems a lot easier to build. Maybe I'm wrong, but that seems a lot easier to build because it's just getting the regulations through than a crypto thing. And, you know, is that really, I don't know, what's helping your customers succeed in their retirement? There's an element of tone deaf for sure. Like even when, when those customers accounts were getting broken into and people were extracting money and they'd reach out to customer

support they want to get back to them for two weeks or whatever that's exactly when they launched a new uh new color green for their mobile app yeah the new color green that's huge guys and people are like are you serious look like we're like your customers need help but yeah yeah i was just gonna say the last thing is is it's hard on ronald hood because i am thankful for them pushing the industry to commission free and i think that is a good thing for investors but the problem is is they've then tried to capitalize that and say they're democratizing finance and we're all investors and we're all, you know, we're doing so much to help the investing community and getting young people

invested, but it's not investing, right? A lot of what they're doing and the behavior that they're really incentivized to promote is not long-term investing. That's going to make meaningful, a meaningful impact on the lives of most of their customers, right? Day traders don't make, most day traders don't make money. Some do if you're a day trader, whatever, some people do. uh it's harder though and uh majority of options traders lose money so they're incentivized to get

people to use tactics that on average they're going to lose money and sounds bad i mean maybe this is sort of too far into the future to think about this but like once these once that generation that adopted robinhood early hits the age where they're high income earners so like 20 30 kind of And they have tons and tons of short-term capital gains tax they have to pay on stuff that they've been trading. And it's not like zero, it's like 25, 30. Yeah, 25, 30%. I think they might recognize like, oh, maybe this isn't the place I should have my money. But Roth IRA, you can trade your hearts away.

No, I guess that's true. Which is, once again, kind of double-edged sword. But I'll have mine. My first thought was just adopt the stigma of being a gambling parlor. and just move to sports gambling. You've got the user interface. You've got the user experience. They're the best at the tactics.

They are so good at that. Maybe a pivot could be in play here. A pivot to a casino, I'd be enticed, actually, as an investment. I'm serious. I guess if they don't want to do that, which I don't think they would, copy the Cash app,

try to do some sort of cash wallet stuff, maybe boost, just try to build out the debit card just marks more optionality for users um yeah i mean you should be copying kind of the cash apps moves i think robin hood has debit cards yeah that's what i'm saying like adding more stuff to that debit card and that leads into my future growth opportunity which is turning into a bank this might be the boring one people roll your eyes you know every fintech company says that but there was a lot of language in the s1 that makes it feel like they want to do

this eventually because they're saying stuff about we're going to manage everyone's financial future or something like that you know it's a bit you know they got those missions and visions and stuff like that but seems like that's what they're going to try to do uh they have that cash management thing where they're talking about i forget the interest rate they were going to give people it was like upwards of three percent and then they that told they botched that rollout back in 2018 or 2019 um and now they have that at a lower interest rate either way that's kind of smart pretty good initiative get people a higher interest rate um then they will get out of regular checking accounts uh it's a crowded space above the risk rate i'm not sure how that

yes it seemed impossible for them to do which is why they definitely lowered that it was a bit of a gimmick at the start but this has got i think they're gonna try to move more into this however it's an extremely clouded industry there's so many of these neobanks definitely all right highlights lowlights and what do you have so the highlights for me is just the initial brand building as i mentioned earlier that it just it really is an impressive story about how much adoption they were able to get and to end in a spot where their vision was actually correct which is often the case with many of these companies that get successful it's kind of survivorship bias but many of them did have visions that actually came to fruition with commission

free and you know quote unquote democratizing finance as much as i i don't agree they're really doing that they did they were able to drive this whole industry to commission free um the low lights for me though is how much of their revenue as you highlighted uh ryan comes from options which is like we were talking about earlier the spread on trades they've expanded a little bit but then the spread on options because it's a a less um there's less volume going on in options it's a more inefficient market and so the spread on options are much higher and if you do options trades, you recognize this, that like, oftentimes, the spread will be will be, you know, 10s of dollars different difference per options contract. So there's just a lot more money to be

made there, because the spread is so much bigger. And they do one of the interesting things is they do it many of the institutions actually do it on a, like just a per transaction fee for the order flow robin hood takes a percentage of the spread and so they're actually the bigger the spread the more money they make it's not just per transaction and so um that's interesting which which i think is why like that's why the options i think is such a high percentage of revenue because they're they're getting more revenue on every single transaction because the spread's just larger and larger um i'm a little bit worried about that from a business standpoint because i just worry that there might be some more regulation that comes into that space with

how many you know just how many bad experiences people have had with options on robin hood and they seem to take a fairly um lenient approach it's much easier to get options you know at least initial options approval on robin hood than it is on some of these other um uh brokers so uh that's one thing the active users declining the last couple of months is another thing and i i well i'll get into that in a second but um yeah that's those are kind of my main my main lowlights okay the highlights same as Ian the brand building

has been exceptional I think the product market fit to go from to go to build this fast in six years

is it requires they had to be in the right place at the right time and they were I mean there's a reason they won

versus everyone else and there's also a huge network effect with with especially with anything stocks related maybe not

switching costs maybe the it goes viral within like communities okay virality yeah definitely yeah like oh he's on like uh like think about the game stop think about how many users they got from that how many texts you got from random people that have never been invested they're like i'll set up an account with robin hood and what's interesting is they use that specific color tone that no other app uses so when someone else is on it you're like hmm i've never seen that type of app before what is that that i think that was one of their smartest moves too yeah i mean it's just it is kind of the go-to app for first-time investors um and this could be a high margin business um

if things go well for sure low lights for me i just i don't like the ceo like i personally have a gripe with him i guess um he probably doesn't care but that's what's kept us out of uh facebook though and that's that's cost us money i don't know i guess another little light is that the entire platform hinges on market sentiment like sure think about those active users could reverse those the activity could reverse like imagine if we got a boring market for a year why don't just get the levered up done why not just get the levered up nasdaq in that in etf that's not that's I mean, I don't think that's equivalent and really don't buy the levered up NASDAQ ETF. I also think they went public at the most opportune time with those first quarter numbers.

Yeah, a little window dressing now. I mean, that's better than going on behalf of the people that gave you convertible notes. that's better than going public at an inopportune time but for the retail shareholders receiving that uh i just be cautious yeah and then another thing with the window dressing okay dogecoin revenue was six percent of revenue in um q1 and peak dogecoin was april so q2 no i think it's and well ahead of us it's ahead of us yes okay sorry sorry but uh i think they could have 20 of the revenue dogecoin in q2 yeah i guess it's possible because there was that huge bump wasn't there yeah and apparently dogecoin

has great margins for them so that's believable yeah um what about you do you have any highlights Let's see. Other highlights. I mean, nothing. I guess infrastructure and operations look to be in a way better spot now. They said they're up. They can take 5x of the demand of what they're currently getting. So that's better than what they were doing in 2020 when they had the app shut down. But everything else you guys said, I agree with. Low lights are good. install base and switching costs matter like yeah they are able they could possibly pivot the business model in a few ways that make them better in the eyes of investors because and they can do it successfully because they have this massive install base yeah yeah but it's a big if um let's see other low lights reliance on crypto that dogecoin stat i mean i'm right back to zero third crypto revenue while not okay i don't know what percentage of it of the transaction revenue it is but in q1 it was up two thousand percent so i don't know that

feels unpredictable to me uh let's see anything else exploiting customers just doesn't feel sustainable so when robin hood does well it's when their customers are doing poorly yeah no i believe you don't know that well on average it has to be true also i don't know is maybe this a low light like the larger percentage of aum that options becomes the higher chance that aum disappears yes yeah it's like when these accounts actually go to zero yeah i know you're using your transaction revenue lost you assets if the majority of options traders lose money that means if you're getting people to do this eventually they won't have any money to trade options i just don't which is a function of options traded like most have to lose money you can't like

they're not going to solve this all right all right we don't need to rant full case ian what's the bull case for robinhood let's say let's put a valuation on it because it's this tougher pre-ipo let's say they go out at a 30 billion dollar valuation like smb global saying yeah i think that the bull cases they become the financial institution for younger generations um and as i've kind of mentioned today i probably i don't think that's likely and i think there's a lot of competition out there between all these ones i've talked about whether it's sofi square paypal even even some incumbents like um some of some of the existing banks and and visa and MasterCard. Like there's a lot of options out there for who's going to really become a major

financial institution for younger generations. And I just, I don't see it, but there's, that's the bull case. I think that they just become more and more intertwined and, you know, millennials and Generation Z's financial lives. Diversified revenue. Yeah. Diversified revenue. Exactly. Yeah. Ryan? Yeah. Same as Ian. It's maybe I am overthinking the downside risks and I'm overthinking the negatives and maybe the perception among the public for Robinhood is a lot more positive than what I'm thinking. Or even positive people might not care. Yeah. And then if a lot of those first-time investors continue to stick around for their lifetime, this could be a good investment at $30 billion, I guess. Possibly. I'm cautious to say

that but um yeah i mean my bold case could be that everyone else that hasn't turned into these degenerate gambler types well maybe they do they they get more and more people to start doing that maybe this drives attraction from would-be non-investors what do you mean like people that would have never invested are adopting it maybe not for the right reasons but they adopt it because you know their friend was on robin hood that made money yeah yeah but it's revenue for them yeah i think if you okay the market if the market goes out like 30 billion something like that 30 times sales you unless they can really diversify the business model into something more of a cash app where they have like a debit card thing that gets a pretty nice take rate and

that's becomes a meaningful portion of the revenue you gotta expect auc to get to like a trillion dollars right yeah that's not that's not crazy but it's not possible if they do i do think it is for sustainability that i think they have to diversify where their revenue comes from which is possible and i believe if i'm not mistaken that in q1 uh transaction revenue was a smaller percentage of overall revenue than in 2020 yeah they had more gold uh gold subscriptions margins i think and then they have the interest of margin was up a lot margins of like tenants margin accounts that's good no that's good not margins cheap that's cheap no one can get in trouble with that all right bear case i mean this one's easy ian yeah i'll jump in here real quick

just to add a couple of numbers to what we were talking about cryptocurrencies um in q1 2021 were 17% of total revenue was transaction-based revenue from cryptocurrency, 17%. Total transaction-based revenues were 81% of all revenue in Q1 of 2021. And then as far as like the net interest revenues, which includes some of what you were just talking about, it was down from 19% in Q1 2020 to 12% in Q1 2021. And so... I'm wrong.

Yeah, a little bit of a smaller piece. And they had, like, the big thing was they earned less interest on their cash and securities while maintaining about the same level of interest earned on margin interest and securities lending. um so anyways just a few numbers there for people who are interested as far as a bear case the cynic in me says and i think i think there's some truth to this is that order flow is about to decrease monthly active users about to decrease as we're coming out of covid and stimulus money we saw that trend start and kind of yes the stem has got to help them right and so especially with an account size of you know what what is it four thousand dollars average account size so um the stimulus monies actually can be a big you know you know you get a couple you add up all your stimulus checks and that's basically your average account size at Robinhood so um anyways I just I

worry that they're IPOing at the perfect time for this business and that these growth rates right they grew 300 or whatever in Q1 that doesn't seem sustainable to me and I I fear that this is a business that may have already hit its peak in terms of revenue I it's probably unlikely that that's the case but it definitely i think is gonna we're gonna see decelerating revenue growth going forward and um that that i think that could really hurt the stock but there's should be high expectations and and um low results over the next few few quarters and years so the there's been some headlines thrown around e-trade td ameritrade back in the 90s it was like 1998 i mean that means bull market has a few more years to run but it's it was like revenue up 100 and those are some

pretty poor investments from then on so like just because trailing revenue is up you have to be able to you have to ask yourself how predictable is that revenue going forward um ryan what's your bear case the bear case we so we just talked about constellation software and we and on that we said all right, there's an incredibly high margin of safety there. There's a high floor. It's going to be hard to lose money because there's so much predictability with the cash that the company generates. The floor on this investment is extremely low. The bear case is- 90% loss of your money. Well, we're assuming the $30 billion. Assuming a $30 billion valuation, you can lose, in my opinion, a ton of money because

the revenue streams are so unpredictable and it's so susceptible to market sentiment. that if things were to go wrong that there's just not a lot of safety on on this investment yeah bear case for me or go ahead if i guess if the convertible notes convert and just to shares um at least they don't have bar at least they don't have to pay back uh lenders that's yeah that's a plus that's a plus it's just bc dollars just be yeah or well you know retail by that point uh yeah what we're in the lock-up period you know that's gonna be it i'm not saying all you know vcs do this or anything but you know that lock-up period that first six months uh you kind of hold on to your chest you're hoping the price doesn't tank or something like that but i'll hit my my

bear case i mean simply it's a bear market it's because if investing ever becomes unfun again like i i don't know if it ever will maybe we're in a new paradigm i don't know and maybe this is just the new this is how financial markets are going to operate for the next 50 years and the thing is robin hood can it's not like robin hood is reacting robin hood made it happen so they can keep making it happen um but if it does if a bear market comes and everyone like when bear markets come it by definition means there's less investors out there so you know then investors and robin are going to lose money they're going to leave they're going to be less trades um might not leave it might just be an idle account

yeah our idle account uh the sec has talked about regulating order flow so that could come through yeah i don't know if i want that i'd rather have order flow than commissions but that's just as someone i don't know i guess that that's how much money you're playing just put in limit orders guys if we all put in limit orders we can crush citadel's business model no probably not they get a they get a workaround they're a lot smarter but that's the other bear case i guess we didn't talk about is the ongoing legal proceedings there's there's a lot there's a few that are active and i if the sec or whoever the regulator is maybe it's better funding and they decide to take action yeah this feels like monsanto you know i mean 70 million was a slap on the wrist

yeah i don't know it feels like that legal risk is is there um but who knows who knows more or less interested yeah i'm less interested um this is a company that like the story has a lot of potential, right? Like if, if it was actually democratizing finance and actually helping all of us to be better investors, um, it would be something I'd be super excited about, but I just feel like they're telling one story, you know, over here, you know, one side of their mouth and actually acting a different way. Um, and it just, it's, it's frustrating. I think there's, as you were just talking about, I think there's some regulate regulatory risk with this one. Um, man, it's just not, not something I'm interested in.

yeah ryan well uh less interested it it's a sin stock that sin stock investors won't touch like well i mean yeah since stock doesn't equal good investment but it i don't know i just i just don't like the hypocrisy of it all that i have a very cynical take i guess the business model and maybe that's not what the standard person perceives it doesn't matter they're They're getting, it doesn't, I mean, it doesn't matter what they think. So what's, what's, what's happening there. There's just so much lack of predictability and risk. It's probably something I will stay away from.

Yeah. The big key. Yeah. I'll say less interested as well. The big risk is unpredictable. I mean, why buy this and not buy up a levered up ETF that, you know, whatever it is, the, I forget those are called the triple levered S and P. futures for the triple lever nasdaq like you're just going off market sentiment here how are you able to predict that it just doesn't i don't know i don't know yeah agreed but okay i added a new question what price would you actually consider buying robinhood at yeah and you have anything i got to think on this so i'll talk for a second so i actually wouldn't consider buying this at

any price. There's a lot of stocks for me that I just say, not interested at all. And I don't let myself get tempted, even if it's at a low price. Facebook's one of those stocks for me, actually. There's a lot of things about Facebook's business that I look at and go, okay, I kind of like that. But for some other reasons, I just don't want to buy Facebook. And part of that is I don't believe in what the company's doing. So, you know, I just, that's the same thing with Robinhood. I think I'm so frustrated and disappointed. And then also their brand image, right? It's a weird business that has both, like many of the financial, many of the people in finance really don't like Robin hood,

right. Of, you know, these people on wall street and they think, Oh, it's a casino and all this type of stuff. But now you've got all these other people, you've got the whole wall street bets community mad at you too, because of the whole GameStop situation. And so their brand image, despite all the great work they did for years and years, their brand image has really taken a hit. And I think they're, I don't think they're, they're walking the walk of the story that they're telling. So it's just, it's one that I wouldn't consider buying at any price, honestly. All right, Ryan.

I am less morally sound than Ian. I think that's, yeah, I mean, it's not, it's not the morals here. That's keeping me away. I think I,

if I could make money on the investment to, I would use that money to shut it down. I guess maybe that's where I get my moral bounce back. I would start up a thing just to get people signing up on Schwab, with Fidelity and we'll get the Roth IRA started. I'll do one a week. Sub $4

billion, I would consider. Yeah. $3 billion came to my head. Because you can still lose money at sub $4 billion or sub $3 billion, but your upside is really high in a market like we've had

last year. Especially at that point, at that valuation, if they're able to diversify their revenue streams at all um this probably becomes a winning investment right yeah i'd say yeah three billion was the number that came into my head but they're not generating i don't know they're not generating cash though i know so you can't really i mean the probabilities they're actually i don't think they can be that high margin yeah i don't think they could be that that high margin like it's not going to be operating expenses will always carry they're going to have to

God, dude. $30 billion is fuck. Sorry for swearing. Sorry for swearing. That's just, it's a lot. It's a lot. Honestly, if there were ever a company that I would say no forever, this might be it. Yeah.

All right. Start for next week. Ian, what are your thoughts? What do you got? I think we're going Paycom next week, ticker P-A-Y-C. It's actually, it was one of the first stocks I bought multiple years ago, And it's been a good winter for me, but I haven't done a whole lot of research on it recently. It's been one of those that I just kind of let do its thing.

So excited to take another deep, deep look into it and share with all you guys. Yeah, that should be a fun one. It's been a really strong performer in the SaaS business. I'm not sure if they're exactly SaaS. Yep, they are. They're human capital management. So kind of similar to an ADP or a paychecks. So, all right. Should be fun. Okay, that's going to do it. Remember, we are not financial advisors. Anything you say on this show is not formal advice or recommendation. Ryan and I are general partners at Arch Capital. Arch Capital clients may hold securities discussed in this podcast. Thank you all for listening or watching. We'll see you next week.