Robinhood: A High-Flying Brokerage Tech Startup Plunges in Value

Last week, rumors spread that cryptocurrency exchange FTX could be looking to buy Robinhood as the company's stock price continues to drop. Despite denials from FTX founder and CEO Sam Bankman-Fried, the idea has sparked interest in whether the self-directed brokerage would be acquired and who could be interested.

In a report compiled by investment bank JMP Securities on the potential sale to FTX, analysts at the Citizens Financial subsidiary concluded that the deal was unlikely to happen, in line with public denials from Bankman-Fried, who had recently bought a 7.6% stake in Robinhood.

That note attributed some of the interest in Robinhood to its material drop in stock price. It was priced at $38 for its IPO, hit a high of $55.01 a week later, and is currently trading at $8.97. Robinhood's total market capitalization is currently standing at a mere $7.8 billion, so it could be an easy target for a larger financial firm such as Morgan Stanley MS, Charles Schwab or Citadel Securities. The analysts point out that Robinhood is part of an overall souring of the entire fintech sector

In the view of JMP Securities, purchasing the second-largest cryptocurrency exchange in the world offers an opportunity to acquire a large U.S. retail customer base, which is a complement to its existing business model despite some obscurity due to FTX's private nature.

As of today, Robinhood has 15.9 million active accounts and is worth less than $500 per customer. In comparison, Charles Schwab's value is about $3,600 per customer when Morgan Stanley acquired E-Trade in 2020, which was worth $13 billion.

Devin Ryan, when shown these figures, acknowledged that Robinhood's youngest clients are worth less than the average client based on account balances. It is possible that as they get older and start making more money, these clients will deposit more funds into the platform.

One of the big questions is whether Robinhood will be able to develop more services to keep its clients as their investing needs become more complex. Ryan also points out that Schwab's numbers are inflated by custodial accounts for RIAs that use the platform, which could be an area where Robinhood could expand in the future.

Despite what co-founders Vlad Tenev and Baiju Bhatt have built, Morningstar MORN's director of equity research Michael Wong sees Robinhood as a unique company. Wong says that the company's position is not as easily compatible with other firms in the industry, which could make it less appealing to some buyers.

Over the last few years, Wall Street's major wealth management players have been acquiring and investing in various ways. This has come in the form of Morgan Stanley buying E-Trade in 2020, Goldman Sachs building out Marcus over the years, and Bank of America BAC investing in Merrill Edge. With a stated goal to attract more young customers, an acquisition by Robinhood could be attractive on the surface with Jim Cramer promoting Goldman Sachs as a good choice on CNBC last week.

"The best asset is the customer base," Columbia University economics professor R.A. Farrokhnia says, noting that Robinhood has millions of younger customers who have a jaded view of financial services. "Larger Wall Street firms have had difficulty attracting the younger generation, and it's hoped that they will remain as customers as they grow older and have more assets to invest."

Wong explains that Robinhood's customers, with their very small accounts, are not well-suited to the services of major wealth management firms.

Asset management firms have been interested in the robo-advice space, looking for a more direct relationship with clients that isn't disintermediated by brokers and other wealth managers. The trading happy client base that is heavy on derivatives and cryptocurrencies, however, is not ideal for a buy and hold mutual fund world. The propensity for self-directed investing makes this pool of clients an awkward fit for asset and wealth management firms alike.

According to Wong, the size of other brokerages is not big enough to attract Charles Schwab, especially after its acquisition of TD Ameritrade, which has 11 million active accounts. Wong says that it would be expensive for Schwab to acquire new clients.

Robinhood’s tarnished reputation could also serve as a deterrent for firms wary of public, or worse regulatory, backlash. The firm was penalized by the Financial Industry Regulatory Authority (FINRA) over outages and misleading customers just over a year ago, and last month it was revealed that the company had failed in its handling of the "meme stock" frenzy of last year in a Congressional report.

One potential suitor that would make sense is Citadel Securities, a high-frequency trading firm. Despite the synergy, this type of acquisition would likely face the highest level of scrutiny. Citadel already faces criticism for its relationship with Robinhood as a purchaser of order flow. Any deal to bring those two parties closer would not only face skepticism from the public but also likely from the Securities and Exchange Commission.

Wong suggests that a bank with sufficient market cap could be the best choice for adding a retail arm or gaining a foothold in the United States.

Robinhood's stock price has been suffering, but it still has over 22 million funded accounts, 30% annualized growth in deposits from May through 2022, and $6.2 billion on its balance sheet.

Robinhood doesn't need to sell to anyone and can use its cash reserve to ride out a difficult period, something that the JMP analysts see as an important strategy since competitors in a weaker position don't make it through.

Ryan says that co-founders Vladimir Tenev and Baiju Bhatt still have enough equity in their company to control its future. He believes that any buyout could be at a premium because the founders haven't been looking for suitors. The fate of the company, he says, rests with those who still believe in the original purpose of "democratizing finance," which is what Robinhood was founded on.

For the time being, he and his colleagues have a market outperform rating on Robinhood with an $36 price target.