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Robinhood: bad news for investors as SEC and PayPal turn up the heat


In 2015 when entrepreneurs Baiju Bhatt and Bladimir Tenev launched a trading platform aimed at providing equitable access to the stock market by eliminating costly trading fees, they dubbed their venture Robinhood Markets (Nasdaq: HOOD) in a nod to the legendary literary figure Robin Hood and his efforts to reduce the disparities between the wealthy and the poor.

But it seems that the parallels to the literary outlaw do not end there —a fact that has many Robinhood investors questioning the stock’s long-term prospects.

Robinhood is in the SEC’s crosshairs

Much like the literary figure’s struggles with the Sheriff of Nottingham, Robinhood now finds itself in the regulatory crosshairs, as the Securities and Exchange Commission takes aim at its practice of payment for order flow.

News broke on Monday that the SEC is considering banning payment for order flow —where brokers receive a portion of the profits generated by the trades they route to specific market makers, because of what SEC Chairman Gary Gensler described as “an inherent conflict of interest” due to the advanced notice that the practice essentially provides market makers about trading activity.

Meanwhile, many investors were already on edge because of the company’s August 30th announcement that it plans to issue additional shares through an overallotment from its July 29th IPO, along with rising competition from payment behemoth PayPal Holdings (Nasdaq: PYPL).

Earlier this week PayPal announced that it is looking into launching a stock trading platform of its own as it steps up its efforts to compete with Square Inc. (NYSE: SQ), which added free stock trading to its own popular peer-to-peer payment app in late 2019. Such a move is bad news for Robinhood, especially since last year PayPal added the ability for its users to trade cryptocurrency, once again following the lead of Square, which began allowing its users to buy and sell bitcoin in late 2018.

“HOOD’s revenues are driven by cryptocurrency trading. The firm recently reported that 52% of its transaction-based revenue came from crypto assets and that 62% of that revenue came from Dogecoin trading. This is not a firm foundation on which to build a business model,” said Robert R. Johnson, PhD, a professor of finance at Creighton University’s Heider College of Business and the co-author of several books including The Tools and Techniques Of Investment Planning and Strategic Value Investing, adding that he believes the long-term prospects for Robinhood are bleak, particularly since its revenues have been largely driven by inexperienced millennial traders.

“These traders view the financial markets, and cryptocurrencies markets in particular, as only going up,” Johnson explained. “Once the Fed begins to taper — and when that happens is subject to conjecture — these markets will likely witness some significant downside volatility, causing these nascent investors to exit the markets.” Once trading decreases, he predicts that Robinhood’s stock price will plummet.

Robinhood IPO got off to a rocky start

Robinhood’s IPO priced lower than bankers initially anticipated at $38 per share, raising the company $2.1 billion, but trading got off to a rocky start. Though the stock rose as high as $40.25 in its first day of trading, before closing that day at $34.82, it fell as low as $33.25 the following day before slowly trending upwards in the following days.

The stock reached a high of $85 on August 4th, before closing that day at $70.39. But it has steadily trended downward since as news such as PayPal’s plans and potential regulatory ban have spooked investors. In its most recent day of trading on September 1st, the stock opened at $43.76 and closed at $44.57.

But not all investors have lost confidence in Robinhood’s long-term prospects.

“With the metrics we use, HOOD is currently incredibly risky, with much more volatility compared to competitors Coinbase, and Charles Schwab. Yet, it shows significantly more upside as well. It is a quintessential high-risk, high-reward play,” said Jeff Tsai, co-founder of JAVLIN Invest, an app designed to help investors understand the risks of specific stocks. “If Robinhood can figure out how to capitalize on its younger user base, who are newer investors with smaller account balances, then it may be a great addition to a long-term portfolio. However, there are significant risks and headwinds such as slowing user growth, inability to diversify revenue streams, and an increasingly harsher regulatory environment.”

And if the company can weather those risks, and interest among younger investors drawn to meme stocks such as GameStop remains strong, some industry experts believe that Robinhood’s business model could well prove sustainable.

“The bottom line is that change is messy, and rarely do you experience a fundamental shift that both conforms to the existing way of doing things AND improves long-term outcomes” said David Arslanian, managing director at M&A corporate advisory firm Progress Partners and president of special purpose acquisition company Progress Acquisition Corp. “In terms of long-term prospects, it’s imperative to realize Robinhood is not seeking to change an industry; companies like this often change the very nature of a market, or in this case, investing. Amazon did not set out to become a cloud storage business or food delivery service – they just knew that books could be delivered to your doorstep without the need of a storefront.”

Arslanian believes it is too early to assess Robinhood’s long-term prospects and that investors need to give the company’s management team time to deliver on its promises.

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This article does not constitute investment advice. Do your own research or consult a professional advisor.

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