Robinhood had a tumultuous first quarter that led to its CEO testifying before Congress, but it is becoming clear it was also an enormously lucrative period for the company.
A federal securities filing shows that Robinhood was paid $331 million by market-makers that execute stock and options orders for the broker’s clients in the first quarter, when the
frenzy grabbed hold of the market. That is up from $91 million in the first quarter of 2020.
This kind of revenue, called payment for order flow, has become a more important way for brokers to make money now that they don’t charge commissions on each trade. Robinhood doesn’t release its full revenue or expense numbers, so the filings are the clearest window into its operations. They show that Robinhood is on track to make well over $1 billion in revenue this year and perhaps more than $2 billion, should this level of activity hold up.
That said, most other brokers are expecting trading activity to slow in the second half of the year as Covid-19 ebbs in the developed world and economies open up more. “All of the brokers are predicting that the current spike in trading is not sustainable,” said CFRA analyst Pauline Bell.
The securities filing does show that while trading activity remained high throughout the quarter, it fell off in March after peaking in February. In February, payment for order flow was $121 million, while it was $97 million in March.
A slowdown in trading could curb Robinhood’s growth rate, and force it to find new ways to make money. The company has already filed confidentially for an initial public offering. It is expected to start trading in the second quarter if regulators give it the go-ahead.
Some convertible debt the company has sold can be converted to equity at a $30 billion valuation. A start-up with $2 billion in revenue and a path to strong profits could conceivably hit or exceed that valuation in the current market. But one that relies too much on a feverish trading environment could falter if trading slows through the rest of the year.
“The $40 billion question is whether volume is going to come down,” Bell said, referring to a valuation as high as $40 billion for Robinhood.
Robinhood was under the spotlight in the first quarter as users flocked to the platform to bet on GameStop (ticker: GME) and other stocks driven by social media. It shut down trading in certain stocks as it faced calls for more capital from its clearinghouse. Users criticized that decision for stalling the GameStop rally and costing them money, and high-profile investors like Mark Cuban encouraged new traders to look elsewhere for better-capitalized brokers. CEO
testified before Congress to explain that the company had no choice but to halt trading temporarily.
But all the turmoil didn’t seem to hurt the company much. Its app was downloaded millions of times during the GameStop frenzy. “For them, it seems like there’s no such thing as bad press,” said Bell.
Payment for order flow is getting more scrutiny, though, and “bad press” around it could affect Robinhood. Basically, Robinhood routes its orders to high-frequency trading firms that match buyers and sellers and profit from the spread between the buy and sell price. The market-makers then rebate part of that spread to the broker.
The practice is legal, but it has become controversial because the “cost” to the customer is not as straightforward as it was when brokers charged fees for commissions. That said, customers are likely getting better deals under the current system than when they paid commissions each time they bought a stock. Brokers are supposed to get the best possible price on a trade, and they say they obtain prices for customers than they would get by going directly to an exchange to trade.
Payment for order flow is also controversial because it incentivizes brokers to encourage active trading. Customers who hold stocks for months are not as lucrative to Robinhood as those who make dozens of trades a month, earning the broker commissions with each trade. Studies have shown that novice traders who buy and sell actively tend to trail behind the market. Critics say Robinhood uses visual cues in its app to encourage active trading, to the detriment of its user base.
said over the weekend that what Robinhood does isn’t illegal or even immoral, but that they are “taking advantage of the gambling instincts of society, and it isn’t admirable.”
Robinhood has responded that it doesn’t encourage trading, and that most of its users are buying and holding for the longer term. The company jumped on Buffett’s statement, arguing that the company’s critics are simply wealthy people who don’t want outsiders to be able to profit from the market. Robinhood even put out a blog post in response, saying “people are tired of the Warren Buffetts and Charlie Mungers of the world acting like they are the only oracles of investing.”
Whether or not payment for order flow ends up attracting more attention from Congress or regulators, it could eventually pose a business problem for Robinhood. The company has said it makes more than half of its money from payment for order flow, much more than brokers like
(SCHW), which makes a higher percentage on other activities, such as lending out customer deposits.
Some analysts believe the figure at Robinhood is well above 50%. Bell, for instance, estimates that the number is closer to 70% to 75%, although that is down from her prior call of 80%.
Using those assumptions, it’s possible to derive a rough estimate of revenue for Robinhood, though it is important to note what isn’t covered by the disclosures of payments for order flow. The filing doesn’t include crypto trading, while Robinhood makes money from crypto trading in similar ways that it profits from stock trading. The company said that 9.5 million customers traded crypto on Robinhood Crypto in the first quarter of 2021, compared with 1.7 million in the fourth quarter of 2020. Even excluding crypto, Robinhood likely made more than $400 million in the first quarter, after including money it makes from enhanced services like Robinhood Gold.
The question now is whether the company can keep up that pace while also enhancing services and revenue sources. With the IPO likely around the corner, Wall Street will soon get a chance to bet on the company’s chances.
Write to Avi Salzman at firstname.lastname@example.org