The New Robinhood: Rob From the Poor to Give to the RichBy Berna Barshay  The poster child for the surge in retail trading over the past year finally went public last week...
No stranger to controversy after its part in the great GameStop (GME) short squeeze of January and starring role in the frenetic pandemic retail trading of dodgy securities like Kodak (KODK), trading app Robinhood's (HOOD) initial public offering ("IPO") stayed on brand and showcased its share of drama. The company broke below its IPO price last Thursday, dropping 8% on its first day of trading. IPOs going bust is common in 2021 – by my count last week, 42% of non-SPAC (special purpose acquisition company) IPOs had busted so far... but it is still pretty rare for an IPO to bust on day one like Robinhood did. According to analysis by Bloomberg, it was the worst first-day performance from an IPO its size or larger ever. It took the title from another brokerage firm, MF Global, which debuted in 2007... Source: Bloomberg MF Global ended up going bankrupt and wound down after liquidity issues were paired with illegal commingling of customer and company funds around four years after its IPO. Lender CIT (CIT) went bankrupt during the global financial crisis in 2009 but emerged after a quick restructuring and is public again. Ride-hailing and food delivery app Uber (UBER) is still trading just below its 2019 IPO price and has been a big underperformer versus the S&P 500 since going public... Regular readers know I remain bearish on UBER shares. If you bought beverage and snack company Pepsi (PEP) back when it went public decades ago, you would be up more than 11,000%... so I guess sometimes the market does get it wrong with being too skeptical. But even considering Pepsi, this club doesn't inspire confidence. Before the first HOOD share traded last week, I tweeted a warning that this deal was not going to go well... (As a reminder, I write Empire Financial Daily Monday through Wednesday and it publishes after the market close. My ability to give real-time commentary is limited by the publishing schedule, so please follow me on Twitter @Hedge_FundGirl for timelier – but less comprehensive takes – on market events.) Unfortunately for retail investors, IPOs are a party you usually won't get the invite to... and if you do get the invite, it's probably a party you don't want to attend. It's unfortunate, but hot deals with shares very much in demand get allocated to Wall Street's highest-paying clients... the hedge funds and mutual funds that pay the highest annual commissions, with perhaps a few shares thrown at ultra-high-net-worth investors that not only trade with the big banks but also take out loans from them or invest in bank-sponsored private equity funds. When retail investors get a big slice of a deal, it's often because Wall Street is "stuffing" them with shares in an unpopular IPO. Many times, a big retail allocation in a consumer-facing company will be spun as a gift to customers, partners, or fans – and on rare occasions, it really is, such as when short-term rental site Airbnb (ABNB) allocated shares to landlords on its network last year. But more often than not, this is just spin. Robinhood likes to say it is democratizing finance, but the IPO brought tons of scrutiny over whether the company is doing more harm than good... Last Thursday, my colleague Whitney Tilson wrote about "the disgrace of Robinhood"... It's a sad day in the investing world as stock trading app Robinhood goes public... Robinhood belongs in the Hall of Shame alongside e-cigarette company Juul and Oxycontin maker Purdue Pharma for pushing products that hurt people. While I agree in principle that demystifying and encouraging broader participation in the stock market is a great end goal – and in fact something I try to do myself by writing the free e-letter you are reading right now – I think Robinhood is going about it in the wrong way... As opposed to trying to educate and inform while entertaining... Robinhood's features attempt to "gamify" trading in a way that makes it addictive. As I explained to a friend, gamification is a great thing when the game is trying to make you form good habits. An app pushing you to do something frequently and consistently is awesome when you are trying to form a good habit like learning a new language on Duolingo (DUOL) or logging healthy eating on the Weight Watchers (WW) or Noom apps. It's not so great, though, when it's pushing you to trade more, especially in speculative securities like meme stocks. Academic studies reliably produce evidence that overtrading reduces returns for retail investors. There is some delicious irony in Robinhood having a rough go of it in the speculative and volatile IPO market it helped create. I published this jaw-dropping Twitter exchange I saw with Robinhood customer service back in December, but the momentous occasion of the Robinhood IPO makes me think this gem merits a reprint (with the customer's handle blocked to protect the ignorant)... Source: Twitter.com/@AskRobinhood
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Encouraging self-destructive behavior is usually not a great business model, but sometimes it works... Cases in point: casinos, tobacco companies, alcoholic beverage makers... I could name more. So, in examining whether investors were right to show some stone-cold skepticism to HOOD shares on day one... let's take a look into the companies 360-page S-1 filing. I don't have room to do a comprehensive dive here, but I will pick out a few red flags. First, there are the fines. $70 million to the Financial Industry Regulatory Authority ("FINRA") for "widespread and significant harm" to customers after giving them false information about their accounts, the fallout of which tragically included the suicide of a 20-year-old viewing an inaccurate $700,000 loss in his account. FINRA announced the day before the IPO that it is also investigating Robinhood's founders for failing to get broker-dealer licenses. Then there's the $65 million fine Robinhood paid to the Securities and Exchange Commission ("SEC") for failing to disclose details about its "payments for order flow" deals. In spread markets, like options, non-executing brokers like Robinhood will sell customer orders to the highest bidder... The winning bidder may not be offering the best price for the trade. This practice is why "free" trading isn't really free, and it's also the inspiration for a whole genre of memes... Source: Twitter.com/@unusual_whales Speaking of payment for order flow... this can be particularly lucrative when it comes to options. In fact, options only account for 3% of customer assets at Robinhood... but they account for 46% of customer transaction revenues. Options are of course highly leveraged, speculative investments, better left to professional or experienced amateur investors... yet Robinhood users are clearly trading them with massive velocity. I would counter any pushback suggesting that the Robinhood investor base is in fact more experienced than I give it credit for with the facts that its average account size is less than $5,000 and its median customer age is 31. Robinhood customers are also trading cryptocurrencies like crazy, as Twitter user @ChrisBloomstran points out... Source: Twitter/@ChrisBloomstran @ChristBloomstran notes that the company's Chief Legal Officer, Daniel Gallagher, was granted stock worth nearly $100 million despite having only joined the company last May. Not a bad haul for a little more than a year's work, but with all its legal issues, I'm sure Robinhood thought it was getting a bargain paying so little for a former SEC Commissioner, which Gallagher was from 2011 through 2015. And if there were any question, this Twitter thread will disabuse you of the notion that Robinhood shares were priced like a bargain because of all of the hair on the company... Source: Twitter/@ChrisBloomstran There is so much more not to like here, and I will refer those who want more of the weeds to jump into @ChrisBloomstran's excellent tweet thread here. Robinhood has clearly enriched its founders, early investors, and even some latecomer employees... But it's pretty likely that very few users are getting anything close to rich using its app... It doesn't shock me that people are seeking overnight explosive gains in cryptos, speculative meme stocks, and options – especially when you think about the Robinhood customer. If you're a 30-year-old with only $5,000 to invest – and have little opportunity to save and add to that pot – even with a market-beating return of 10% per year, every year (something almost no professional investors can achieve)... when you're 65, you will have turned that $5,000 into $135,000. That's impressive compounding, but hardly the stuff of retirement dreams. People living hand-to-mouth and making low wages have the choice of either a lottery ticket or a casino – or now, a stock market casino! – to earn their way to financial independence. Robinhood turns the stock market into a casino... which is what people want, even if it might not be good for them. New York University Professor Scott Galloway summed up last week's blast e-mail, which focused on Robinhood, with the following observation... We've implemented policies in the U.S. that have resulted in a halving of the wealth of Americans under the age of 40 (as a percentage of household wealth) over the past three decades. With so much less to lose, today's young Americans are justifiably looking for new asset classes and embracing volatility. Put another way, there is cause for a rebellion. The food industrial complex wants you to be fat, social media wants you to be divided, and RH wants you to believe you can get rich quick by day trading. Rebel. And it looks like we may be at the early stages of a rebellion, as @ChrisBloomstran notes... Source: Twitter/@ChrisBloomstran It's possible the first quarter uptick in customer churn was a one-time, non-recurring response to the GameStop debacle, but there is ample evidence that eventually consumers experience an epiphany and abandon addictive things that are bad for them, at least some of the time... See the multi-decade decline in the volume of cigarettes and sodas sold in the U.S. for evidence. Robinhood is an expensive stock with a shaky business-model from a regulatory standpoint... and it's profiting off the desperation of people with limited means and financial literacy. HOOD shares rallied as much as 8% today and closed in on their $38 IPO price. Even if this IPO manages to "un-bust" itself, stay away from HOOD shares. There are plenty of less ethically challenged companies like Fidelity and Vanguard that will let you trade for free... and if you prefer an app that is "not your dad's broker," alternatives like Public don't sell customer order flow. Robinhood's customers will ultimately figure out that the game here is to steal from them to pay the rich. In the mailbag, readers react to the essay on "drunk shopping"... Do you think that financial institutions have a fiduciary responsibility to prod their customers into fiscally responsible behaviors... or do you think Robinhood's gamification of trading is fair game? Would you feel comfortable using this app? If not, why not... is it the payment for order flow, the regulatory fines, the interface, the GameStop restrictions in January, or something else that bothers you? Share your thoughts in an e-mail to feedback@empirefinancialresearch.com. "as someone who is drunk adjacent while reading this, i really enjoyed the article. "many times i have been at sober wit's end, what to purchase as a gift, usually for my wife, so after a few, bourbon siren of choice, i lazy river the always accommodating amazon (AMZN) and it gently directs me to potentially relevant purchases. "the dumbest thing: one time i bought the same damn top twice, a month or so apart! upon glorious presentation sand gently said, 'lovely, but you already gave this to me.' "on another topic, thanks for your tomra recc, made over 1000. are u still positive? "stay well, safe and your family and enrique and whitney et al too. "thanks for your help." – Dave K. Berna comment: Dave, I have to tell you this was one of my all-time favorite reader letters, for both its searing honesty and that incredible use of "lazy river" as a metaphorical verb. Since you admitted to being drunk-adjacent, I did not edit punctuation or capitalization, so the letter could maintain its authenticity and impact! As for Norwegian recycling equipment maker Tomra Systems (TOM.OL) – which was the idea I gave away for free to anyone who watched our September webinar on how to make money off the coming Blue Wave – the stock has done great... It's up 44% since mid-September and closed at an all-time high today. While it is by no means a cheap stock, trading at 30 times next year's earnings before interest, taxes, depreciation, and amortization ("EBITDA")... it is the leading supplier by a mile in a market that is guaranteed to grow. With the EU mandating increased use of recycled plastics over the next decade – and other countries following suit – the demand outlook for the company's products is excellent for the foreseeable future. This company is the ultimate example of impact investing... It runs a business that makes the world a better place. And unlike many companies that qualify as impact investments, this company is profitable... and will double its earnings between 2018 and 2023. I'm still bullish even after its run higher. "If I wasn't a tech dinosaur waiting for my asteroid, I'd consider designing an app to monitor/prevent Shopping Under the Influence. Of course I'd be banned from Amazon." – Joe R. Berna comment: I know a lot of people who could use that app, Joe! Regards, Berna Barshay
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