The Biggest Risk to Robinhood’s IPO

Lou Basenese

Tuesday, July 27, 2021

One of the year’s most anticipated IPOs is set to debut on Thursday.

I’m talking about the company leading the retail trading phenomenon, Robinhood Markets (Proposed Ticker: HOOD).

While the trend is certainly working in the company’s favor (retail trading now accounts for over 22% of daily volume, up from about 10% a decade ago), I wouldn’t touch this stock.

I don’t even need to put it through our rigorous five-point IPO screening process. A single characteristic of the IPO makes it immediately apparent to me: this is a stock to avoid.

Of course, management wants you to believe the opposite — that an obvious and massive risk is instead a major benefit. Nonsense!

And now, to ensure you don’t buy into a supposedly “hot” IPO that does nothing but flop, let me give you the truth about this situation…

It’s Demand — Not Access — That Matters Most

Headlines abound about how Robinhood plans to use its IPO to further its mission “to democratize finance for all.”

You see, it’s allowing its customers to buy as much as 35% of the shares offered in the IPO.

“We anticipate this would be one of largest retail allocations ever,” said Chief Executive Vlad Tenev. And “largest” is an understatement…

When companies decide to offer shares to “friends and family” like their employees and customers, it’s typically around 1% to 2% of the deal. And even then, it’s rare. So 35% is off the charts.

But here’s the thing: every time I’ve seen a company make such offers, it’s been a tell-tale sign of weak institutional demand — and ultimately, institutional demand is what drives IPO markets.

As such, expanding access to customers (i.e., retail investors) represents a major IPO red flag.

It often foreshadows poor stock performance, which explains why this feature of IPOs comes and goes like any other investment fad. If retail investors are going to fall for it again, they need time to forget that it doesn’t work!

But Wait, There’s More

I’m even more convinced this is what’s going on at Robinhood because the company confidentially filed its IPO all the way back in March. That means management “tested the waters” by pre-marketing the IPO to leading institutional investors.

There’s absolutely no way management would decide to give 35% of its IPO shares to (in their own words) “random” customers if high-quality sophisticated institutions were clamoring to buy the IPO.

This leads me to believe that institutional demand in March was tepid at best, which is why management is resorting to Plan B: leveraging its massive retail trading army for the ultimate self-serving purpose of creating demand for its own stock.

Don’t fall for this marketing trick!

Just like with Facebook — if you don’t pay to use the product, you are the product.

Robinhood’s rare IPO feature is yet another example of how the company isn’t truly interested in benefiting Main Street. It’s just trying to make money off Main Street by getting paid for order flow, this time for its own stock.

But even if that wasn’t the case, I’d still be skeptical of the IPO. Why?
Because of the company’s massive and widening losses, and because of its inflated valuation, which is nearly 2x the price-to-sales ratio of The Charles Schwab Corporation (SCHW).

And now that you know the truth, you know exactly what to do with this IPO: avoid it.

Ahead of the tape,

Tags: ipos robinhood