July 24, 2021
Yesterday, Executive Editor Kim Iskyan started a deep dive into stock trading app Robinhood’s recent massive IPO announcement. (Did you miss it? Need a refresher? Read that essay here.)
So should you buy shares of Robinhood (or any other IPO)? Kim poses nine questions to ponder before you do.
And here’s the rest of the story…
5. Are the shares expensive or cheap?
Robinhood is aiming for a valuation of around $35 billion. That means that at the forecasted IPO share price, multiplied by the total number of shares outstanding, the entire company will be worth around that much. (Of course, that will change once the shares start trading.)
That sounds like a lot (it’s more than Nasdaq, which is a traded company, for example). But that figure alone doesn’t tell us anything about whether the shares are cheap or expensive on a valuation basis. If I told you that I just bought a car for $25,000, and asked you for your thoughts on whether I got a good deal, you’d need to know some more details before you could give me a reasonable answer. New or used? ’85 Corolla or ’21 Bentley? Four wheels or three? Brakes or Fred Flintstone-style?
For a stock, these details would entail looking at the financial statements and a range of financial and valuation multiples (like the price-to-earnings, or P/E, ratio), as well as industry-specific factors… like, say, revenue per user. An important question would also be the comparables universe of the stock – the other companies in the sector (and how that sector is defined) that are the valuation benchmark. Robinhood is probably best compared to other online brokers, like Charles Schwab, for example… though it’s also a fintech company, which has a different set of parameters, and valuation benchmarks.
For a high-growth company like Robinhood, another central issue is how much growth is being built into the valuation. How large and profitable does Robinhood have to become – and over what time period – for a $35 billion valuation to be reasonable? (Short answer, big, and very, respectively.)
(Worth noting… back in December, Reuters reported that Robinhood could be valued at $20 billion in what was a targeted first-quarter IPO… Now it’s happening in the third quarter of the year – at nearly twice that level. Not bad for a few months of delay.)
6. What about fees?
Once upon a time, investment banks made a killing on initial public offerings. They could regularly earn around 7% of total proceeds, though that could vary according to the size of the deal.
Incredibly – talk about an industry ripe for disruption – investment banks still earn, on average, around 5.5% of funds raised in IPOs, according to CNBC. Fees amount to a smaller percentage, but a bigger absolute sum, for larger IPOs… For example, banks skimmed only 2% of the $4.4 billion offering of Chinese ride-hailing company Didi Chuxing, but closer to 7% for biopharma company Aerovate Therapeutics’ $140 million offering, both of which took place in late June.
But as an investor, you can’t control this… And while you can be annoyed, you can’t do much about it. Robinhood’s anticipated IPO will likely generate fees of around $70 million for its bankers. That’s just the way it is.
(Until, that is, the blockchain bigfoots the antiquated way that companies go public. It’s coming, and when it does, you’ll see a lot of prematurely balding 30-something mid-level bankers – the type who take solace in their Rolex for not having a life – discovering that their skills aren’t remotely transferable to anything else.)
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7. What rights will you have as a shareholder?
Traditionally, when companies issue equity to shareholders, those shares come with voting rights. “One share, one vote” used to be the conventional wisdom underpinning corporate governance.
That, though, was yesterday. Google (now known as Alphabet) led the charge in 2004 for what has become a common practice in technology IPOs of issuing different classes of shares with different voting rights. Google, for example, issued Class A common stock for new investors with one vote per share. But the companies’ founders retained Class B common stock that carried 10 times the number of votes per share.
Facebook did something similar. Company CEO and co-founder Mark Zuckerberg owns around 13% of the company’s shares (if you’re counting at home, that’s worth $128 billion) – but controls 60% of the voting rights. If something feels a wrong with that, go with your gut.
But that’s child’s play compared to chat app Snapchat. Its 2017 IPO was structured in a way that new investors bought shares with no voting rights at all – leaving control of around 90% of the company in the hands of its small handful of (then) 20-something founders.
After the IPO, taking into account incentives and restricted stock, the two founders of Robinhood will each own a 7.9% stake. Thanks to the magic of different share class structures, though, they’ll together control 65.2% of the voting power.
As an investor, you’re always putting a lot of faith in the people who run the company. If they don’t perform, though (even if they’re paid very well), they can be kicked out.
But in the case of some tech companies, and Robinhood, that isn’t a realistic option: Voting power is what matters. You’re stuck with the man.
8. How high is the corporate bullshit factor?
Google famously encapsulated its corporate philosophy in the prospectus of its 2004 prospectus as “Don’t be evil.” And then it went on to create one of the world’s fastest-growing businesses by harvesting the personal data of its users and selling it – manipulating, and allowing its customers to be manipulated, on a vast scale and to an unprecedented degree.
Google is a for-profit company, and yes, its customers – me, you, all of us – have allowed ourselves (our interests, our concerns, our thoughts, the deepest secrets that only our browser history knows) to be strip-mined by Google. More so than most for-profit enterprises, though, Google is more evil than not evil. By 2018, the “Don’t be evil” phrase was moved to the very end of the company’s code of conduct as a throwaway line.
Robinhood says that its mission is to “democratize finance for all.” And that’s far more dangerous than that sounds, as marketing guru, market maven and podcaster Scott Galloway explained last year, focusing on the addictive nature of Robinhood’s interface…
“[Robinhood’s mission statement] is similar to Pablo Escobar saying his mission was to “democratize cocaine”… Providing people access to the tools of finance is a worthwhile mission… Robinhood, on the other hand, is the Sith Lord of finance – monetizing the addictive nature of day trading. Day trading is gambling. And it doesn’t pay off.”
If you can hold your nose through the corporate bullshit… good for you. But Robinhood’s stench will make your eyes water.
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9. Will the shares rise?
This is what it’s all about in the end, right? And here, Robinhood just might have a unique ace in the hole.
Earlier this year, amateur speculators gathered on message-board website Reddit to orchestrate squeezes on beleaguered stocks – like GameStop, AMC, Blackberry, and others – that were being targeted by short-selling hedge funds. Many of these speculators – whose influence has spread far and wide in markets since then – are young people relatively new to investing. And many of them were introduced to it through… Robinhood.
What better “meme stock” – that is, a stock that skyrockets on the back of viral social media activity – than the main host of meme stocks itself?
It’s in the spirit of Dick Cheney heading up George W. Bush’s committee to find his best vice-presidential candidate – and discovering that in fact the most qualified guy was Cheney himself. It’s like the guy responsible for reading out the numbers from the rotating bingo ball cage calling out the lucky word from his own card.
There would be something so satisfyingly circular about HOOD (that will be its ticker) doubling on its first day of trading because of all the buy orders coming from… the Robinhood platform. And rising, GameStop-style, into the stratosphere because, you know, Robinhood…
And that would be enough to make all those other eight questions not matter at all… for now.
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July 24, 2021