Robinhood (HOOD) and its IPO

HOOD is an online broker that has carved out a niche for itself by marketing its services to younger investors, a group badly served by long-standing online “discount” brokerage services like Fidelity or Charles Schwab. The latter group, as I see it, caters almost exclusively to an older, more affluent clientele and competes directly against much higher-cost traditional “full service” brokers like Merrill Lynch or JP Morgan, who maintain physical offices, research capabilities and a staff of highly-compensated, commission-based sales representatives. (Btw, during the twenty years I managed equity mutual funds sold through the “full service” channel, I routinely heard two complaints from brokers: their clients maintained parallel discount brokerage accounts, where they kept most of their money (to avoid the high “full service” fees); and no matter how good the investment performance for their parents, clients’ children refused to open “full-service” accounts.)

So HOOD is a very smart idea, in my view.

HOOD also made a brilliant name selection, connoting counter-culture, integrity, self-sacrifice and defense of the interests of ordinary people against a powerful evil, predatory establishment.

the offering

Last week, HOOD went public, using establishment brokers Goldman and JP Morgan to lead a traditional IPO. The announced price range was $38 – $42. The company came public at $38 a share, the low end of the range. There was reportedly little interest from mutual funds and pension plans.

One of the peculiar features of a traditional IPO is that the managers are allowed to “stabilize” the stock price during the initial day of trading. That is, they are allowed to buy stock at the offering price in order to prevent the issue from falling below that level. The brokers get the money to do this through an “overallotment,” the amount of which is disclosed in the prospectus. In HOOD’s case, this was 5.5 million shares, or 10% of the offering.

(the overallotment process: the underwriters place, in this case, the 55 million shares in the offering plus the 5.5 million overallotment to buyers, for a total of 60.5 million shares. If the offering goes well, the underwriters get an extra 5.5 million shares from the company. Those go to buyers and the money goes back to the company. If the offering goes poorly, as the HOOD offering did, the underwriters buy stock in the market, up to the overallotment limit (here, 5.5 million shares) and deliver them to buyers.)

Total volume in HOOD on the offering day was 102.5 million. Sellers overwhelmed the stabilization effort, with the stock reaching an intraday low of $33.35 and closing at $34.82.

how so?

Press reports say institutional investors decided to stay away from HOOD on the worry that two big sources of the company’s income–selling customer orders to third parties for execution, and making it super-simple for customers to trade in unhedged stock options (generally regarded as an ultimate dumb-money thing to do)–could invite government scrutiny …and new regulations that would end these practices.

Personally, I’m not a fan, but for slightly different reasons.

My overall impression about HOOD, from opening an account (which I haven’t used) to reading about the company in the financial press, is that the overall goal of the founders is to separate their clients from their money as quickly and fully as possible.

What makes me say that? …the young customer who killed himself over assumed losses because there was no customer service on the weekends; the halt to GameStop buys because of insufficient infrastructure (credit lines); the way my account approval for options trading was jetstreamed and I was pointed toward them as an investment. There’s also the issue that HOOD’s two big features, options and the sale of order flow, are both, in my view, bad for clients even though they make lots of money for HOOD’s founders. One could argue, as well, that in the GME trading halt incident, HOOD protected the interests of big hedge funds at the expense of their customers.

As a human being, I’ve decided that HOOD should not get my capital, in the same way I won’t buy tobacco companies or News Corp. As a professional investor, my observation is that companies that have the sort of indifferent or adversarial relationship with customers that I think HOOD has tend to trade at considerably lower PE multiples than those whose attitude is that we’ll all make gains together from our interaction. They also leave themselves much more open to competition.

What’s going on with HOOD now–up by 24% yesterday and another 16% in the pre-market today? My guess is that it’s the latest meme stock, GME all over again.

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