It has recently been reported that retail brokerage company robin hood, is preparing for its own ipo in the coming months, while an official date hasn’t been announced, it could happen within the next few weeks. Robin hood has earned a bad reputation stemming mainly from its incompetent handling of the gamestop situation. Earlier this year, many people on wall street vets have left the platform in protest of this debacle. Despite this, robin hood has continued to grow exponentially with 18 million funded accounts. As of the first quarter of 2021, given the growth potential, we should give vlad a chance to make his case in this. Video we’ll do a deep dive into robin hood’s business and financials to make a price target and determine whether it’s worth investing keep in mind. That we are not financial advisors, and this video is, for entertainment purposes, only make sure to do your own research and consult with a professional before making any investment decision. Robin hood’s business has boomed throughout the pandemic, as people were forced to stay inside and throw their stimulus money into the stock market. At the end of 2019, the trading app had 5.1 million funded accounts once the pandemic started, their user base started to explode and has since tripled to 18 million. Over half of robinhood’s accounts are first time investors. The total value of these accounts has reached a staggering 81 billion dollars. This means that the average robinhood account size is 4 500, their revenue more than tripled in 2020, increasing 245 to 959 million dollars for the year they made 76 dollars per funded account, but with robinhood charging zero commissions per trade it’s important to understand how they make Money they make the vast majority of their money from payment for order flow.
When you trade on robinhood, your order is routed to a market maker who trades against you to understand this let’s. Take a look at a simple example: let’s say you own, a penny stock that you want to sell the bid price is 5.50, which is the best price that you could sell it for the ask price is five dollars and seventy cents, which is the best price That you could buy the stock for you place a market order to sell your shares. The market maker buys them from you for five dollars and fifty five cents, which is slightly better than the best bid. They then turn around and try to sell those shares for 5.65 cents, making 10 cents of profits. They make money from the options in a similar way, while all options are traded on limit orders. The market makers can selectively decide which orders they trade against and can make a profit by flipping them, while they only make a few cents or dollars per trade, when there are millions or even billions of shares transacting. This adds up very fast. They kick back. Some of these profits to the boys over at robinhood. This is payment for order flow, while robinhood technically offers commission free trading it’s not really free. There are market makers skimming a few pennies off each transaction, almost half of their payment for order flow comes from citadel. With susquehanna wolverine and other market makers making up the remainder, robinhood has capitalized off the crypto boom of the past year.
However, crypto is still a very small part of their business. Only making up four percent of transaction related revenues for the year 2020.. The majority of the transaction revenue comes from options. While there is much less options, volume than stock volume options have much wider spreads. This means that market makers can make more money off them and consequently pay robinhood more for the order flow. They also make non transaction based. Revenues 54 of their non transaction. Revenues come from securities lending robinhood lends out their customers, shares to short sellers and keeps all the profits for themselves. If you own heavily shorted stocks such as gamestop or amc on robinhood, they are likely lending out. These shares to the same short sellers that you are betting against. The other. Significant portion of non transaction revenues is margin. Interest from robinhood bold accounts. Robinhood has a pretty steady business model and it’s pretty easy for them to make money if they can keep growing their customer accounts over the first quarter of 2021, the daily active users and monthly active users have started to decline as the economy reopened and people could Go back outside, but they’re likely to keep a lot of the users that they gained over the past year. Despite the protests over the gamestop fiasco, robinhood is still the most commonly used brokerage app on wall street bets. This is a testament of how sticky the app is. Its user interface is quite good and is one of the easiest to use apps out there.
Most people are either too lazy or don’t care enough to switch to a different brokerage. They’Ve also done a great job. At gamifying the platform they use, colorful, graphics and gifs to make the trading experience fun. This keeps people hooked on the platform, making frequent trades and generating more transaction revenue for the company. Another tailwind for robinhood is that their user brace is currently very young as they age they will accumulate more money in their accounts and trade. More volume now it’s time to dig into the financials to find the fair value of the stock. We made a discounted cash flow model to determine the fair value of robinhood stock. All numbers are in thousands of us dollars, except for per share or per user numbers. The first line is the number of funded accounts. At the end of 2020, they had 12.5 million accounts. Currently they have 18 million. I will assume the number of accounts won’t grow in the back half of the year. A lot of new account demand was pulled forward during the pandemic. Now that people are going outside again, there will likely be sluggish growth for the remainder of the year. The number of funded accounts will end the year at 18 million, which is the same number as it is today. After this year, accounts will start growing at a 15 annual rate. As robin hood becomes bigger, they will eventually run into the law of large numbers, and growth will slow by 2030.
They could have 33.5 million accounts which would make them one of the biggest brokerages in the country. The next item to consider is assets per account. As of 2020, the average account size was 6475 dollars. This is much lower compared to other brokerages, as robinhood’s user base is very young. E trade, for example, has 93 000 per average account, while robinhood will probably never get to such a high number. Their assets per account will likely grow as robinhood users become older over time. They will deposit more money into their accounts and their investment returns will also increase their account size. We assume that by 2030 the assets per average account will increase to 40 000 in 2020. Robinhood made revenue per user equal to 1.2 percent of the average account size, as the accounts become bigger, the revenue will likely become smaller as a percentage. If you only have a few thousand dollars in your account, you are more likely to be actively trading your positions once your account size is tens or even hundreds of thousands of dollars. You are more likely to buy and hold for longer periods of time. Less portfolio turnover means less revenue for robinhood, as they make the majority of their revenue from transactions. We assume that revenue as a percentage of account size, declines to 0.8 percent in 2030.. The growth of number of accounts, in average account value, will cause total revenue to increase. We estimate 10.7 billion dollars of revenue in 2030.
in 2020, robinhood managed to eke out a tiny profit with 99 of their revenue taken up by operating expenses as they gain operating. Leverage we assume their operating costs as a percentage of revenue will eventually decline to 60, which is in line with their peers. We assume a constant tax rate of 21, which is the current corporate tax rate. By 2030. They will be making an estimated 3.4 million dollars of net profit after taxes. Currently they have 245 million common shares. With this share count, they’ll make an estimated earnings per share of 13.88 cents in 2030. for simplicity, we assume free cash flow will equal net income. This is a reasonable assumption, because robinhood is a capital light business. We use a discount rate of 10 percent. The discount rate is basically the rate of return that you should expect to make on the stock if it is fairly valued. In this case, we use 10, which is pretty close to the market average. We use the discount factor to price the discount of the cash flows into present value. We assign a terminal growth rate of three percent which is about in line with gdp growth. This gets us to a fair value of 105 dollars per share or a market cap of 25.8 billion dollars when they price the ipo it’s possible that they could do a stock split to make the shares cheaper, so it’s more important to look at the market cap.
While robinhood has not yet priced its ipo, the shares were most recently trading at a 40 billion valuation in the private markets, it’s likely that the ipo will be even higher than that based on our dcf calculation. This would make the company grossly overvalued. So why are investors in the private markets willing to assign a 40 billion valuation to the company? One potential area for growth is international expansion? Currently, robin hood is only available to us customers if they could get approved in other countries. Their users in revenue could surprise to the upside of our estimates. They’Ve been trying to launch in the uk for a few years now, but have so far been unsuccessful. It may be difficult for them to get approved in other countries, given their poor track record with outages controversies around execution quality in the gamestop fiasco. Robin hood’s growth has been impressive so far and they’ve built an incredibly valuable brand. However, their valuation seems a bit stretched if it does ipo at 40 billion dollars of evaluation or higher. I personally would wait for a pullback to get a better buying opportunity, alright, guys that wraps it up for this video. If you enjoy this content, don’t forget to like subscribe and share as always. Thank you.