Who Will Buy Robinhood?

Of Jason Bisnoff

Last week there were rumors that cryptocurrency exchange FTX might be looking to buy Robinhood as its share price continues to fall. Despite denials from FTX founder and CEO Sam Bankman-Fried, the idea raised questions: whether the brokerage is for sale and who might be interested in buying it.

In a report by investment bank JMP Securities on the potential sale to FTX, analysts at subsidiary Citizens Financial said there was little chance of such a deal going ahead, in line with public denials by Bankman-Fried, which bought a 7% stake .6% in Robinhood in May, sparking talk of a takeover.

The note in question attributed the interest in Robinhood in part to the drop in its stock, which was priced at $38 for its IPO, hit a high of $55.01 a week later and today trades at $8.97.

Robinhood’s market capitalization is currently just $7.8 billion, potentially making it an easy target for a much larger financial firm such as Morgan Stanley, Charles Schwab or Citadel Securities.

Analysts at JMP Securities see some value in the market for the world’s second-largest cryptocurrency exchange with the opportunity to gain a significant US retail customer base, a complement to its current business model, despite any opacity because FTX is private.

Robinhood’s 15.9 million active accounts are currently valued at less than $500 per customer versus $3,600 per customer for Charles Schwab. When Morgan Stanley acquired E-Trade in 2020, the price was $13 billion which meant a value of about $2,500 per customer.

When presented with these numbers, JMP Securities director of financial technology research Devin Ryan acknowledged that while these Robinhood customers are currently worth less based on the average customer’s account balances, any buyer will invest in the potential for these new customers to earn more and in turn depositing more on the platform as they grow.

The big question is whether Robinhood can develop more services to retain these customers as their investment needs become more complex. Ryan points out that Schwab’s numbers are inflated by the escrow accounts of registered investment advisors (RIAs). that use the platform, the kind of more advanced services that Robinhood could aspire to add in the future.

Despite what co-founders Vlad Tenev and Baiju Bhatt have built, Morningstar director of equity research Michael Wong sees Robinhood as a unique company, with “not as many applications as a more typical retail broker” when it comes to a takeover case. However, Wong admits there may be some buyers who see this unique placement as a really great asset to own.

The big wealth management players on Wall Street have swept the market in recent years through both acquisitions and internal investments. This was done, for example, by Morgan Stanley who bought E-Trade in 2020, Goldman Sachs who developed Marcus over the past six years and Bank of America who invested in Merrill Edge.

Coupled with a stated desire to attract more new customers, a Robinhood takeover could be tempting, with Jim Cramer pitching Goldman Sachs as “a good suitor” on CNBC last week.

“The best asset is the customer base,” says Columbia University economics professor RA Farrokhnia, pointing to Robinhood’s millions of mostly younger customers, many of whom have a negative view of financial services. “The bigger Wall Street firms have had a hard time attracting the younger generation, and the hope is that you keep them as clients as they get older, and as they have more assets to invest, you can build on that relationship for a long time.”

Wong points out that the very low balances that are unlikely to move from retail accounts to RIA accounts in a short period of time mean that Robinhood’s clientele is not a good fit for these big wealth management players.

Asset management firms have become interested in the robo-advice sector, seeking a more direct relationship with clients that will not be disintermediated by brokers and the aforementioned wealth managers.

However, this heavily derivatives and cryptocurrency trading client base is not ideal for the world of buy-and-hold mutual funds. The trend towards self-directed investing makes this client pool a tough case for asset and wealth management firms.

Looking at other retail brokerages, size simply isn’t attractive enough for companies like Charles Schwab, according to Wong, especially after its acquisition of TD Ameritrade, which had 11 million active accounts, in late 2019. Wong says that customer acquisition costs would be high for Schwab.

Robinhood’s tarnished reputation can also act as a deterrent for businesses that fear public, or worse, regulatory backlash. A little over a year ago Robinhood paid its largest-ever fine to the Financial Industry Regulatory Authority for outages and misleading customers, and just last month a congressional report detailed the company’s failings in meme stock frenzy of the previous year.

A potential suitor that would make sense is a high-frequency trading firm like Citadel Securities. Despite this synergy, this type of acquisition would likely face the highest level of scrutiny. Any deal that would bring these two parties closer together would be met with skepticism not only from the public but likely from the Securities and Exchange Commission as well.

Perhaps the best solution, Wong surmises, would be a smaller bank with sufficient capitalization to absorb Robinhood looking to add a retail arm or an international firm looking to gain a foothold in the US.

Despite its share price woes, Robinhood boasts a customer base of 22.8 million funded accounts, net deposit growth of 30% year over year in 2022 through May and $6.2 billion in cash and equivalents in its balance sheet.

Perhaps the answer is that Robinhood doesn’t need to be sold to anyone and can use its cash hoard to tide it over, which JMP analysts see as a potentially valuable strategy as worse-off rivals don’t. they succeed.

Ryan points out that co-founders Vladimir Tenev and Baiju Bhatt still own a significant equity stake in Robinhood and control their company’s fortunes. The fact that they have not sought a suitor means that any purchase could come at a high price. For Ryan, it’s about founders still believing in the underlying ethos of “democratizing finance” on which the company was founded. He also points out that everyone has a price.

Currently, he and his fellow analysts have a market outperform rating on Robinhood with a price target of $36.