Description

Recommendation: Long Robinhood Markets Inc.

Upside: $15-$20 in a base case, higher if turnaround succeeds; Downside: $6 of net cash per share.

The market has shifted radically over the last 9 months, from celebrating the excesses of growth at all costs, to treating any cash-burning business as a sinking ship, with no hope of recovery. Many formerly high-flying tech companies are modern day "net net's", trading well below replacement cost / the aggregate capital that has gone into their businesses. Some of these justifiably so, but others have been sent to valuation purgatory unfairly.

Robinhood is one of the best consumer products of all time, and the market is currently valuing it's ongoing operations at just over $2bn, well below takeout value, replacement cost, and what it is reasonably worth as the business starts to turn the corner toward profitability.

While there are a number of businesses that pursued growth at all costs depsite unit economics that only made sense in distant theory, Robinhood is not that. While retained earnings are -4.5bn implying there has been heavy investement to become one of the leading financial services platforms, the business can be profitable in the future. Brokerage and financial services broadly can be immensely profitable if bundled properly and operated efficiently. Robinhood has certainly made a range of missteps - first focusing too much on short-term gamification, and second focusing to an obsessive degree on the design of the product over the economics - while having the best designed consumer experience is great, in financial products the economics tend to rule the day for winning customers, especially the large $ accounts in either investing or banking.

Robinhood in its current form is a turnaround play, with optionality on a potential acquisition, and presently being valued by the market with barely any ongoing value.

Robinhood has to take a few critical steps to start to turn the corner toward profitability:

1) they must radically reduce expenses - the recent layoffs do not go far enough - they need to cut G&A / Tech Development costs another 40-50% to reflect their current lower revenue baseline in case revenues take longer than expected to recover. They also need to aggresively pare back SBC which is still at legacy, elevated levels.

2) they need to aggressively pursue the power traders and larger accounts from the legacy brokerage platforms like Schwab, TD, Etrade, and IBKR. Robinhood has the best designed investing experience on the market, hands down. But they have prioritized design over ensuring that they are economically among the most competitive on the things that matter to larger $ accounts - competitive interest rates, margin rates, stock borrow availability, options pricing, etc.

3) repair the brand so it is seen as a bona fide financial institution consumers trust - too much focus on cryptocurrency, gamification, have pidgeonholed them as more of a gambling platform than a bank-like institution - they have enough brand recognition and a high-grade enough product to turn this around, but have to focus more on multi-product attachment acrosss financial products vs. cryptocurrencies like dogecoin

If they can execute well on those 3 objectives, Robinhood can double from current levels. If they cannot which is a real possibility, then there are two downside protections:

1) Robinhood is an attractive activist opportunity - while voting is controlled by the founders, it is still a classic situation of a company that has lost its way that needs a reality check to maximize value - calls to cut costs, buy back shares at current depressed values, pursue strategic alts, can be very impactful

2) Robinhood is an attractive takeover target at current levels for both strategics and financial investors - Robinhood is still by far the best investing product in the US market - many others in the space would happily want to own the platform, especially for buying it well below replacement cost. Additionally, given Robinhood has $6bn of cash and an EV of just over $2bn, it could set up well for an LBO or a takeout by a tech-focused private equity firm who can do the necessary cost rationalization and economic optimization that needs to happen. In this case the stock is still worth $15-$20 based on precedent transactions and napkin LBO math. Precedent transactions have occurred at ~6-8x revenues. FTX has already been reported as being potentially interested and SBF personally bought ~7.6% of the company. https://www.bloomberg.com/news/articles/2022-06-27/bankman-fried-s-ftx-said-to-be-seeking-path-for-robinhood-deal FTX has a large cash pile and could get a deal done at a reasonable premium to current levels. There are likely a number of other bidders that would be interested as well - either brokerages or banks or other financial conglomerates.

Key Risks:

-turnaround fails and M&A / activist fail to materialize

-PFOF - this is a real risk but unlikely anything major happens in the near-term; even if it does, they can likely find other ways to monetize the trading volumes

Catalyst

-progress on turnaround

-stock trading activity recovers over time and Robinhood returns to growth

-M&A / activist materializes