Investing in Robinhood's IPO gives everyday investors a chance to be part of a significant financial event. This trading app plans to make its initial public offering (IPO) accessible, allowing users to buy shares when it debuts on the Nasdaq under the ticker HOOD on July 29, 2021. However, the actual opportunity for most users may be limited.

Robinhood's approach marks a shift from traditional IPOs, which typically favor exclusive clients and institutional investors. But for average users, the likelihood of securing shares might still be low. Let's explore how Robinhood's unique IPO structure operates and what potential returns could mean for you.

Understanding Robinhood's IPO: Essential Details

As one of the standout IPOs of 2021, Robinhood's offering is positioned amid a record year for IPOs. The company has gained both fame and infamy, especially highlighted by its involvement in the GameStop trading frenzy. While the app markets itself as a platform for democratizing investing, it now faces scrutiny as it prepares for its own stock launch.

Unlike conventional IPOs where shares are primarily reserved for insiders, Robinhood plans to allocate up to 35% of its offering for its customers through its new IPO Access initiative. This means a portion of the shares will be available to its users, enhancing the platform's ethos of democratizing finance.

However, the selection process for who gets to buy shares is randomized, and initial estimates suggest individual investors might receive minimal allocations. With 60.5 million shares up for grabs, customers could collectively access around 21.2 million shares in a best-case scenario. Given Robinhood's 22.5 million funded accounts as of June 30, this translates to less than one share for many users.

Even if the company were to select just 1% of its users to participate, the average allocation would still be under 100 shares. Thus, while Robinhood aims to broaden access to its IPO, the actual impact for most users may be minimal.

Experts acknowledge this limitation but note that even a small number of shares can be significant for Robinhood's typical user, who often trades smaller amounts compared to clients at larger firms like E-Trade or Charles Schwab.

5 Challenges Facing Robinhood's IPO

As with any IPO, Robinhood has its share of challenges that investors should consider.

1. Valuation Concerns

Robinhood aims to price its shares between $38 and $42, setting its market capitalization at around $35 billion. This valuation raises questions, especially when compared to established competitors. For example, Robinhood's assets under custody total approximately $102 billion, while Charles Schwab reported a staggering $6.69 trillion in client assets.

Brokerage Client assets Market capitalization Market cap/$1,000 in assets
Robinhood $102 billion $35 billion* $343
Charles Schwab $6.69 trillion $128 billion $19

* Based on IPO target price

This comparison illustrates that investors would pay significantly more for Robinhood's assets than for those of Schwab. Additionally, Schwab's diverse revenue sources, including management fees and interest income, contrast with Robinhood's current revenue model.

2. Profitability Outlook

Potential investors will want clarity on Robinhood's profitability, which may not be readily available. In 2020, the company reported a profit of $7.5 million after a substantial loss in 2019. However, 2021 projections indicate significant losses due to rising costs and accounting adjustments.

Despite these challenges, revenue has surged, with estimates showing a 129% increase in the second quarter. If this trend continues, Robinhood may maintain profitability in the long run, but its financial history remains inconsistent.

3. Dual-Class Shares

Robinhood operates with a dual-class share structure, which can deter some investors. This system allows insiders to retain greater voting power, which could limit the influence of average shareholders. Insiders hold Class B shares with ten votes each, while regular investors receive Class A shares with just one vote.

4. Investor Behavior

Offering customers access to a portion of its stock is a bold strategy. However, there's uncertainty regarding how these investors will behave post-IPO. Will they sell their shares quickly for short-term gains, or will they hold them long-term? The market's reaction could significantly influence the stock's performance.

5. Revenue Model Risks

Investors should scrutinize Robinhood's reliance on payment for order flow, which accounts for 81% of its revenue. This practice involves receiving payments from trading firms for routing orders, which poses potential conflicts of interest. As regulatory scrutiny increases, any changes could impact Robinhood's business model.

Final Thoughts

When considering Robinhood's IPO, investors should reflect on the motivations behind the offering and the timing. The current market conditions, buoyed by low interest rates and government spending, make it an opportune moment for the company to capitalize on its popularity. Ultimately, while Robinhood's effort to include customers in its IPO might seem noble, it also serves to bolster its financial position during a peak market period.