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Robinhood Update - July 29th It Is.

Isaiah Chapter 41 verse 10 states, "So do not fear, for I am with you; do not be dismayed, for I am your God. I will strengthen you and help you; I will uphold you with my righteous right hand."


There's a lot in life that creates fear, especially as we get a little older. This really hits home as we've all gone through a very difficult past year and a half. But God's word promises that He will be there during my time of need. In fact God is with me whether rain or sunshine - it is up to me to believe what His word says. Jesus Christ promises that death is not the end, based on this, I need not fear anything (boy do I fall short though).


I see a strong parallel here with investing. There's always a lot to worry about from each day's information, just the same as in all aspects of life. The key is recognizing and highlighting key areas of focus, and consistently understanding risk versus reward. Having the right metrics in place can serve as a guide to consistently revisit the investment opportunity, and company execution based on set targets. Like continually going back to God's word during times of need, I also need to continually revisit key metrics and targets.


I wrote a blog on Robinhood Markets, Inc. (HOOD) July 1st as the initial S-1 was filed. the Amended S-1 was filed July 19th and we've now got all the pieces we need to make final conclusions before the company begins trading - recently stated to be July 29th.


Like many new IPOs, I begin by deconstructing the company's key operating segments, while forming an opinion of financial strength and ability to generate Cash Flow. As part of this, the recent blog provided a review of the fundamental snapshot, important financial line item considerations, and a preliminary forecast. For this update, I will provide a revised fundamental snapshot and preliminary forecast. I recommend readers review the initial blog to get up-to-speed on the important financial line item considerations as these explanations remain the same, and are important to understand Robinhood's future investment potential.


Revised Financial Snapshot

Per the Amended S-1 filing, Robinhood has provided the number of Shares Outstanding, up to 841 million, and Stock Price, SP information with a current ceiling at $42 per share. I don't see Robinhood pricing before its first trading day below $42, so I'm going to assume that the company will raise a minimum of $2.1 billion. From this capital raise, Robinhood expects to repay approximately $342 million for borrowings related to fund anticipated tax withholding and remittance obligations. That leaves a net capital raise amount at just below $1.8 billion.

My initial reaction to this pricing is that at around $42 per share Robinhood is valued fairly, especially when considering the preliminary forecast below and future potential. Financial strength is improved greatly with Net Cash at $5.4 billion, more on this later. Valuation multiples are also lower from the initial review at 22 times EV/Revenue and just over 65 times OCF per share, with a $30 billion EV.

Not much as changed on the other financial details side above, simply the Adjusted OCF/FCF per share information. The key component is revisiting the OCF/FCF rationale. As discussed last time, Robinhood has line items on the B/S that impact its operations directly, as well as its customer accounts. I've taken the liberty to segregate the working capital line items from the Statement of Cash Flows between what transcends both Robinhood's operations and customer accounts (regular OCF/FCF), versus what only impacts Robinhood's business explicitly.


It may seem a bit odd at first glance, as one could question how the two can be separable. But based on Robinhood's increase in trading volume and timing of Receivables from Users, Net increase, I suspect that the company will see lumpiness on a quarterly basis for Cash Flows, especially as Q1 2021 witnessed extreme trading gyrations related to public companies like GameStop Corp. (GME) among others. Receivables from Users, Net are primarily made up of margin receivables, and it is clear that an inverse relationship occurred during Q1 2021 versus the prior two years. For all of 2021, we may see a return to normalization between regular and adjusted OCF/FCF, but I still don't see how I can use a valuation where OCF/FCF are larger than Revenue. To me this is the biggest red flag that an adjusted metric is required, similar to Coinbase Global (COIN).


Importantly also is Note 10 in the Amended S-1 which states that Robinhood will be converting $3.6 billion of convertible notes into shares of Class A common stock as part of the IPO, further reducing debt. This also suggests that maintaining leverage is not necessarily a short-term objective.

For all of the remaining financial line items above, there is no change. I simply wanted to provide the same table as a reference. Clearly from a competitive standpoint, there are concerns regarding Robinhood's dependence on Transaction-Based Revenue. There are also concerns from the fallout of short-term trading volatility from Q1 2021 on multiple fronts.


Lawmakers are looking to impose federal oversight on large family offices like Archegos Capital Management and banning the controversial practice of market makers such as Citadel Securities paying Robinhood and other brokerages to execute investors’ trades, per a confidential note recently sent to Democratic members. There are more than a dozen proposals under review and not all are are expected to be taken up by the Financial Services Committee.


Per Robinhood's disclosed Concentration of Credit Risk, and specifically, Transaction-Based Revenue from market makers in excess of 10% of Revenues, 81% of total Revenue was from market makers during Q1 2021, increasing from 62% and 75% respectively for all of 2019 and 2020.


Legislation on the table includes the requirement of hedge funds to publicly disclose their bets against stocks, as well as derivatives holdings that firms have used to conceal their stakes. Others calls for speeding up the timing of the reports to the SEC, which is currently done quarterly -- to monthly. Another measure could require family offices to register with the SEC as investment advisers unless they oversee less than $750 million.


The timing of these discussions and the push by Robinhood to go public in eight days is interesting to say the least. Depending on what side of the fence an investor sits, there may be some short-term volatility working to a mid- to long-term position's favor.


Revised Preliminary Forecast

The revised preliminary forecast is consistent with key metrics deriving Revenue estimates over the mid-term. The only change is the SP and per share information from the updated Amended S-1 information.

It's not that complicated here, as I'm looking for Robinhood in this growth scenario, to potentially achieve mid-term EV/Revenue and Adjusted OCF/Share multiples at 14 and 45 times respectively. From the upper range current SP at $42, this is a great opportunity leading to a potential 22% annualized return. The problem is for investors outside of having an account with Robinhood, or another platform offering pre-IPO trading day access, many will not get as rosy of an opportunity.


The good news is that Robinhood is looking to get this IPO completed next week so there isn't a lot of time. That being said, the upper range could still increase and the final pricing before the first trading day for the public could always adjust. My gut is that $50 or so will possibly be the highest before Robinhood begins trading. From there, it's anyone's guess as to trading activity on day one. I could see a range of $40 to $65 per share for either positive/negative outcome.


Conclusion

Robinhood is going to test investors. There are multiple items to consider, that do not provide investors with clear indications for the short-term. What will the company's Cash Flows look like over the next few quarters, what regulatory impacts will there be, how will competitive and regulatory risks impact the growth thesis - these are some of the key questions that will remain during most if not all of 2021.


For me, as is usually the case, it will all come down to valuation versus potential, or in other words, the risk profile. Based on the opportunity, I would consider Robinhood below $50 per share. Anything north of $55 would be pushing it to initiate on day one. As we've seen with Coinbase, a couple months after IPO day can lead to a sustained downtrend. Affirm Holdings (AFRM) is another example of a painful post-IPO drop. For these reasons, investors should be prudent in determining when to pull the trigger. Especially with respect to personal expectations, level of commitment and investment goals an objectives.








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