Why did the Robinhood share price fall on its IPO?

Robinhood (NASDAQ:HOOD) shares made their public debut last week at a price of $38. But it seems the IPO wasn’t as explosive as many investors had hoped. While the business did manage to raise around $2bn, it failed to reach the $35bn market capitalisation the management team had expected. Based on the Robinhood share price today, the company is currently valued at around $29bn. But that still makes it one of the most valuable businesses to go public in America.

So, is this performance a sign of trouble ahead? Or is it a buying opportunity for my portfolio? Let’s take a look.

Looking at the business

Robinhood is a trading app. Like any ordinary broker, it allows users to buy and sell shares in businesses, in addition to other financial assets like options and cryptocurrencies. So, what makes it special? It was the first broker in the US to offer commission-free trading, significantly lowering the barriers to entry for investors with only a small amount of capital.

There are plenty of other services today that offer commission-free trading. But the advantage of being first has allowed Robinhood to grow its platform to over 17.7 million monthly active users. In total, there’s currently $81bn under the custody of the business. That’s quite extraordinary, in my opinion. And if it can continue to expand this user base, I think the Robinhood share price can start surging. But if it isn’t charging commissions, how does Robinhood make money?

It uses something called Payment for Order Flow. This is where things get a bit technical. But in simple terms, Robinhood receives transaction-based revenue from market makers in exchange for sending them customers (its users). But what’s a market maker? These are either firms or individuals that fulfil the buy and sell orders for investors using their own assets or capital, profiting from the difference between the current buy and sell prices of an asset to turn a profit.

The idle Robinhood share price

There are undoubtedly many reasons why the share price didn’t explode as many investors had hoped. But the primary reason seems to be the uncertainty surrounding its Payment for Order Flow transaction model. In fact, the company is already facing regulatory pressure due to its controversial nature.

While it does enable users to execute those commission-free trades, it also creates a conflict of interest between investors and market makers. Investors want the lowest buying and highest selling price. Whereas the market makers want the opposite to maximise their profits.

Given that Robinhood currently makes 80% of its revenue from this system, the introduction of new regulations could jeopardise its future growth and, in turn, its share price. 

The bottom line

The current volatile nature of the stock market and cryptocurrencies has created a favourable environment for trading and, in turn, for Robinhood’s platform. But as the vaccine rollout continues, this volatility has already started to stabilise. Consequently, the firm is already expecting revenue to begin falling next quarter. 

Having said that, it seems more people are realising the wealth-building power investing can provide. And with many brokers still charging expensive commissions, Robinhood may become the leading trading platform for many retail investors. For now, I believe there are better growth opportunities elsewhere. But I am adding Robinhood to my watchlist.