With Robinhood’s IPO Coming Up, Is it Worth to Keep on Your Radar?

Robinhood is set to release its IPO this Thursday with unprecedented access to public investors. Is this the time to jump in?

(image credit: finance.yahoo.com)

Robinhood Markets Inc.’s initial public offering is stirring public interest among individual and corporate investors. The trading app, which now has 22.5 million funded accounts, is urging its own customers to invest. The company plans to sell its users up to 35% of its IPO shares, or up to 18.3 million shares. Typically, during an IPO, nearly all shares of a company aren’t available to individual investors as most are given to institutions first. However, recently firms such as Public and SoFi have started to offer IPOs at offering price to their customers as part of their mission to make markets more accessible for individual investors. This is, in part, a strategy to take advantage of the newfound power and enthusiasm of the everyday investor. The market for new listings is on track for its busiest summer in years. Companies have sold more than $190 billion in stock in U.S.-listed IPOs so far in 2021, according to data provider Dealogic, already exceeding 2020’s record total.

For Robinhood’s upcoming IPO, the company has stated that it plans to sell its users between 20% and 35% of its IPO shares through the app’s IPO Access feature, which will most definitely bring new exposure to this new feature of the app. The IPO is expected to price Wednesday, July 28, and start trading Thursday, July 29, with the ticker symbol (HOOD). Like E*Trade, Robinhood doesn’t have minimum asset requirements for its users to buy IPO shares common at other brokerages. For example, Fidelity requires customers to have at least $100,000 and up to $500,000 in assets, and Schwab requires $100,000 in assets or 36 trades in the past year to participate in traditional IPOs. This is why investing with Robinhood’s new IPO Access feature is a viable way to partake in the initial public offering, but beware as buying Robinhood shares can come with some looming regulatory risk.

Normally an IPO pop occurs on the first day, and with that comes a momentary jump in stock price that can bring huge immediate gains to shareholders. Robinhood customers are allowed to sell IPO shares within 30 days, known as flipping, but if they do so, they won’t be able to use IPO Access for 60 days. Since 1980, standard U.S. exchange-listed IPOs have on average risen about 18% from their pre-trading offering price to the close of first-day trading, according to data from Prof. Ritter of the University of Florida. For operating company IPOs so far this year, the average first-day jump has been 33%. However, given the demand for shares and the limited availability for individual investors, Prof. Ritter doesn’t expect to see individuals getting rich overnight. “I expect a fairly large fraction of their clients will ask for shares, and Robinhood will spread it around,” he said. Prof. Ritter made a prediction when Facebook went public in 2012. He expected the company stock to jump 30%, but it didn’t; in fact, over the following months, the stock plummeted.

“Individual investors got a bigger proportion of the Facebook IPO than the average IPO, but it didn’t jump, and in fact, over the next six months, it dropped 50%,” Prof. Ritter said. “So this is the problem with IPO investing. The ‘hot’ companies are harder to get shares in than the ‘cold’ IPOs.”

While a steady rise could be a possibility, investors should still expect some volatility, according to Prof. Aggarwal from the University of Georgetown. “We’ve seen individual investors get driven by sentiment quite a bit,” she said, referring to forums like WallStreetBets and the fast-changing nature of retail rallies seen earlier this year. However, Prof. Aggarwal does add that IPOs making a debut on the Nasdaq in 2020 typically saw a 40% jump from offer price to open price, according to research from Prof. Aggarwal.

Looming Regulatory Risk

With Robinhood being one of the hottest investing apps on the market in 2021, Robinhood has the potential to beat all expectations in its initial public offering. However, Robinhood could face more scrutiny from regulators and additional risks. In June, the company agreed to pay nearly $70 million to settle an investigation by the Financial Industry Regulatory Authority. This settlement was paid to resolve sweeping regulatory allegations that the brokerage misled customers, approved ineligible traders for risky strategies, and didn’t supervise technology that failed and locked millions out of trading.

The practice of payment for order flow, the main source of Robinhood’s revenue, is also facing a review by the Securities and Exchange Commission.

Robinhood disclosed that 81% of its first-quarter revenue came from sending its customers’ stock, options, and cryptocurrency orders to high-speed trading firms. This practice is known as payment for order flow, or PFOF makes it possible for Robinhood to let customers place trades with no upfront commission payment. Zero-commission stock trades helped the company win over millions of younger, less affluent customers and are now standard practice at many other investing apps.

Last month, Securities and Exchange Commission Chairman Gary Gensler was reviewing payment for order flow, fueling speculation among some market observers that PFOF could eventually be banned. Payment for order flow became a national headache after the meme-stock mania of GameStop Corp. earlier this year. In June, Mr. Gensler questioned whether brokers accepting PFOF were fulfilling their duty to provide the best execution to customers. He also voiced concern that routing small investors’ orders to trading firms could undermine the quality of public market data provided by stock exchanges that miss out on much of individual investors’ activity.

How much should I invest?

Individual investors should be extremely careful when it comes to investing in IPO’s, especially Robinhood’s upcoming offering.

“Not all IPOs are the same,” Prof. Ritter said. “There is the potential to lose everything.”

There is no specific amount or rule when it comes to investing. A recommended amount would be something you would be safe with losing, preferably less than 5% of your total investing portfolio at most.

What will Robinhood do with the money?

Robinhood has stated that around $342 million from the IPO will go to repaying debt. Additional proceeds will go to expanding its workforce and customer-support operations, as well as capital needs.

CEO Vlad Tenev said the company will work towards expanding its products and services with the funds raised as well as other initiatives, such as adding additional IRAs and Roth IRAs, to help turn short-term investors become long-term investors.