FinS đ˛ for the Soul (8 Aug 2021): Robinhood goes public, Square acquires Afterpay & Monzo reports going concerns
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Latest headlines:
1. Robinhood goes public stonk-style
Background: Breaking with Wall Street tradition, Robinhood went public last week under the symbol HOOD and unconventionally offered 25% of its IPO shares to hundreds of thousands of its customers. (Typically, individual customers get under 10%.) Opening at $38 a share, its stock surged up to $85 at one point, representing an over 100% weekly gain.
The rise of the retail trader. The average Joe, armed with their stimulus cheques, has given institutional players a run for their money this year. Data from Credit Suisse has shown that retail trading as a share of overall market activity has nearly doubled to comprise over 30% since the start of 2020. Robinhood has been at the center of this stock market and cultural phenomenon and Reddit uprising. Its customer base is diverse - with 16% from the Hispanic community and 9% African American, compared to 7% and 3% respectively at other brokerages. Millennials and Gen Zers comprise 70% of their user base, which has an average age of 31 and a median account balance of $240.
Gamification of the trading process. Robinhood has removed the confetti animation that it introduced as âpositive reinforcementâ when new investors made their first trade. However, much of the appâs UX design incorporates features that induce addiction and tap into the FOMO mindset of young and inexperienced investors. Such include introducing the number of users âprioritisedâ before you during the on-boarding process, overemphasising the popularity of a stock over other parameters, and requiring more clicks to access oneâs detailed account breakdown, to name a few. Most of the platform's trades are tied to complex and speculative products such as options and NFTs. Given that consumers have a right to safety and to be informed, associated risks should be as intuitive and easy to access as it is to place a trade on the platform.
Regulatory hawks are circling. Robinhood offers commission-free trading on its platform and earns revenue via a payment for order flow business model. They receive payment for routing orders to a market maker for trade execution. This practice is blocked in the U.K. and Canada as it generates a conflict of interest for brokers maximising sales revenue. Charges have been brought by SEC about issues related to best execution, insufficient disclosures, and misleading clients.
Conclusion: Controversy has been a mainstay of Robinhood and it is unlikely to evade the spotlight anytime soon. Regulators are looking into how brokers market and adequately provide access to complex financial products, but in the meantime, the next stonk wave with all its dizzying volatility might be just around the corner.
2. Square acquires Australian fintech Afterpay for $29B
Background: Afterpay offers buy-now, pay-later (BNPL) services with zero interest. Square provides payment processing, analytics, and lending capital to its merchant customers. Its gross payment volumes have grown 29% year-on-year, hitting $33B in the first quarter of 2021. 90% of volume comes from its B2B seller ecosystem, while the remaining 10% from its B2C Cash App business that promises faster peer-to-peer payments. Squareâs stock price shot up 11% on Monday during trading hours following the announcement.
It is essentially an ecosystem play. The acquisition will enable the integration of BNPL functionalities that appeal to higher-income Gen Zers and Millennials and those trying to stretch their dollar during the pandemic. It will also boost Cash Appâs reach by adding Afterpayâs 16M customers to its existing base of 70M annual users. These would in turn attract and retain merchant sellers on Cash Appâs platform.
Is the deal overpriced? This acquisition would be the biggest-ever buyout of an Australian company, amidst an M&A boom in the country. Square plans to use $29B of its stock to acquire Afterpay in this all-stock transaction - that represents close to a quarter of its current market capitalisation, for a company that earns revenues amounting to 5% of its own. Both are high-growth companies, doubling their revenues from 2020 to 2021. However, with significant headwinds and competition, and the fact that Afterpay has yet to turn over a positive EBITDA, it is questionable whether it is worth the premium (at 40X transaction sales multiple) on its shares.
Headwinds and competition: Afterpay competes with Sweden-based Klarna ($46B market cap), Affirm ($17B), Sezzle ($1.5B), and Paypal ($319B). BNPL has been on the rise, with even companies like Apple joining the fray. Close to half of mobile payment users in the US already use Apple Pay and providing an additional functionality may not prove too difficult. Furthermore, BNPL (a.k.a. deferred payment credit) remains a largely unregulated market. FCA has called for greater customer protection following the Woolard Review but has not spelled out what form this would take. More stringent regulation may curtail growth in the long run.
Conclusion: Itâs a huge and bold bet by Square to offer 20% of their company in return for a stake in the Australian BNPL juggernaut. The magic may not be in the additional functionality acquired per se, but rather Squareâs ability to bring together merchants and customers and provide value for each with this acquisition.
3. Monzo reports going concerns
Background: Despite an increase in revenues from ÂŁ12M to ÂŁ79M between 2020 to 2021 and a 124% increase in deposits, Monzo reported ÂŁ114M in pre-tax losses. The audit report indicated a material uncertainty in the groupâs ability to continue as a going concern for the next 12 months.
The road to profitability for neobanks has not been easy. While being touted as âthe next big thingâ, most neobanks such as Monzo, Revolut, and Starling posted losses in their 2020 financials. Starling and Revolut both said they began to break even at the end of 2020, 6 years from when they began operation. With expensive internal expansion plans in place, profitability may continue to be compromised for growth.
The pandemic has taken a toll. Monzo opted to reduce its lending during Covid from ÂŁ143M to ÂŁ104M a year. Despite doing so, it took on greater credit risk, with its loan loss reserve growing from 13.9% to 16.7%. The company also saw a 40% drop in valuation from $2B to $1.25B in its Series G VC funding, amidst the departure of its co-founder, several layoffs, and a reduction in card spending.
Radical transparency is a key differentiator. Monzo is focusing on âradical transparencyâ as a way to attract customers and build the business and product. Emails sent between colleagues can be read by anyone in the business. Customers are sent a copy of its earnings reports. They also get full visibility of their monthly budget and transactions. The firm runs an active online community forum to solicit feedback on new feature ideas and allow customers to socialise.
Conclusion: Having grown to serve over 5M customers, Monzo has accomplished the feat of establishing itself as an upstart in the digital banking space. Yet compared to traditional consumer banks that serve between 50M to 100M customers each, there remains much room for growth.
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