What the $13B E-Trade deal says about Robinhood’s valuation

Hello and welcome back to our regular morning look at private companies, public markets and the gray space in between.

Today we’re living up to the introduction of this daily column by digging into the recently announced E-Trade sale and what its new price and recent financial performance can tell us about Robinhood, a startup competitor, and the unicorn’s valuation.

As always, when we’re comparing a fast-growing, private company in contrast to a larger, more mature, slower-growing, and profitable business, we’re working in broad strokes. But if we don’t take our contrasts too literally, we’ll be able to learn a thing or two.

After all, Robinhood is not only a richly-valued unicorn, it’s also a leading player in the burgeoning fintech and finservices startup niches, a sector we recently learned has capital flowing in at nearly record rates. So what we can learn about the value of Robinhood comps should prove illustrative and important.

We’ll start with an overview of the E-Trade sale, dig into its 2019 results and then compare the resulting multiples (with reasonable amounts of caveating, of course) to what we know about Robinhood. This will be fun!

E-Trade’s exit

News broke this morning that Morgan Stanley, a banking behemoth, will buy E-Trade, an online brokerage and financial services firm, for around $13 billion in stock.

In a release touting the deal, Morgan Stanley called out E-Trade’s more than “5.2 million client accounts with over $360 billion of retail client assets.” Morgan Stanley has 3 million clients, fewer than E-Trade, but $2.7 trillion in client assets, implying a far higher per-client account balance. This shouldn’t surprise, but the differential is notable. E-Trade’s average works out to $69,230, while Morgan Stanley’s is $900,000. (Keep those numbers in mind for later.)

Regardless, the deal puts E-Trade up more than 23% in pre-market trading. For now, we’ll presume that the company’s shares appreciate to the $13 billion market cap mark to match the sale price, and that the deal happens at that value for the sake of argument. Now let’s peek at E-Trade’s numbers.

E-Trade’s numbers

Briefly, E-Trade is a growing, profitable business that returns capital to its shareholders in the form of both dividends ($32 million in the last quarter) and share buybacks ($176 million in the last quarter).

Meanwhile, it is widely accepted that Robinhood is growing quickly, but it is also thought of as a money losing enterprise. Therefore, it does not return capital to shareholders as it needs to conserve cash to fund its own operations. Flush with over $900 million in raised capital, Robinhood is likely still quite wealthy at the moment, but probably not rich enough to begin to disburse capital back to its shareholders.

In 2019, E-Trade reported record revenue of $2.9 billion, net income of $955 million and 304,000 net new accounts. However, dialing into Q4 2019, we see a bit of a surprise: E-Trade’s revenue fell from both the sequentially-preceding quarter (Q3 2019) and the year-ago period.

Why? The company’s interest revenue dipped some (E-Trade makes money off an interest rate differential between what it collects and what it pays to the holders of certain interest-bearing assets). But more notable was the difference between the company’s Q4 2019 commissions revenue and what it collected previously. Down from $123 million in Q4 2018 and $122 million in Q3 2019, E-Trade brought in just $56 million in commissions revenue in its most recent quarter.

Why the dip? Robinhood.

As TechCrunch and I covered extensively, Robinhood’s rise as a fee-free stock trading platform forced incumbent brokerages to slash their fees, often to zero, in a bid to compete. (You can read more about that here, here and here.)

This is why we’re comparing E-Trade’s final worth as an individual company to Robinhood, as the smaller company kicked hundreds of millions of dollars in revenue out from under the larger entity. That changed happened in early October, the start of Q4 2019. Over that period, E-Trade’s operating margin fell from 50% to 37%, showing the stark impact of Robinhood’s rise on the old guard.

However, E-Trade is worth $13 billion and that provides some benchmarks. Let’s keep going.

The Robinhood comparison

As Robinhood is yet a private company, we don’t know too much about its size or wealth. We do know some things, like it had one million users in 2016, six million in October 2018, and ten million in December of 2019. The final two numbers mean that Robinhood added around 4 million accounts in about 14 months (about 860,000 per quarter). That dwarfs E-Trade’s most recent Q4 2019 net new account adds of 52,000.

Also, with 10 million accounts, Robinhood has about twice the accounts that E-Trade supports. But, as Morgan Stanley’s data showed us, we can’t take number of accounts as indicative of the value of those accounts. E-Trade probably has more assets under management than Robinhood, even if the latter has more total accounts. The difference in growth, however, is a point in Robinhood’s favor. And with a valuation of about 58% of E-Trade’s, that’s good.

Sticking to the account value point, a survey pegged the average Robinhood account size at between $1,000 and $5,000. That would give Robinhood assets under management of around $10 billion and $50 billion, a small fraction of E-Trade’s $360 billion.

Faster account growth, but of smaller accounts, appears to be the chief difference between the two companies. But we know a bit more. According to Fortune, per “data shared with [the publication] by one of Robinhood’s competitors, the company’s lifetime revenue to date is between $600 and $650 million, while 20-25% of its current income comes from interest on customer accounts and 55% from so-called order flow.”

Given that Robinhood is nearly seven years old now (that data point was published just three months ago), the revenue result is probably pretty fresh. Let’s be generous and say that the company generated half of the larger lifetime revenue number in 2019. That would give Robinhood $325 million in revenue for the year—a revenue multiple of around 23.4x. E-Trade is worth around 4.5x revenue after the deal’s premium is factored into its valuation. It also sports a price/earnings ratio of 14.5x, a metric that we can bring up in the case of Robinhood as it isn’t yet reportedly generating profit.

So what?

Chief in our learnings today are the following: Robinhood’s impressive account growth isn’t as bullish as we might have thought, given the company’s reportedly smaller account size. This means that the revenue it generates from the assets it controls is smaller on a per-account basis. So 10 million Robinhood accounts are worth less than 5 million E-Trade accounts. E-Trade is also worth far less per dollar of revenue despite spending over $200 million in quarterly shareholder return off of smackingly good historical operating margins.

I read all of that as saying that Robinhood has shown an impressive ability to grow its account base, but it has a long way to go yet to generate the sort of revenue (let alone profit) that it will need to support its valuation.

Of course, that the startup has more work to do is not a surprise given that it raised nearly $400 million last year, and it still has time to deploy those funds into business value. But I also didn’t expect that Robinhood would appear to be quite so far behind its more mature cohort—especially as Robinhood is growing tall in a time when the markets have only gone up. What will happen to its account base and trading activity (as we quoted above, Robinhood makes the majority of its revenue from selling its customers’ deal order-flow to others) isn’t known, but it probably won’t grow more quickly during a downturn.

The E-Trade deal is an overall boon for Robinhood in the post-trading fee world; it shows that brokerages are still very valuable. The question is how fast Robinhood can grow its GAAP metrics to match the non-GAAP hype it has stirred by attracting eight-figures worth of accounts.

Give us this S-1.