• Robinhood’s upcoming IPO is overvalued and packed with regulatory risk, according to veteran stock analyst David Trainer.
  • Trainer’s investment research firm said Robinhood’s main source of revenue-payment for order flow-could be banned by regulators.
  • A ban would severely harm Robinhood’s business model, Trainer said.

Robinhood’s upcoming initial public offering presents “alarming” risks to investors as regulators could stifle the brokerage app’s main source of revenue, according David Trainer, CEO of investment research firm New Constructs.

81% of Robinhood’s revenue in the first quarter of 2021 came from a controversial practice known as payment for order flow. The brokerage app argues that payment for order flow allows it to offer free trading to their customers. In June, SEC chief Gary Gensler questioned whether payment for order flow provides investors with best execution.

“Payment for order flow raises a number of important questions. Do broker-dealers have inherent conflicts of interest? If so, are customers getting best execution in the context of that conflict? Are broker-dealers incentivized to encourage customers to trade more frequently than is in those customers’ best interest?” the SEC chair said in prepared remarks.

If the SEC ever outlaws payment for order flow, Robinhood may not be able to offer commission-free trading, which would put the app at a disadvantage against competitors Fidelity and Charles Schwab. Unlike Robinhood, those firms generate more revenue from other services, he added.

In June, SEC chair Gary Gensler said the US regulator is reviewing payment for order flow, but the practice is still legal. Trainer noted that Robinhood hired former SEC Commissioner Dan Gallagher as chief legal officer in 2020 and paid him $30 million after seven months.

"$30 million to one person is a lot for a firm without any regulatory concerns," Trainer said. "The mounting regulatory risk Robinhood faces makes us concerned that the public may see Robinhood's stated goal to 'democratize investing' as a ruse to lure them into speculative trading and gambling that benefits Robinhood more than the individual investor."

Trainer also said that Robinhood's valuation is worth no more than $9 billion, significantly less than the firm's expected $35 billion price tag.

According to Trainer, Robinhood's $35 billion valuation implies the firm will be able to maintain its pandemic-era profitability, grow revenue by almost 3,000%, and compete with established rivals like Schwab. But the app lacks scale and with the meme stock frenzy fading for now, its best years may already be behind it, he said.