Robinhood IPO is 'selling investors on exploiting other investors': Strategist

Robinhood is reportedly expected to make its public debut on July 29. New Constructs CEO David Trainer joins Yahoo Finance Live to discuss.

Video transcript

KRISTIN MYERS: Welcome back. Well, Robinhood held a public livestreamed road show for its upcoming IPO this past weekend. And Robinhood executives, including its CEO Vlad Tenev answered questions from the public, like what is their favorite planet and also discussed the creation of cryptocurrency wallet. So let's chat more about their upcoming IPO.

We're joined now by David Trainer, New Construct's CEO. So David, New Constructs reading through the notes has given Robinhood an unattractive rating. We just heard from Ross Gerber who said that Robinhood essentially plays with people's money and can't be trusted. Why do you think right now that investors should steer clear?

DAVID TRAINER: I think Ross makes a good point. Look, I mean, this IPO is effectively selling investors or exploiting other investors. The whole payment for order flow business model is probably not going to be long for this world. It's already illegal in the UK. And let's face it. I mean, it's a legalized form of frontrunning. So how long it remains legal is a big question. And payment for order flow's 80% plus of Robinhood's revenue. So if they lose that, they lose a lot of revenue. And their business model effectively falls apart.

ZACK GUZMAN: Yeah, that's the interesting thing to me, David, because I can't really-- I can't think of an example of a company coming out that might have that much-- 81%, as you said-- of the revenue in Q1, potentially in the crosshairs. The SEC talks about payment for order flow and kind of regulating that a bit closer.

To the people who say, look, you know, all the other brokerages out there have adopted that model. So if they get hit, it's going to be all the other brokerages getting hit in kind. They'll be able to weather that storm. What do you say to that as you kind of look into the business as it matches up against some of the bigger boys in Fidelity and the like?

DAVID TRAINER: You know, great point. There's two parts to that answer. Number one, the big-- there are some big players like Fidelity, who don't take payment for order flow. Some of the larger players that do take payment for order flow are able to probably get away or be able to run their business without that revenue because they have so much more scale in terms of assets and the ability to generate revenue from other sources, which Robinhood does not have.

So for example, Schwab has close to $7 trillion in assets, whereas Robinhood has about $81 billion, all right? So there's a big difference there. And Schwab has a variety of ways from which it can generate revenue, a variety of different businesses that generate revenue for that business, that if payment for order flow goes away, it can afford to give away trades for free without payment for order flow.

And I think it's important to note that the only way Robinhood can give away trades for free is because of payment for order flow. The other thing to point out is that there are some businesses out there that are like Robinhood, like M1 and Public, who are very outspoken about not taking payment for order flow and really standing up for doing what's right for investors and not really sort of selling away their trading intentions to Wall Street insiders. And they are finding a way to make their business model work that way. So I think there is a way to make the brokerage, the online brokerage business work with a little more integrity and without the conflicts of interest we see at Robinhood.

KRISTIN MYERS: So I do want to ask about that payments for order flow. And you keep mentioning that it might become a legal. It might go away. And of course, that would be a huge dent to Robinhood, at least for their revenue generation. But I'm curious to know because they clearly seem like they're about to make some moves to start lobbying Congress, at least on this measure.

Is there at all a chance that perhaps some of these fears, while we can probably expect some sort of regulatory headwinds, but that some of these fears that payments for order flow becoming illegal might be a little bit overstated, especially since Robinhood does plan to go fully in on lobbying the SEC congressional members to make sure that they can maintain payments for order flow?

DAVID TRAINER: Yeah, Kristin, a great point. They've hired a lot of ex-regulators to join the team there at Robinhood. And look, we know that money talks on K Street, so-- just like it does on Wall Street. So yes, I think that it's possible that the regulators may continue as they have for several years now, continue to give payment for order flow a pass.

The big question is whether or not investors will, right? I mean, as there's more light shined on kind of this dark corner of the online investing world, how much are investors going to want to give their trades and give their time and equity and trust to a firm that's effectively selling off, you know, information that they should be selling to Wall Street insiders?

That kind of goes against the whole Robinhood ethos, right? So I just don't know how long that trick works. And it may continue to work. I think really kind of raises the flag for us, though, is the valuation, is giving Robinhood credit for payment for order flow, not just going away, but growing and doubling and tripling over the next several years.

ZACK GUZMAN: Yeah, and I want to get into valuation, too, there because you're talking about a company that's looking to target a $35 billion valuation. So when you come out and say, this looks closer to $9 billion in our eyes, clearly, a mismatch there. So walk me through maybe where you think outside of payment for order flow, when you factor in kind of tripling the accounts we've seen, there is growth there, but just too hot as you walk through the model. Why?

DAVID TRAINER: Yeah, I mean, our approach to valuation is always to try to not to be a fortune teller, right? The market's a fortune teller, so we try to be a critic of fortune tellers, as opposed to being fortune tellers. And so we reverse engineer what the business--

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ZACK GUZMAN: Yeah, I think we might have lost David Trainer, New Construct's CEO, right when he was getting into the heart of that thesis around the valuation. But it is, again, kind of comparing it to the growth that we've seen at other retailers, as they say in there, other exchanges, essentially the size of what Robinhood has been able to build, growing quickly but still lagging quite a bit in terms of how many assets under management they have there.

Something that we'll be watching here, Kristin, as that company does go public, because as we talked about, obviously, there are a lot of question marks in terms of the future of that company and maybe not the hardest of hitting questions there on the roadshow, the virtual roadshow over the weekend. But we'll see, expected later this week.

And a reminder here, too, Robinhood kind of kicked all those questions off about payment for order flow. One of the meme stocks, of course, if you recall, GameStop and the surges there and the halt to trading, at least to buys. That obviously was the heart of what sparked all of this discussion here.

And we're highlighting that in a special today at 1:00 PM Eastern time, Yahoo Finance's Reshaping the Market special, to break down the current dynamics that are driving the meme stock madness. That's coming up, again, at 1:00 PM Eastern. Not just GameStop anymore-- we got a lot more names on that list to discuss.