Robinhood announced its plans for an initial public offering earlier this month, and today we got a rather surprising number for the expected IPO valuation: $33 billion. That’s shocking because it’s nearly 18% below the $40 billion valuation that the ultra-hot stock trading app had been expected to hit.
The declining number tells a profound story about the role of sentiment and mood in markets – what economist John Maynard Keynes in 1936 called “animal spirits.” Keynes’ invocation of something as woolly as the mood of the investing public ran directly counter to the concept of homo economicus that stood, then as now, at the center of the so-called classical economics that has dominated the discipline. This fictional human has complete access to market information and is able to make the objectively correct decision about the price of assets, not just based on present conditions but on likely future projections.
The all-knowing homo economicus is in turn the core of Efficient Markets Theory, or EMT. EMT is the idea that the arbitrage opportunities presented by markets (especially equity markets) attract traders with unknown information to those markets. Those traders and their information, according to EMT, then help markets find the “correct” price for an asset.
But Robinhood’s stunted IPO encapsulates many of the shortcomings of EMT, and shows why economics as a discipline is broadly rethinking the theory. More than perhaps any other company, Robinhood has benefited immensely from the animal spirits unleashed by a coronavirus pandemic-driven 18 months of meme trading and stimulus-fueled speculation. And it now seems poised to taste the other edge of the blade as a falling short-term market damps enthusiasm for what should be a long-term bet.
Compare, if you will, Robinhood’s $33 billion valuation to the $85.8 billion IPO valuation earned back in April by Coinbase. I’m not going to do a full rundown, but in terms of both their basic business models and their user numbers it’s truly nonsensical that Coinbase should be worth nearly three times Robinhood. To make just one comparison, Robinhood recently reported 22.5 million funded accounts and nearly 18 million monthly active users. Coinbase, in its first quarterly report as a public company, claimed 56 million accounts, but only 6.1 million active users. Robinhood also has a vastly stronger competitive moat than Coinbase, which is at severe risk of undercutting by competitors with lower trading fees. Those competitors include Robinhood itself, which currently offers trading of BTC, ETH, LTC and dogecoin, but could easily expand its offerings.
So given all that, how did Coinbase wind up with an IPO valuation nearly three times as high as Robinhood’s?
The simple answer is: IPO timing matters, even though the dominant way of viewing capital markets says it shouldn’t.
The facts fit together neatly. Coinbase IPO’d in the middle of a bull market for the crypto assets on which it’s focused. That timing helped it raise at a valuation nearly five times the $18.1 billion that one respected analyst found reasonable based on its fundamentals.
Robinhood, by contrast, is a stock-trading company poised to IPO just as an overheated stock market cools off. Just this morning we saw a chilling 3% sell-off in the Dow Jones industrials, partly over fears that the new Delta variant of COVID-19 is going to slow the worldwide economic recovery. That’s a six- to 12-month headwind at most, but it’s helping rob Robinhood of hundreds of millions of dollars in capital it likely could have raked in if the IPO took place four months ago.
That holds some important and maybe scary lessons for capital markets because timing the market for IPOs shouldn't really be a thing, according to Efficient Markets Theory. EMT says investors should be able to fully and accurately zero out the short-term state of the market and economy when making a long-run investment like an IPO. Translated into real terms, EMT would argue that investors in Coinbase in April should have been able to intuit the crypto market was about to top out, based on historical patterns that are widely established. But, of course, when you put it like that, the absurdity becomes obvious.
Now, in fairness, a more realistic interpretation of EMT takes into account a certain time lag as markets figure out what an asset is "really" worth – it doesn’t assume every investor is individually perfectly rational, but that the market converges towards rationality as information spreads. Since its IPO, Coinbase stock has dropped more than 30%, so maybe early buyers took a harder look at the numbers and changed their minds.
Just as important to that drop, though, has been the broader downshift in the crypto market, which is itself immensely speculative and therefore highly driven by sentiment. In other words, the drop itself is just as likely sentimental as some sort of acknowledgment of reality. And even after dropping 30% from its IPO, Coinbase is valued at $45 billion, still well over Robinhood’s IPO valuation. Timing and sentiment have trounced long-view market rationality.
This disconnect between the Coinbase and Robinhood IPOs is just one example of market irrationality, but there are now so many economics is consciously turning away from, or at least complicating, the ideas of efficient markets and homo economicus. That re-evaluation has progressed to the point where the top prize in economics, the Bank of Sweden Memorial Nobel, has been awarded twice in the past decade to scholars who have worked specifically to highlight problems with EMT and Economic Man.
In 2011, the Bank of Sweden prize went to Daniel Kahneman, whose work on humans’ “fast and slow” thinking systems provides a compelling way to understand that puzzling breed of impulsive, greedy, fearful trader who always manages to buy the top and sell the bottom. In 2013, the prize went to Robert Shiller, whose work on the economic impact of narratives is key to a modern understanding of financial bubbles and bull markets.
As the narrative of a never-ending bull market breaks down, both bodies of work are well worth reviewing. Robinhood, I’m sure, is wishing it had moved fast enough to harness the wild beasts of the market when they were stampeding in the right direction.
Update 7.22.21: This story was updated to add more comparative data on Robinhood's userbase.
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