All The Fintech - 5.30.18 - Robinhood's valuation is...reasonable?

It’s a common refrain that if it wasn’t for VC funding growth at all costs, apps such as Robinhood or Acorns would not be able to sustain their commission models. But when you dig a little bit deeper into exactly how brokerage firms really make money, I believe that premise starts to fall apart.

I recently spent a few hours going through E-Trade’s 10k to get a better understanding of their business model, and found something that was surprising to me - trade commissions only makes up ~18% of total net revenue. E-trade’s revenue concentration looks just like a traditional retail deposit-taking bank. E-Trade holds a significant amount of customer cash and deposits on it's balance sheet, and like a bank tries to generate a return on these assets that is higher than the interest rate it pays.

E-trade's net revenue is generated primarily from net interest income, commissions and fees and service charges. Net interest income is largely impacted by the size of its balance sheet, balance sheet mix, and average yields on assets and liabilities. By the end of 2017, E-Trade had $42.7B in consumer deposits, representing 76% of total liability on their balance sheet. Out of 2017's $2.4B in rev, $1.48B was net interest income (over 60%).

E-trade's market cap is currently trading at a $16.42B. When put into that light, Robinhood’s $5b valuation doesn’t seem so crazy - giving up commission fee revenue looks much more like customer acquisition cost. They've experience a massive amount of explosive growth (<4MM brokerage accounts which is already more than E-Trade). I also wouldn't be surprised if future products will be focused around growing customer deposits + offering banking services.

Platforms such as Acorns and Robinhood are also experimenting with a variety of new revenue streams. I would imagine if they ever went public, the road show KPIs for health of the business would be different from what E-Trade tracks. I pulled down a list below of what’s important to E-Trade, and it’s a pretty stark different from the numbers that a company such as Acorns reports publicly.

I believe that 2018 and 2019 will see an increasingly convergence of larger scale fintech applications competing for customer deposits. It will be interesting to see how fintech upstarts compete with larger financial institutions (oh hi Marcus) in the product arena...

Notes:
2017 eTrade revenue -
$2.4 B in total net revenue
$1.485 B in net interest income
$441 mm in commissions (interesting that commission revenue decreased from 2016 even as DARTs increased...)
3.6 MM brokerage accounts
2016 eTrade revenue:
$1.9B in total net revenue
$1.23B in net interest income
$442 mm in commissions
3.5 MM brokerage accounts

E-Trade KPIs

  • Daily Average Revenue Trade (DART): predominant driver of commissions revenue, the average trades per day that generate commissions or fees.

  • Derivative DARTs: key driver of commissions revenue, is the daily average number of options and futures trades

  • Average commission per trade: indicator of changes in customer mix, product mix, and product pricing.

  • Net new brokerage accounts: indicator of ability to attract and retain brokerage customers

  • Customer margin balances: key driver of net interest income, represents credit extended to customers to finance their purchases of securities by borrowing against securities they own

  • Customer assets: indicator of the value of relationship with the customer

  • Brokerage related cash: indicator of the level of engagement with brokerage customers and is a key driver of net interest income as well as fees and service charges revenue

  • Net new brokerage assets: indicator of the use of products and services by new and existing brokerage customers