Can Zero-Commission Trading App Robinhood Challenge Large Brokerages?

by Trefis Team
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Robinhood Financial made news at the end of 2013 with the possibility of launching its commission-free Robinhood app. The company raised $3 million in seed funding in December 2013 from Index Ventures and Google Ventures. [1] Initially planned to be launched this summer, Robinhood received overwhelming customer response which led the developers to delay the launch. Recently, the company announced that it raised an additional $13 million in funding from its investors. [2] This funding will be used to hire developers, engineers and designers for the app.

Below we discuss the app and how it could impact major brokerage firms such as E*Trade Financial (NASDAQ:ETFC), Charles Schwab (NYSE:SCHW) and TD Ameritrade (NYSE:AMTD).

What Robinhood App Offers

The app, which mainly targets 18-to-30-year-olds with relatively limited financial assets at their disposal, is set to be launched on the Apple iOS in early 2015. The creators of the app state that younger people spend a lot of time “glued to their phones”, which is why making a mobile trading app was a logical move. [3] Moreover, the makers of the app have designed the interface such that it can be easily used in 15-30 second time spans, so that it can be used, for example, when users are waiting in line for coffee or using public transport. Since there is no minimum account balance required to start or to maintain an account, the app is an ideal option for first timers or casual traders.

The founders of the company also believe that existing mobile trading platforms or websites mainly target professional and active traders – many of whom belong to an older generation than the target audience for Robinhood. Additionally, they mentioned that there was currently no available platform in the market for first-time investors, so they have focused on making the Robinhood interface more accessible, mobile friendly and specifically convenient for casual traders. [4]

After initially registering with the SEC, Robinhood Financial also received approval from the Financial Industry Regulatory Authority (FINRA). The company is also a member of the Securities Investor Protection Corporation (SIPC). With the current round of funding, the company can improve features such as security, following which it can launch the app in early 2015. [5]

Can Robinhood And Similar Apps Affect Trading Volumes Of Brokerages?

While the app is still in its beta testing phase, there is a waiting list of around 450,000 as of September, and the number of people signing up for the app could grow further before the official launch. However, given the target users – casual first timers and existing traders that want to experience brokerage-free trading – it is unlikely that the app greatly impacts trading volumes of large brokerage firms. First-time traders that weren’t comfortable paying brokerage fees weren’t contributing much revenue to brokerages anyway, while existing customers are unlikely to completely switch over to free apps because of the lack of add-ons such as asset and investment management, broker-assisted trades and stock analysis.

If zero-commission (or very low commission) platforms do gain popularity in the long run, it may not be at the expense of the core customer base of large brokerage firms, which includes an older generation of traders more assets. However, even if they don’t impact the customer base, these apps could bring added pricing pressure, which could lead to brokerages reducing their fees.

Possible Impact Of Pricing Pressure

Most brokerage firms charge their customers in the range of $7-10 per trade and require their customers to maintain a minimum account balance in the range of $500 to $2,500. Some brokerages, such as Merrill Edge and Ameritrade do not have an initial funding or minimum balance maintenance requirements. Adding pricing pressure to the fees charged by brokerages could directly affect the bottom line of brokerage firms since since most costs incurred by brokerages are fixed in nature.

Ameritrade’s daily average revenue trades (DARTs) have been around 450,000 in 2014 thus far. This translates to about 17.6 annual trades per account for Ameritrade. The brokerage charges about $12.50 per trade on average and we expect it to remain at present levels through the end of our forecast period. If the revenue charged per trade declines to $10.50 per trade by the end of the decade, there could be a 5-6% downside to our $33 price estimate for Ameritrade’s stock. Our current price estimate is slightly lower than the current market price.

Year-to-date DARTs at Charles Schwab are around 485,000 from over 9.3 million active brokerage accounts. Schwab generates about $12.40 per trade and we forecast its average revenue per trade to stay at around $12 through the end of the decade. If the average revenue per trade falls to under $10 in the next five years, there would be a 3-4% downside to our $27 price estimate for Charles Schwab’s stock.

The number of revenue trades on E*Trade’s platform averaged about 150,000 per day in 2014 from January through August, from 3.1 million active brokerage accounts. E*Trade’s implied average revenue per trade is calculated to about $11.30 per trade. We forecast E*Trade’s average revenue per trade to rise to just over $12 by the end of our forecast period. A decline in the brokerage’s average revenue per trade to about $10 per trade through the end of the decade could imply a 5% downside to our $21 price estimate for E*Trade’s stock.

See our full analysis for brokerages | E*Trade Financial | Charles Schwab Corporation | TD Ameritrade

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Notes:
  1. Robinhood’s Pitch to Millennials: Free Stock Trading, Venture Beat, December 2013 []
  2. Zero-commission Robinhood brokerage gets funding, CNBC, September 2014 []
  3. Robinhood Snags $13M to Make Stock Trading Hip, Venture Beat, September 2014 []
  4. Robinhood Raises $13M To Democratize Stock Market With Zero-Commission Trading App, Tech Crunch, September 2014 []
  5. Robinhood and its VC heavy hitters join fray changing how Americans invest, Biz Journals, September 2014 []
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