Per TechCrunch:

Robinhood announced on Thursday that it was acquiring X1, a no-fee credit card startup, for $95 million in cash.

X1, which offers an income-based credit card with rewards, raised a total of $62 million in venture-backed funding from investors like Soma Capital, FPV, Craft Ventures and Spark Capital since its 2020 inception. The company announced its most recent raise of $15 million in December, when it also touted a 50% boost in its valuation.

X1 co-founders Deepak Rao and Siddharth Batra will oversee the new business for Robinhood, and Rao will serve as general manager of credit cards.

This is an acquihire deal for Robinhood. With $95 million, the trade platform company is getting the existing X1 card portfolio, which I suspect is not big, and more importantly the people at X1. I am not talking about just the cofounders Rao and Batra. Instead of spending time hiring for compliance, credit risk, IT or other positions, Robinhood can hit the road running right away. There are some areas where the acquirer can streamline to cut expense such as compliance, HR or marketing. Robinhood should be well-staffed in these departments.

Given that X1 raised $62 million in total, the deal’s price tag indicates Robinhood is getting a bargain. Whether it ACTUALLY IS a good deal depends on two things: 1/ the assets that X1 brings and 2/ what Robinhood plans to do with X1.

Credit card issuers can monetize their portfolio balance in two ways: sell it outright or use it as collaterals for bonds. The value depends on the quality of the balance such as credit quality, delinquency, activeness or charge-off. There’s no information on the quality of the existing quality of the X1 portfolio. Hence, it’s hard to say if Robinhood got a bargain. The same goes for the folks at X1. Only their FUTURE performance at Robinhood will determine the outcome of this deal.

I struggle to think of what Robinhood may do with X1. I don’t buy the argument that Robinhood did the deal to get an additional revenue stream in interchange. Yes, extra revenue is nice, but there is a lot of work to stand up and operate a credit card portfolio. Will future interchange revenue justify the $95 million price tag? The juice is not worth the squeeze. Not even remotely in my opinion.

Is it to help Robinhood appeal to young customers more? Robinhood doesn’t have a branding issue. Young folks know the company and a lot trade on its platform. Growth; however, has stalled recently. If X1 is the catalyst that turbocharges new customer acquisitions at Robinhood, this argument means new customers are more interested in getting a Robinhood/X1 credit card than becoming a trader on its platform. From that point of view, Robinhood has a bigger problem than just this purchase.

Challenges of running a credit card portfolio

Look, anytime a startup cashes out more than what it raised, it’s a success. X1’s team members will receive generational wealth and can go on to do other things in life. Investors in X1 have some return on their investment. Not as great as they hoped, but at least it’s not a loss. With that being said, the value at which X1 is sold indicates that its credit card portfolio has issues.

Economies of scale offers a business lots of benefits and it’s the same in the credit card industry. The more accounts an issuer has, the lower its unit operating expense is. Plus, an issuer can leverage more data from a bigger pool of accounts to do the following:

• Design machine learning models to be more efficient with marketing dollars or to minimize losses
• Gain valuable lessons in managing portfolios and industry knowledge

A growing portfolio is also an excellent tool to generate more money. For an established financial institution, it’s either a divestment or using a portfolio balance as collateral to raise debt. For a startup like X1, portfolio growth gives investors a reason to invest.

The challenge; however, is that X1 cannot acquire new customers recklessly. Any disregard for risk will result in high delinquencies and ultimately expensive losses. This puts the company in an undesirable position: grow too fast and the book will blow up or grow responsibly and either raise a lot more money or risk the anger of existing investors. I think X1 found its escape route in Robinhood.

This is precisely why I think Goldman Sachs chose to go with Apple. The iconic investment bank wanted to venture into retail banking. It gave up a lot in the deal with the tech giant, but what the bank got in return is the ability to scale quickly while staying in reasonable risk parameters. Think about it this way. Goldman Sachs can set whatever criteria they like to minimize risk exposure and thousands of people will still apply for an Apple credit card. Because it’s Apple. The bank can then proceed to leverage data from a large pool of customers like I mentioned above and go on to launch other credit card portfolios.

Imagine the opposite. If GS had started its venture with, let’s say, Lyft, its executives would have to answer to analysts and investors who there is little growth for the giant investments into this consumer space.

As someone who works in the credit card industry, I don’t think ordinary consumers understand how hard it is to grow and operate a portfolio. I remember talking to some college students and their jaw was on the floor when I said that our company was not allowed to underwrite on demographic attributes. And that’s just the very tip of a big iceberg. To see what is underneath, one has to be in the trenches.

Because of my own personal experience, I am happy for the X1 team to have this sale to Robinhood. Their work is being rewarded. This deal, in my opinion, offers additional validation to why Goldman Sachs went with Apple.