Merely three months after the Indian government rendered high-value currency notes invalid, taking 86 percent of cash in circulation (by value) out of circulation, the chief of the country’s most valuable private sector bank said digital wallets had no future.
“You cannot have a business that says, pay a 500-rupee bill and take 250 rupees cash-back,” said Aditya Puri, the then-chief executive officer of HDFC Bank Ltd.
Five years later, Puri’s prophecy may have come true; digital wallets account for less than 1 percent of retail payments today. But India’s biggest digital wallet company, Paytm, has been nimble enough to morph itself into a one-stop shop for all financial products. The change may have thwarted irrelevance, but has done little else for Paytm in terms of profitability.
The company is struggling to convince investors about the value of its business. The chasm of value perception between Paytm and its investors has only widened since its listing in November. The more than decade-old firm needs to generate returns on the capital deployed in it by investors. It can no longer behave like an aggressive start-up burning cash.
The capital fuel
Paytm was founded in 2009 as a cashless option for mobile top-ups and bill payments. The wallet business was born in 2014 and progressively the company added various digital options to become the full-stack fintech company it is today.
The November 2016 demonetisation triggered exponential growth in Paytm’s business. Founder Vijay Shekhar Sharma’s timely marketing push lured Indians to the Paytm app after they found themselves queuing in vain at banks for cash.
It also triggered a flurry of investment into the company. Paytm has received chunks of capital in several funding rounds from marque investors such as Ant Financial, Softbank, Blackstone, Berkshire Hathaway, and SAIF Partners. According to Macquarie, Paytm raised an aggregate of Rs 19,000 crore since inception to financial year 2021, and has accumulated losses worth Rs 13,200 crore. The cash burn is evident.
To be sure, the Initial Public Offering (IPO) has given an opportunity to some investors to sell their stakes. Of the Rs 18,000 crore raised from the IPO, nearly half went into the pockets of existing investors who chose to sell.
Even so, on balance, Paytm has destroyed wealth for most of them. Paytm is still a revenue-generating business, but its costs outweigh the money it generates, keeping its losses high. As for revenue itself, the firm has had a volatile history.
Revenue still chugging
Paytm’s payments and financial services business, through which it enables online transactions and distributes third-party financial products, contributes more than 80 percent of its revenue. The rest comes from cloud and commerce.
In both financial years 2020 and 2021, the company reported a fall of 7 percent and 6 percent respectively in revenue. For the first nine months of financial year 2022, cumulative revenue was Rs 3,424 crore, 22 percent more than that for the full financial year 2021. For the same period, the payments business revenue is 25 percent more.
This shows that the payments business is improving its revenue trajectory although its past performance doesn’t exactly inspire confidence.
Under payments comes the payment gateway, wallets, Unified Payment Interface (UPI), and merchant payment services. Paytm does not provide a detailed break-up of revenue from each stream. That said, the non-revenue generating UPI contributes more than half of Paytm’s gross merchandise value (GMV). UPI was made free with the merchant discount rate (MDR) brought to zero by the government in 2019.
“Even incrementally, the new business generated is via UPI. So incremental business is not generating revenue,” said Anand Dama, head of BFSI research at Emkay Global Financial Services Ltd.
Dama echoes the concerns expressed by Paytm’s most vehement critic, Macquarie Capital Securities (India) Pvt. Ltd. Macquarie has pointed out that with UPI’s share in GMV high and likely to rise, Paytm’s revenue may decline.
As such, the overall payments business is a high-volume one, and to achieve a reasonable level of revenue, payment providers need to corner a high amount of transactions in the market.
It gets tough for Paytm here too. According to Reserve Bank of India (RBI) data, digital wallets processed transactions worth Rs 19,789 crore in January, or 0.4 percent of the total retail transactions processed during that month. Retail payments include wallets, UPI, cards, and online banking modes such as IMPS and NEFT. UPI’s share in total retail payments was more than 17 percent.
Paytm would need to increase transactions on its own payment platforms and at the same time continue to offer UPI for customer acquisition. This is a delicate balance to achieve. UPI is the cheapest route to acquiring customers, something Paytm needs as its operating costs continue to be high. But more on costs a bit later.
Merchant of menace
Amid a sobering revenue outlook for payments, Paytm’s biggest selling point has been the merchant segment of the payments business. The company is the market leader in P2M (person to merchant) transactions and prizes its merchant base of 22 million as of financial year 2021, which has now increased to 23 million.
Its closest competitor, Phone Pe of Walmart, was a shade lower at 20 million and others were far lower. India’s mom-and-pop stores give Paytm not only a cut from their transactions, but also a steady stream of revenue through the digital payment devices they install in their shops. That said, revenue from the merchant business either matched or marginally exceed that of the customer end.
In the third quarter of financial year 20221, revenue from merchant business was Rs 586 crore while that from the customer end was Rs 406 crore. Notwithstanding its market leadership, Paytm’s revenue from its merchant business hasn’t broken the charts among its various streams.
Paytm’s Chief Financial Officer Madhur Deora had told Moneycontrol that the merchant business take rate was 4.5-5 percent. Take rate is the percentage of GMV that Paytm records as revenue. The company’s strong merchant base brings in one of the highest take rates among its various business streams. But Paytm’s overall take rate in financial year 2021 was below 1 percent, and is far lower compared to that of international peers.
In a blog, NYU Stern School of Business professor Aswath Damodaran pointed out that take rates for payments companies such as Visa, Paypal, Mastercard, Shopify and Paytm’s own marque investor Ant Financial ranged 1-3 percent.
Paytm has time and again made a case for monetising the merchant business through lending. But Paytm cannot lend from its own balance sheet. So far the company is only a distributor of loans through tie-ups with banks and non-bank finance companies.
Macquarie believes that scaling up here would be tough. As of the third quarter of financial year 2022, Paytm had disbursed only 35,000 loans to its merchant base of 23 million. Note that loans are on the balance sheet of other lenders and Paytm only earns a fee as a distributor.
Customer behaviour data forms the backbone for lending and mainstream banks are loathe to lend unless they have a credit score. For most small stores, a credit score is hard to find. Paytm’s founder Vijay Shekhar Sharma has at almost every public forum upheld that the data on the company’s platform enables effective lending. No wonder that the company has tied up with a host of banks and non-banking financial companies (NBFCs) to hawk their loans. Be that as it may, the big revenue lies in lending from the balance sheet.
Its troubles with the regulator has dimmed its prospects of getting a bank licence.
Regulator’s wrath
Paytm’s biggest trouble is potential regulatory change. Note that in the past the move to waive MDR on UPI was opposed by payment companies, especially wallet givers. But the resistance didn’t hold.
Then there are Paytm’s own troubles with the RBI. The regulator has banned Paytm Payments Bank, the group’s most profitable company, from acquiring new customers.
“With the RBI recently raising issues with Paytm payments bank and Chinese ownership being 25-percent-plus, we believe the probability of Paytm getting a banking license is significantly lower now, thereby impeding its ability to lend,” Macquarie warned in a March 16 report.
Bereft of a licence to lend, Paytm can continue as a direct sales agent of banks and NBFCs, hawking their loans on its platform. To be sure, the company earns fee income which is no chump change. That said, its lending business too would be a dependent on scale just like its payments business. Building scale would take time given the regulatory penalty.
As noted earlier in this article, Paytm’s payments business is a high-volume one. Without the advantage of volume, the outlook on the company’s revenue dims further.
Cost of being Paytm
When faced with headwinds on revenue, a company can cut costs to reduce its losses. In the case of Paytm, cost reduction too doesn’t seem to have helped much. Paytm’s biggest cost is payment processing fees that it has to pay to card networks such as Visa, banks and other financial institutions for processing its transactions.
The next big expenses are marketing and promotional costs followed by employee benefits. Ahead of the IPO, the company cut its marketing and promotional spending sharply in financial year 2021. In the first nine months of financial year 2022, this has increased by 40 percent year-on-year.
Paytm gives cash-backs to lure customers onto its platform and make them stick to its wallet. This brings us back to the point made earlier of UPI being the cheapest route to acquire customers. Rivals Phone Pe and Google Pay have cornered more than halfthe market share in UPI. For all the companies, UPI is a non-revenue generating business but a great way to acquire customers.
Employee cost has also surged owing to employee stock option plans (ESOP). ESOPs are an integral feature of new age companies and Paytm is no different. Some analysts see this as a high recurring expense that would need to be taken into account while assessing profitability.
Because of an increase in costs, Paytm’s loss widened in the April-December period of financial year 2022. Morgan Stanley expects Paytm to be EBITDA-positive by financial year 2025. EBITDA is short for earnings before interest, tax, depreciation and amortisation. Macquarie expects the company to reach operating profitability not before financial year 2030.
The upshot is that Paytm’s path to profitability seems a long-drawn-out one, making a premium valuation hard to stick.
The pressure points on revenue, the sobering outlook and the sticky costs ended up getting glossed over by unbridled market liquidity when the company launched its IPO. That has now changed and investors are taking a hard look at the numbers, which explains the erosion of 75 percent of Paytm’s market value.
“If you remove the liquidity of the market, the FOMO (fear of missing out) from investors few months back, what is left is a business that has stiff competition, heavy regulation and a modest layer of revenue. Excluding the valuation hubris, the market is yet to figure out what price to put on this,” said an analyst with a foreign brokerage requesting anonymity.
Valuation doesn’t seem to be the only thing wrong about Paytm. But the company’s shares have gained more than 10 percent today, suggesting some bottom-fishing by investors. It remains to be seen how the company faces the headwinds towards its revenue and builds scale.
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