»Profit Hunter by Equitymaster

On This Day - 9 NOVEMBER 2021
Why I Would Avoid the Paytm IPO

You can love it. You can hate it. But you can't ignore it.

Paytm or 'Pay through mobile' started off in 2010 as a platform to let people top up their mobile phone balance.

By 2021 the company is a fintech powerhouse.

Digital wallet. Payments bank. E-commerce. Fantasy sports. Ticketing. Mutual funds. Stockbroking, Insurance...you name it and it's a part of Paytm's offerings.

So, it's hardly surprising the company has managed to plan a grand entry into the stock market with one of the biggest IPOs of the year.

Needless to say, the IPO has generated a lot of interest among investors. They're hoping to grab a share of India's bulging fintech pie.

Global fintech behemoth like Alibaba and Warren Buffett's Berkshire Hathaway were early investors in Paytm.

So, as an investor to what extent should the Rs 183 bn Paytm IPO interest you?

Well, if you ask me, Paytm is not a profitable company where you can rate the IPO based on traditional valuation metrics. At the same time, it's unfair to rule out the stock based on its P&L alone.

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So, let me tell you what kind of safety rating I look for in such disruptive stocks.

When I say safety rating for an IPO, here is what I mean...

S - Sustainability of the business

A - Adaptability to regulatory norms

F - Financial strength of entity

E - Economic viability of its offerings

Let's look at how Paytm scores on each of them one by one...

Sustainability of the Business

Paytm has a share of 13% in overall UPI payments, India's instant payments mechanism.

Paytm does have the advantage of being in the Indian mobile payment market the longest. Plus, the company has the largest user base.

However, competitors, PhonePe and Google Pay, have outdone Paytm in the UPI app ecosystem. PhonePe and Google Pay put together had 80% share of the UPI transactions in September 2021.

Nevertheless, it's the peer-to-merchant segment where Paytm is truly dominant with a 50% share. Peer-to-merchant is when you visit a store and make a payment to the store owner with the Paytm app.

The value transacted on its peer-to-merchant segment has grown by 33% year-on-year for the past 2 years and the total number of merchants have exploded?-?from 7 m to over 20 m.

And that's the segment that matters. Because unlike UPI, it's here that the company actually makes money.

The growth in the Indian mobile payment market will provide enough of a tailwind for Paytm to grow its user base and transactions.

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But its bigger challenge will be to sustain the massive growth in merchant payments.

Remember, competitors like Google, Apple, Amazon, and Facebook have very deep pockets. So, their entry into the payments space, will make Paytm's growth sustainability very uncertain.

Another risk is that Paytm has more than 30 subsidiaries, both domestic and international. Of them, entities like Paytm Money, Paytm Insurance Booking are still new to regulations.

The IPO Prospectus admits that 24 of the 43 litigations currently against Paytm, involve its subsidiaries. The web of transactions between the company, its founder, and subsidiaries is a key sustainability risk.

So, the rating here is 0 on 1.

Adaptability to Regulatory Norms

Having the proverbial finger in every pie - payment bank, e-commerce, insurance, and broking - Paytm will, over the years, need to adapt to a host of new regulations. Probably more than any other fintech player in the country.

However, compared to China, which is overhauling nearly every aspect of its fintech industry as it cracks down on companies like Alibaba, the regulations in India have so far been transparent, predictable, and benign.

So, there is a good chance that players like Paytm will remain pretty adaptive to the changing regulatory norms.

The rating here is 1 on 1.

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Financial Strength of the Entity

Since the last decade, access to capital from its deep pocketed investors, especially Alibaba, seems to have made Paytm casual about its business model and profitability, even by young, tech company standards.

In fact, the company has raised so much capital year after year there is very little focus on profitability in conventional terms in the corporate presentations and press releases.

Like Prof Damodaran recently wrote...

  • The picture that emerges of Paytm is that of a management that is too focused on racking up user numbers, and too distracted to care about converting those into revenues and profits.

But if the company has raised enough capital and is having a massive IPO, where is the financial problem you may ask.

Here is what concerns me...

Paytm's origins and business are in India. But it's now primarily a Chinese-owned company.

Ant Group, Alibaba, and SAIF Partners (a Hong-Kong based private equity firm) collectively own more than 50% of the shares.

The Softbank Vision fund as the next largest investor with 18%. Founder Vijay Sharma's holdings in the company have dwindled to 15%. So, his tenure as CEO depends on whether he can keep his foreign shareholder base happy.

Such foreign ownership is a matter of grave concern when it comes to financial stability. Especially for an entity that is not cash flow positive.

I would, therefore, rate Paytm's financial strength as 0 on 1.

Economic Viability of its Offerings

When I say economic viability, it's the company's ability to generate operating profits over the long term.

For fintech platform business, the metric that is considered is called the 'take rate'. It's nothing but revenue as a share of gross merchandise value.

Over the years, Paytm, has diversified into various financial services such as Insurance, mutual funds, ticketing, etc with lower service costs, discounts, and cashbacks. These did not bode well for its take rate.

In the case of Paytm, the take rate has dropped from 2.2% in 2016-17 to 0.8% in 2020-21. That's because the company has prioritised acquiring users and user transactions over actually generating revenues from these transactions.

How does this compare with its international peers in the payment processing space?

Well, companies like American Express, Papal, Shopify, and Square, have take rates between 2% and 3%. This is because they handle a variety of financial transactions.

Mastercard's take rate is 1.8%. Visa's is much lower at 1.1%.

Alibaba owned Ant Financial, perhaps the company that Paytm has most closely modelled itself on, has 1.4%. But makes up for it with huge transaction volumes.

So, when you compare these numbers with Paytm's 0.8%, the company seems to be a long way from achieving economic viability.

The fourth rating is also 0 on 1.

So, all in all, notwithstanding the valuations of the Paytm IPO which anyways are based on future projected profitability, the rating on the SAFE safety parameters is according to me just 1 on 4.

Therefore, please bear this in mind before getting enticed to subscribe to the IPO for speculative near-term gains.

And if you do subscribe for the long term, ensure that you keep a close watch on these ratings.

Warm regards,

Tanushree Banerjee
Tanushree Banerjee
Editor, StockSelect
Equitymaster Agora Research Private Limited (Research Analyst)

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