Should you subscribe to PayTM IPO?

The much-awaited IPO of One97 Communications, the holding company that owns and operates the PayTM super app and other allied apps (such as PayTM Money and PayTM for Business), opens on November 8, 2021. The offer worth ₹18,300 crore, comprises of a fresh issue of ₹8,300 crore and the rest being offer for sale. Founder promoter Vijay Shekar Sharma, along with other marquee investors such as Antfin (Netherlands), Alibaba.com Singapore E-Commerce and BH International Holdings are selling partial stakes in the IPO.

Portfolio Podcast | PayTM IPO: Should you subscribe?

The excitement around the IPO of PayTM is purely a play on the current under penetration of digital payments in the country and the leadership position that the company enjoys (according to reports by RedSeer). While the growth story of Indian digital payments holds true, PayTM’s revenue growth hinges on how it deals with a lot of other factors/constraints such as the high competition it faces in each of the segments it operates in, low take rate (implying per transaction revenue for the company) and limits on transaction fees and commissions by RBI. Translating these revenues to profits may be another tall task, given its previous track record of acquiring customers and merchants through discounts and other offerings and lack of any defined path to profitability in the near future. Apart from regulatory curbs, complicated business structure, and the exodus of several senior level personnel months prior to the launch of the issue, pose risks to the company’s business and management.

Long term investors need not subscribe to this issue. At a price band of ₹2,080-2,150 apiece, the company is valued at EV/revenue (FY21) of 40.3 times compared to its profitable foreign listed peers that trade in the range of 7 to 12 times.

Business

The company offers an entire digital ecosystem for its customers and merchants –ranging from payment services (money transfers, in-store payments, recharge, and bill payments), and financial services (digital banking including FASTag, PayTM Wallet and deposit accounts, loan or BNPL referral, wealth management and insurance). Generating revenue in the form of transaction fee, consumer convenience fee, and recurring subscription fee (from merchants), payment services comprises 62 per cent of the company’s consolidated revenues in FY21 and 4 per cent comes from cross-selling financial services.

Besides apart from offering online payment solutions for merchants (through Paytm Payment Instruments and major third-party payment methods), the company also offers services such as selling tickets to customers, advertising, and app listing on the platform, to help them facilitate more commerce (8 per cent revenue flows from such commerce services).

It also provides software and cloud services (14 per cent of revenue in FY21) for large, medium, and small merchants (including telecom companies, digital and other fintech platforms) to improve their business operations (through billing, ledger, vendor management, customer promotions, catalogue, and inventory management) and access important financial tools such as banking, wealth, and credit facilities.

Per the survey report of RedSeer, the company has the largest network of customers and merchants in India– 33.7 crore and 2.2 crore, respectively (as of June 30, 2021). Its monthly transacting users and merchants grew at a compounded annual growth rate (CAGR) of 15 and 37 per cent respectively, over FY19-21 to 4.1 crore and 2.1 crore respectively.

Consequently, the company’s Gross Merchandise Value (or GMV, defined as total payments made to merchants through transactions on the app, excluding peer to peer money transfers) grew by 33 per cent CAGR over FY19-21 to ₹4 lakh crore.

Risks

Despite steady growth in merchant on-boarding and transaction volumes (GMV), its operating revenues dropped 7 per cent CAGR over FY19-21 to ₹2,802 crore. This implies an average take rate of 0.69 per cent, which further dropped to 0.61 per cent in June 2021 quarter.

Irrespective of the change in mix of services provided to customers, the take rate may remain low for the company, going ahead. This is because the RBI has restricted the transaction fees and commissions on various payment services to less than 1 per cent (varying across payment instruments), apart from imposing per transaction limits on such fee income (in the range of ₹15 to ₹1,000). This restricts the scope of revenue scalability for the company beyond a point.

That apart, going ahead PayTM continuing to grab a significant share of the Indian digital payments pie is uncertain, given the existing and emerging formidable competition from large players such as Google, Walmart-Flipkart/PhonePe and Reliance-Facebook. Besides there are numerous other fintech players it competes with in each segment.

The company also has no history of profits in the past. Its EBITDA (loss) margin, improved from negative 130 per cent in FY19 to negative 59 per cent in FY21. This was predominantly achieved due to drop in marketing and promotional expenses (comprising digital marketing, brand marketing, sponsorships, cashbacks, Paytm points and other promotional expenses, given to consumers or merchants for incentivising acquisition and retention), which fell from 95 per cent of total consolidated revenues in FY19 to 17 per cent in FY21.

However, the marketing and promotional expenses surged by 64 per cent y-o-y in the June 2021 quarter. That apart, the company intends to earmark ₹4,300 crore from the IPO proceeds towards growing and strengthening the Paytm ecosystem, including through acquisition of consumers and merchants and providing them with greater access to technology and financial services (inter alia implying a rise in marketing and promotional expenses, being funded by the issue proceeds); and the rest towards investing in new business initiatives, acquisitions and strategic partnerships and other corporate purposes.

Besides, the likely recurrence of the cash-burns is also indicated in the size of the offer – the company is sitting on a cash (and bank) balance of ₹2,498 crore (pre-issue) as of June 2021 and plans to raise another ₹8,300 crore through the IPO.

Further, its complex structure with 32 subsidiaries (includes PayTM Money and 17 foreign subsidiaries), 10 associate companies (includes PayTM Payments Bank) and other joint ventures, could pose risks to the parent’s shareholder value. Besides inter-company transactions are other hard nuts to crack. For instance, the company spends 60 per cent of its consolidated revenues on payment processing charges, of which 49 per cent (₹946 crore) is paid to PayTM Payments Bank which is an associate company of One 97 (holds 49 per cent stake, rest held with Vijay Shekar Sharma). The processing charges paid by One97 (disclosed as related party transactions) constitute 33.8 per cent of PayTM Payments Bank’s revenue.

The company has also hogged media limelight for the wrong reasons in the past. Recently around June-July 2021, PayTM saw a series of exits from Key Managerial Personnel, such as Amit Nayyar, Rohit Thakur, Jaskaran Singh Kapany and Amit Veer. The time of the exits (just before the launch of the IPO), coupled with their likely entitlement to ESOPs is worth pondering on.

Spreading too wide

Betting big on the under penetration of digital transactions and financial services in the country, the company has adopted a scattershot approach, by growing into numerous segments in a short span of time (commenced in 2009). However, lack of any clearly defined path to profitability makes it an unviable investment. The company also intends to expand its horizon further, which could change, (rather complicate) its business dynamics more — the prospectus mentions its associate, PayTM Payments Bank, eyeing a small finance bank license in the years to come. While this can expand its customer base with increased deposit balances, venturing into credit underwriting with no prior experience comes with credit risks which can impact shareholder value.