The digital payments unicorn has its work cut out if it wants to convince investors that it is on a sustainable profitability track, which warrants its valuation
Life has come full circle for Vijay Shekhar Sharma's One97 Communications, parent to digital payments firm Paytm, which has witnessed several ups and downs in the past 13 years. Even as it became a prominent name in India’s ambitious transition into a digital economy, the company’s stock market woes made it an infamous example of why investors remain wary of new-age start-ups.
A unicorn since 2015, the fintech was valued at $16 billion when it raised $1 billion in November 2019 in a funding round led by US asset manager T Rowe Price along with existing investors SoftBank Vision Fund and Ant Financial. But things started coming undone for Sharma after Paytm became a publicly listed company on 18th November 2021.
The fintech’s market capitalisation dropped 65 per cent within the first four months of it turning public. In the next year, Paytm witnessed the exit of China’s Alibaba Group, one of the company’s early investors, even as shareholder’s wealth continued to erode. This was followed by SoftBank reducing its stake in the company by 2.07 percentage points.
Through this all, Sharma tried to tune out the noise and got down to putting Paytm's house in order. The fintech's Q4FY23 and FY23 results indicate that he might have succeeded in this endeavour.
The company's revenue from operations jumped 61% Y-o-Y (year on year) to Rs 7,990 crore in FY23, while EBITDA before ESOP stood at Rs 1,342 crore. Led by an increase in payment volume and higher subscription revenue from device merchants, its payment revenue increased 44 per cent to Rs 4,928 crore in FY23.
Achieving positive operating profit—EBITDA minus ESOP costs—is a personal victory for Shekhar Sharma, who faced barbs from critics about Paytm's business model, traction and profitability for a very long time. The criticism over its financials increased after Paytm’s anticlimactic market listing and uninspiring revenue growth between FY18 and FY21, which many felt was due to its over-reliance on the ecommerce business.
However, Sharma is having the last guffaw. Since the much-spoken-about market debut in 2021, he recalibrated Paytm's business strategies by keeping the pursuit of profitability at the forefront of all his business decisions.
Now that the company has posted a positive operating profit, Sharma seems to be back in the game with all guns blazing. He ascribed the company's success to its methodical resource allocation and focus on core revenue, propped up by payments and financial services distribution businesses as growth drivers.
“The team was asked to focus on growth with quality revenues that contribute to the bottom line. We have achieved this milestone without losing sight of growth opportunities and keeping all compliances as well as risk factors under a strict watch,” he told shareholders after the financial results were released.
Some industry watchers believe it is too early to bring out the pompoms, as Paytm still has a long way to go when displaying consistent profitability. The performance of a couple of financial quarters is insufficient to determine whether the fintech has finally cracked the code for sustainable growth.
According to Milan Sharma, managing director (MD) and founder of 35North Ventures, a Mumbai-based venture capital firm, listed start-ups like Paytm and Nykaa will have to keep reinventing their business model to reach profitability on a stable basis. “There is nothing new about the loan disbursal business using Paytm since many new-age lenders are trying various out-of-the-box lending models to achieve growth. The key question is whether these companies that use the Paytm platform can scale up lending without adding on the NPA pile,” he says.
While Paytm's Q4 results are a positive sign, its high losses and dependence on new business lines like lending will remain causes of concern for investors. Paytm's net loss went up by 9 per cent to Rs 1,568 crore in FY23, and its disbursal-to-revenue ratio has decreased from 4.87 per cent in June 2022 to 3.78 per cent in March 2023.
Gaurav VK Singhvi, the co-founder of community-based investment platform We Founder Circle, feels that the upcoming quarters will provide valuable insights into Paytm’s ability to scale effectively and generate profits. “It will be important to monitor the company's financial performance, operational efficiencies, and strategic initiatives during this period. By observing how efficiently Paytm can continue its growth trajectory, we can better gauge its potential to achieve profitability and justify its valuation,” he opines.
Milan notes that the justification of valuation is a complex subject matter. “New age start-ups have lost between 50 per cent to 80 per cent of their value based on their IPO listing price. So, to keep pace, Paytm will have to do a minimum adjusted EBDITA (EBITDA without including ESOP costs) of Rs 800 crore to justify its valuation,” he states.
Additionally, the digital payments company will need to scale operations significantly. One metric could be fixing a profitability target, which could be maintaining 5X gross merchandise value (GMV) of its existing levels, suggests Sonam Srivastava, founder of investment advisory firm Wright Research. Other key strategies include expanding its user base, increasing transaction volume, reducing costs, monetising users, and launching successful new services like lending, she adds.
These efforts are especially important given the variety of challenges in the fintech domain. This includes competition from companies like PhonePe and Google Pay, stricter government regulations, and uncertainties in long-term profitability.
Niraj Bora, founder of Pune-based Surmount Business Advisors, is confident that Paytm can overcome these challenges. “The kind of scale it needs to improve further profitability is not as high as we think since more products ensure better loan-to-value ratio from the same customer base, and India has adopted digital payments at a great speed,” he points out.
After announcing the FY23 results, Sharma told shareholders that the next milestone is to make the company's free cash flow positive in the near future, though he did not commit to a concrete timeline.
Getting its business model right is critical to achieving this cash flow positivity. In addition to covering its operational costs, it will also have to generate surplus cash flow, which would depend on factors like its growth rate and the competitive landscape. Srivastava expects this profitability to be at least five years away based on current valuation levels.
At the same time, Paytm will have to navigate regulatory challenges like the ban on Paytm Payments Bank and online merchant onboarding, which could reflect on its balance sheet. The RBI directed Paytm Payments Bank to halt new customer onboarding in March 2022, and in November, the onboarding of new online merchants on the Paytm payment gateway was also prohibited. To resolve these issues, Paytm requires clearance from the central government for foreign investment in its payment subsidiary.
Sharma points out that only some prominent payment banks have been successful in India. “Regarding the question of leveraging debt raise for onward lending, a non-book lending model is better than creating its own book. Since this will create confusion as to what Paytm's business model is, it’s best that the company avoids this route,” he suggests.
Another reason for Paytm's high-margin revenues was loan disbursals through NBFC and bank partners. As per the company's financial reports, in FY23, 9.5 million customers borrowed Rs 35,378 crore on its platform and lending business revenue tripled to Rs 1,540 crore.
However, industry experts say that the sequential growth of this business vertical has gradually slowed over the past few months. One explanation for this is that many of these loans have matured since borrowers made timely payments.
In an earnings call, Bhavesh Gupta, Paytm's COO, who was elevated to President recently, explained that Paytm now charges a lower commission from the partners, which could impact its revenues, but not its bottom line. To get higher commission, experts suggest that Paytm has to increase the ratio of personal and merchant loans as compared to postpaid loans, since the former are of bigger ticket size with longer tenures. Its personal and merchant loan stood at 27 per cent and 18 per cent respectively, in Q4 whereas postpaid loans constituted 54 per cent.
Agreeing with this conjecture, Bora says that the fintech's profitability would increase going forward due to its strong distribution capabilities. “Lending, a competitive space in India, has high growth potential since the country has a substantial underbanked population who are only now starting to use digital payment mechanisms. They are the future customers, and despite the competition, there is enough space for everyone to grow,” he claims.
Despite its first-mover advantage, growing competition in the loan distribution business poses a challenge to Paytm's growth momentum. This could lead to lower interest rates, higher marketing costs, and the potential loss of customers to other companies.
Moreover, while Paytm is unable to lend from its own books as a payments bank, competitors like BharatPe have established in-house NBFCs and offer postpaid as well as merchant loans. Paytm will have to chart its plans to strategically navigate this domain to sustain its growth in the loan distribution business.
Srivastava feels that Paytm can mitigate these challenges by innovating its fintech offerings, investing in marketing and advertising, forming partnerships and prioritising customer service. These strategies can help it differentiate itself and maintain a pole position in the market, competition notwithstanding.
Paytm has demonstrated its keenness to adapt to the evolving digital payment landscape. For instance, it recently launched Paytm UPI Lite, which facilitates instant multiple small-value UPI payments through an on-device wallet. It showcases their commitment to providing seamless and reliable payment solutions. The trust and familiarity associated with the Paytm brand also significantly influenced this product's user adoption. Last month, it also launched the Paytm SBI Card on the RuPay network, in partnership with credit card issuer SBI Card.
Paytm saw a jump in its Q423 revenues, up from 31 per cent in December 2022 to 55 per cent in March 2023, because of the UPI-linked incentives that the government paid to the company. In 2022-23, One 97 Communications received Rs 182 crore in UPI incentives from the government, which is likely to remain flat now.
However, expanding the use cases of UPI to instruments beyond bank accounts can help Paytm in revenue generation and profitability. By making UPI more accessible to users who do not have bank accounts, the digital payments firm can increase the number of people using UPI, leading to higher transaction volumes and revenue. Additionally, it can charge fees for each UPI transaction, further contributing to its revenue channel.
Shekar Sharma seems to be thinking on these lines already. A day after the company declared its March quarter figures, he told analysts in an earnings call, “I believe UPI has started going towards monetisation…different payment instruments will come on UPI. (The prepaid wallet instrument) has an interesting MDR (merchant discount rate) structure… If our Paytm wallet is being used on somebody else's QR, the merchant-side QR will have to pay us.”
Other experts opine that the fintech can also consider using the UPI route to cross-sell other products. For instance, with the growing acceptance of UPI in several South East Asian countries, it can sell wealth management products to NRIs. While the margins in these initiatives may be thin, UPI offers robust potential for user acquisition and engagement channels, creating monetisation opportunities.
Since demonetisation in 2016, when Paytm expanded its digital payment user base, competition has increased by leaps and bounds. Srivastava states that in FY22, its gross merchandise value (GMV) grew by 200 per cent, indicating increased transaction volume and user activity. The company's revenue also grew by 80 per cent, showcasing its ability to generate income from its user base. Furthermore, Paytm managed to narrow its net loss by 50 per cent, highlighting progress towards profitability.
“These data points suggest that Paytm's user base and merchant network continue to support its growth. However, it will need to address challenges such as innovation, marketing, and competition to maintain its position in the market,” Srivastava cautions.
Singhvi affirms, “Paytm's 90 million monthly transacting users (MTUs) and 7 million merchant devices can significantly deliver profitability and growth despite increasing competition from players like PhonePe and Google Pay. While PhonePe currently holds a larger market share of 47 per cent in the UPI space, with Paytm trailing at 15 per cent, there are several reasons to remain optimistic about Paytm's prospects."
Paytm's strength lies in its merchant base and easy-to-use digital wallet. If it can exploit the opportunity of leveraging its merchant base and designing innovative lending products for this community, it can steer ahead of the competition.
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