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Paytm IPO: Should you invest in India’s biggest IPO?


2021 could well break the IPO record set by 2017 as the best year for IPOs. Best in terms of the total funds raised. Close to ₹ 67,100 crore was raised in 2017 by 36 companies that went public that year. This year in 2021, so far, 27 companies have raised close to ₹ 40,600 crore. And one of the largest IPOs of all time is slated to open – Paytm.

One97 Communications Ltd., which operates the brand Paytm, filed its draft prospectus with the market regulator SEBI for its initial public offering of up to ₹ 16,600 crore. The IPO will include a fresh issue worth ₹ 8,300 crore and an offer for sale worth ₹ 8,300 crore.

Paytm’s IPO could be the biggest in India’s stock market history since Coal India’s ₹ 15,200 crore share sale in 2010.

The ₹ 8,300 crore that the company plans to raise by offering new shares will be used for growing and strengthening business including acquisitions and strategic partnerships. Of the total fresh issue, the company can raise ₹ 2,000 crore by undertaking a pre-IPO placement, while the remaining would be through the IPO route.

Paytm’s Business: Jack of all trades?

India’s first unicorn (valued more than $1 billion) which started as a digital wallet-based platform focusing on mobile recharges and utility payments has now transformed itself into a super-app. It provides services like lending, banking, money transfer, insurance, wealth advisory, e-commerce, travel and event bookings, gaming, and obviously recharge and bill payments. It also offers software and cloud services to merchants.

Paytm IPO: Should you invest in India's biggest IPO?

Paytm or “Payment Through Mobile” has 33.3 crore consumers and 2.1 crore merchants registered across various services. Payment services are the core business of Paytm.

Paytm Payments Bank

One97 owns a 49% stake in Paytm Payments Bank, while the remaining is owned by Vijay Shekhar Sharma, Paytm’s founder, and CEO. A payments bank license allows Paytm to collect deposits from its customers and it offers them payments services. It cannot give loans and can only deploy the deposits in pre-approved debt securities that usually offer a low yield. Hence, it offers a modest interest rate of 2.5% on a savings bank account.

As the payments bank does not offer many avenues for profits, the net interest income is supported by fees from cross-selling. The payments bank license restricts Paytm from giving loans off its own balance sheet. It is currently offering credit under a co-origination model – Paytm sources loan customers to banks and/or NBFCs and earns a commission on the same.

As of March 31, 2021, Paytm Payments Banks had 6.4 crore savings accounts, and over ₹ 5,200 crore in deposits (including savings accounts, current accounts, fixed deposits with partner banks, and balance in wallets).

Paytm IPO: Should you invest in India's biggest IPO?

Paytm Money

It started in 2017 as a mutual fund distribution platform. However, now it not only offers other investment avenues like retirement schemes and gold but has also launched its tech-enabled broking business. The platform charges zero fees for users trading in cash markets and a flat fee of 10 per derivative trade. The company has around 2.08 lakh equity trading accounts of which 1.4 lakh are active.

Paytm Postpaid

This is a ‘buy-now-pay-later’ product that gives select users a monthly credit line loaded on their mobile wallets. They can use the wallet to make day-to-day payments at merchants. Users here have an option to either repay the credit line within 30 days where they won’t be charged any interest, or else the same can be converted into EMIs at nominal interest rates. This service replicates the credit card model. This product was re-launched in 2020 and has seen a quick adoption.

So How Does It Make Money?

It offers consumers a mobile wallet and a UPI product which are highly relevant and high-frequency products. It then uses this as a hook for consumers to drive engagement and cross-sell its other products – short tenure loans, credit cards, Paytm postpaid, insurance, e-commerce, broking, and others.

For short tenure loans, it earns a sourcing fee and a collection fee from financial institutions based on a percentage of the loan amount. For distribution of credit cards, it earns a distribution fee and a percentage of the total annual spend. On insurance and mutual fund products, it earns a commission. For equity broking services, it earns consumer fees – upfront account opening fee, transaction fee, and an annual subscription fee. On travel, entertainment and ticketing, and other commerce businesses, it generates revenue by charging consumers a convenience fee.

For merchants, it offers a full suite of payment products and services – Paytm QR code, Soundbox or POS devices, an all-in-one payment gateway, and solutions to help manage cash flows and payables. From merchants, it earns by charging them a transaction fee which is a percentage of the amount transacted. On soundbox and POS devices it earns a rental fee as well. For software and cloud services, it charges merchants a subscription fee, and in some instances a fee linked to the volume of activity on the platforms.

What Stands Out?

To largely everyone’s understanding Paytm is a financial institution. But it is actually just a distributor. It distributes mostly all types of financial products. It leverages its wide customer network to sell these financial products of which it earns commissions.

This model is something that everyone follows, but hardly anyone has been able to successfully deploy other than Paytm.

A few years ago, Paytm was the dominant e-wallet player, but UPI – mobile payments platform managed by NPCI – killed this moat. Currently, PhonePe and Google Pay lead the UPI market, while Paytm ranks third in terms of total volumes and value.

UPI is a revenue-less market, hence Paytm rather than focusing on volumes, focused on acquiring merchants – to whom it could cross-sell its other products. For instance, these merchants usually open an account in their associate bank – Paytm Payments Bank. Thus, not only the amount transferred from a person to a merchant started getting deposited in it, but the merchant also starts using other payments bank features. The merchant also starts using the QR codes and other payment solutions – soundbox, PoS device, and others – offered by Paytm, which increases engagement and retention of Paytm’s ecosystem.

Soundbox is a unique battery-operated product that provides voice-based confirmation of payments received by merchants. Its upgraded version gives instant visual confirmation along with the voice notification. Because of this, merchants do not need to check their mobile phones for payment confirmation, thereby increasing efficiency, reducing queues and customer waiting time, while also allowing them to keep track of payments, prevent false confirmations and customer fraud.

The company recently expanded its stockbroking services to include futures and options (F&O) trading. Paytm is trying to eat into competitors’ pie by offering low fees. It charges a fee of only 10/transaction, while other brokerages charge anywhere between 20-25/transaction.

Factors That Matter

The key driver of Paytm’s revenue is the gross merchant volume (GMV) that is processed in its platforms and the average commission that it earns on the same. It defines GMV as total payments made to merchants using Paytm products. It does not include any consumer-to-consumer money transfers.

GMV growth largely depends on two factors – transacting users and merchants.

Transacting user and merchant growth goes hand-in-hand. As the company offers a variety of services and various payment solutions, the average number of monthly transacting users and merchants on its platforms keeps on increasing. Paytm define MTU as unique consumers who have completed at least one successful transaction on the Paytm ecosystem in a particular calendar month.

Other than the GMV for payment and financial services, commerce GMV defines the total value of goods and services sold via e-commerce, travel, and entertainment ticketing business.

Paytm IPO: Should you invest in India's biggest IPO?

The Financials: Trying to get leaner

Paytm has been a loss-making company. That is because of its high-cost base. However, over the years, the company has drastically reduced its costs. A major part of this cost reduction is on the back of lower cashback and incentives.

Paytm has scaled down its marketing expenses over the last two years. These spends refer to cashback/incentives given to users to maintain a higher market share.

Another major cost for the company is payment processing charges. On the back of improvement in transaction rates from banks, the same as a percentage of GMV has reduced to 0.5% in FY21 from 1% in FY19.

Due to a reduction in these direct costs, the company has reported a positive contribution profit in FY21. However, the company is still loss-making largely due to higher employee costs.

Despite a 33% growth in GMV over FY19-21, the company’s revenue from payment and financial services grew only 12% because of a reduction in commission rates. Overall FY21 revenue declines due to the commerce & cloud business. The pandemic affected Paytm’s volumes in the travel ticketing, events, and entertainment-linked business.

Employee costs have been higher as the company has been investing in talent for building its financial services offering. However, the company’s total costs have contracted by 21% over FY19-21.

Paytm IPO: Should you invest in India's biggest IPO?

Total cash currently forms 36% of the balance sheet, which will increase to 66% as the company is looking to raise 8,300 crore. Its current assets form nearly half of the balance sheet due to trade receivables and recoverable from other and related parties – a significant rise in FY21 compared to last year. Paytm has a short-term debt of 545 crore.

Paytm IPO: Should you invest in India's biggest IPO?

In FY20 and FY21, the company’s average monthly cash burn stood at 192 crore. Post-IPO, the cash balance of the company can support this current rate of cash burn for at least five years.

Competitors: Too many

There is no single direct listed competitor of Paytm in India. This is because the company has a presence in various segments. The list is just too long. Despite the competition, Paytm has managed to grow and make its mark in each of the various business segments present.

Paytm IPO: Should you invest in India's biggest IPO?

Paytm Valuation: In top-25 and Possible Entry Into Nifty

In the last 21 years, Paytm has raised close to 19,000 crore from various investors. And now the company is aiming for an IPO worth 16,600 crore of which 8,300 crore will be a fresh issue – equal to 44% of the funds raised in the last 21 years.

Based on the last round of fundraising – in November 2020 – the per share of Paytm is valued at 1,877. This values Paytm at 1.14 lakh crore. In the unlisted market, the share prices are currently valued at 2,500, i.e., a valuation of 1.5 lakh crore. For perspective, at 1.5 lakh crore – Paytm will be the 25th most valued company (by market capitalisation) in India.

Do remember, that there is no “promoter” in Paytm. Thus, all its shareholders would be free to sell their shares in the open market after the normal one-year lock-in period as per SEBI guidelines.

Paytm has 2,167 shareholders, of which 27 are looking to sell their shares in the IPO. These 27 shareholders control 71.7% of the shareholding. We currently don’t know, what percentage of their holding will be sold in the IPO.

Also, note that at the valuation of Rs. 1.5 lakh crore, Paytm will qualify to be in the Nifty (which measures “free-float” i.e. non-promoter market capitalization). This will however require a year of operations. Also, some of the MSCI indexes that target India may add Paytm into their indices before NSE or BSE do.

Final Thought: Monetisation remains the key

Paytm is the first unicorn of the country and has been touted as a fintech giant. It has come a long way from being a start-up offering a simple digital wallet business to now the largest payments and fintech ecosystem in India.

In FY21, the company has displayed financial discipline by cutting its costs. However, profitability could still be some time away. Also, the fact that the company is raising funds to further grow its businesses, means that cash burn might continue for some more time. At current cost levels if the company monetises its customer base well enough, we think, it can achieve profitability in FY24 or FY25.

The growth will also be aided by the recently launched businesses – discount broking, Paytm postpaid, co-branded credit cards, and insurance. Their current contribution to revenue is very small, but going forward, these businesses could be the biggest growth driver.

Along with this, the company through its associate is also in process of buying out a general insurance company. Also, an internal working group of RBI has proposed allowing payments banks to convert to a small-finance bank, after three years of operation. Such conversion would significantly increase monetisation opportunities in consumer & merchant lending.

Paytm’s IPO will certainly garner a lot of interest not only because of the scarcity premium but also because of the vast total addressable market. The market segments that it serves have large growth potential, due to significant under-penetration and the ability of technology to grow the market.

However, right now, the company has just filed its DRHP. Till the time it comes out with an IPO, a lot of things might change. However, if one plans to invest in Paytm, then the most important things to track would be how well it monetises its existing customer base and its road to profitability.

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This article is for information only, and should not be considered as a recommendation to buy or sell any stocks. Stocks discussed might be part of Capitalmind Portfolios

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Paytm IPO: Should you invest in India's biggest IPO?


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