Paytm’s IPO has raised many eyebrows. Then, what makes it 2021’s most-awaited public issue? – The Economic Times

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SynopsisThe grey-market premium for the upcoming public offer rose 2.5x in just two months. Touted as the country’s largest-ever IPO, Paytm brings hope to investors despite the criticism around its potential revenue and profitability. But the Street isn’t known to be kind to cash guzzlers and loss-making companies. Should investors take the plunge?

This week will be busy for senior executives of Paytm, India’s first and largest payments bank by market share. The company has called for an extraordinary general meeting (EGM) of shareholders today (July 12) and if things go as planned, Paytm’s holding company — One97 Communications Limited — is likely to file its draft red herring prospectus with market regulator Sebi in some days.

In simple words, the EGM will set the ball rolling for the most-awaited initial public offering (IPO) of 2021.

Targeting a valuation of USD24 billion-USD25 billion and its IPO likely sized at USD2.3 billion, Paytm is set to do what Coal India did a decade ago — tease the market with the largest-ever public issue the country has seen.

Adjusted for the recent stock split, the grey-market premium for Paytm shares has compounded by 2.5 times – from INR950 apiece to INR2,400-INR2,500, in just two months. “There’s a lot of demand from retail investors, high net-worth individuals and wealthy family offices,” says Dinesh Gupta, founder of UnlistedZone, a platform that facilitates trading of unlisted, ESOP, and pre-IPO shares. Interestingly, a former senior executive who continues to hold a sizable portion of Paytm ESOPs says he won’t exit his investment despite the premium multiple the IPO could offer. “I will hold these shares as an asset class. People are buying Bitcoin, why not Paytm?” he asks.

But what explains this mammoth demand?

After all, there is a lot of criticism around the company and its business model. More importantly, the point often highlighted is that it is still a loss-making company.

One97 Communications- consolidated financials@2x

What’s fuelling the rush?
Paytm has challenged and disrupted the way banks were approaching the transaction business.

India remained largely a cash-driven economy until the 2016 demonetisation, and it still is. People said demonetisation would spell doom for small businesses, but small businesses were quick to get back on their feet and didn’t shy away from adopting digital payments. So did the shoppers.

By 2020, digital payments expanded multi-fold to become an INR29.5 lakh crore market and much of it was captured by new-age fintechs or payments aggregators. According to Statista, a Germany-based market and consumer data research outfit, Paytm was voted the preferred e-payments service provider by 89% of the respondents. This explains why investors are queuing up for it.

“The company has a much broader and deeper customer and merchant legacy than its competitors and has a broad-based business model. Coupled with an opportunity to get a banking licence gives them tremendous value.”

— Shishir Mankad, head of financial services, Praxis Global AllianceToday, the company claims to do over 1.3 billion transactions monthly with more than 20 million merchants having deployed their payment solutions. In fact, despite the seeming loss of market share to popular Unified Payments Interface (UPI) players such as PhonePe and Google Pay, the company has held its fort.

The question next is, at what cost? How is a company with over INR1,700 crore losses in FY21 justified in tapping the market?

Here’s where a market veteran, instrumental in today’s large-caps hitting the bourses about 25-30 years ago, has a different take. “When you invest in an IPO, the question to ask is whether the company is a dominant player in a sector, which today maybe a sunrise segment, but has the potential to scale up 30 years down the road,” he says.

Simply put, it’s akin to identifying today’s small-caps that can grow into tomorrow’s large-caps. “Valuation or balance sheet of the company in its initial years should barely matter,” he adds.

As Shishir Mankad, head of financial services at Praxis Global Alliance, a consulting firm, puts it, the Paytm IPO may not suit a traditional retail investor “who buys stocks after looking at an Excel sheet”. He believes that institutional investors who do not take calls based on a few quarters of losses or profit but adopt a long-term strategy would consider the IPO.

Deleveraged and widened
From a business perspective, too, Paytm has a few advantages to back it. Over the last couple of years, the company has diversified its business model and is no longer the mobile-wallet firm it was five years ago. It has developed a strong digital payment-gateway business, including that of managing LIC’s digital insurance-premium payments. It is the largest issuer of FASTags in the country.

The payments-banks space, which initially saw 11 aspirants in 2015, is now down to just four operating players. Paytm is the only one with a decent scale and presence and is reckoned as India’s first mobile-only and digital-first bank with a banking licence.

With a deposit base of INR3,200 crore, way higher than the Airtel Payments Bank, Paytm has established some credibility and recall among savers. The introduction of business-banking products and wallets for all requirements has placed it ahead of the curve with respect to innovation.

In fact, the company has redeemed itself owing to its payments bank as reported by ET Prime earlier.

With its deep and wide network with merchants, Paytm has managed to carve a space for itself and today it has close to 15% market share in UPI. Its all-in-one-QR did the trick. And how. A large segment, as Paytm claims, uses its payments bank as their banking account for these QR transactions and not the merchants’ mainstream bank accounts, thus ensuring that transaction or float funds are retained within Paytm’s fold.

During March and April this year, Paytm Payments Bank was the top beneficiary bank for UPI transactions, with 470 million and 430 million transactions, respectively, indicating the stickiness of its merchant base.

Paytm Payments Bank- financial snapshot@2x

The banking dream
Just as destiny favours the brave, in the banking business, profits chase those who take the risk of lending. For money to be made, it is critical to look beyond plain-vanilla payments and product distribution. Is Paytm CEO Vijay Shekhar Sharma sowing the seed to become the next HDFC Bank or ICICI Bank? Directionally, yes.

Completing six years of operation as a payments bank, elevation to small finance bank, and ultimately a universal bank is a natural aspiration. As Paytm is now eligible to rightfully scale up, and considering how the pieces on the chessboard are being moved, Sharma seems to have set his eyes on a larger game. After all, in FY21 not only did the Paytm Payments Bank business establish its profitability, but also contributed 25% to its parent’s top line.

“The SFB (small-finance bank) licence will be a catalyst. How many unlisted banks are there for potential investors to invest? Paytm’s clientele is upmarket and offers a lucrative retail-lending business,” says a former senior executive with Paytm, perhaps also dropping a hint that a deal may be in the making for the payments giant.

According to news reports, about 13 Chinese board members were replaced with Indians. The RBI has always been particular about promoter holding and foreign participation in banks. A combination of offer for sale (OFS) and fresh issue of shares would adequately ease this hurdle for Sharma, SoftBank, and Ant Financial, setting the stage for a larger narrative.

“The company has a much broader and deeper customer and merchant legacy than its competitors and has a broad-based business model. Coupled with an opportunity to get a banking licence, it gives them tremendous value,” says Mankad.

If Sharma sticks to his core retail customers, where there is immense scope to customise and personalise products, and doesn’t get lured by easy and lumpy corporate loans, Paytm could carve a niche for itself.

Paytm already has a decent customer base, thanks to its merchant and payments base. With the seeds sown for the SFB transformation, a bank licence can flip over a low-margin business to a high-yielding one with practically zero acquisition cost.

Its digital distribution platform for mutual funds, digital gold, insurance, and stockbroking may be highly fragmented, but partnerships forged with service providers across savings categories will help keep its mobile app relevant as a one-stop shop for customers.

That said, while Paytm has started disbursing small-ticket personal loans and issuing credit cards in association with banks, whether it has the capabilities to build robust risk models and underwriting standards for the larger business will be rigorously tested.

How competition will play out is another grey area. “In all traditional business verticals, digital players are growing the overall business and they are taking market share from the existing players. Paytm still has to do more things and justify the valuation based on today’s revenue,” says the former C-suite executive. But more on this in a bit.

Paytm's key business verticals@2x

Sizing the issue
At USD2.3 billion, Paytm’s IPO may be a combination of an offer for sale and fresh issue. The word on the Street is that both Jack Ma’s Ant Financial and Masayoshi Son’s SoftBank may look at a partial exit through the IPO. Given Ant’s own troubles with its local government, Ma may want to take back some money to make peace at home.

Paytm- key shareholders @2x

For smaller investors, holding less than 10% stake, the IPO draws up a ready path to exit at convenience.

But here’s the catch. News reports are abuzz with how Paytm is expected to price its offer at a steep premium. While premium pricing is everybody’s aspiration, for an offer of this size to find acceptance, there must be something left on the table for investors. Based on FY21 financials, shares of Paytm were valued at INR11,271 apiece. This went up to INR28,000 in the grey market around May this year when the company’s IPO plans first surfaced. In order to make the pricing attractive, a 1:10 ratio of stock split happened on June 30. Gupta expects a 1:10 bonus issue to be rolled out ahead of the IPO, which would further soften the pricing.

Paytm IPO- how pricing could be derived@2x

With Zomato listing ahead of Paytm, smart pricing will be crucial for the IPO’s success.

Competition hot on the heels
While a couple of years ago, Paytm was the undisputed leader in mobile payments, consumer preference towards UPI has resulted in market-share loss to Walmart-backed PhonePe and Google Pay. The lack of market leadership in any single area of business may put off investors.

BharatPe, with a customer base of just 6 million and solely focusing on merchant acquisition, has cut into Paytm’s merchant base, giving the latter some jitters. Last month, BharatPe in partnership with Centrum Financial Services acquired the troubled PMC Bank. It will soon function as an SFB, thus gaining an edge over Paytm in the battle.

Google Pay and PhonePe’s efforts to monetise their customer base by up-selling and cross-selling products seems to have been rather slow going by what their FY20 numbers indicate. With their customers remaining sticky, cutting into competition for customer acquisition would be difficult. So, can Paytm grow its base at the high multiples as seen of late? That’s a metric the Street will monitor after listing, and it will have a direct bearing on Paytm’s valuation.

Other challenges
While the narrative around Paytm’s IPO is pitch perfect, and as Shyam Sekhar, founder and chief ideator, ithought advisory, puts it, the IPO could be a huge success, it’s worth remembering that up until early 2020, Sharma was clear that an IPO didn’t make sense unless the business returns cash and makes profit. Going by the FY21 financials, neither have happened.

What changed between then and now for the company to dial back on these parameters is best known only to Sharma. Perhaps it was the investors’ demand for an exit and the government’s blockade of Chinese investment in Indian startups. Its largest shareholder Alibaba has its own share of troubles in China with the regulatory crackdown.

But there are two things to be mindful of.

One, the Street isn’t kind to cash guzzlers and loss-making companies. Even if mutual funds have a longer investment horizon, their ultimate responsibility to retail unitholders may force them to hold back from the stock after listing. “Ultimately, at some point, the issue price and market price must converge,” says Sekhar.

Two, unlike in the past, after listing there may be no godfathers to handhold Paytm and fund its losses.

Sub-par corporate-governance standards are strongly reprimanded by the Street, which could have a direct impact on Paytm’s stock price after listing. Sharma remains the face of the company, though it has a strong leadership team under him. However, attrition, especially at the top, is very high, like in most startups. Once listed, such huge manpower churns would come under scrutiny. Also, investors may question forays into new verticals where competition is already strong.

In all, the run-up to listing and the listing itself may be an exciting journey, but what Paytm should flesh out ahead of the IPO is how it will sustain investor interest after the event. Organically or inorganically, fixing the financials must be Sharma’s top priority.

The final call
Sharma may have a lot to think about. But the question for investors is whether they believe in what he has built in over a decade.

Paytm may not be the market leader in every segment in which it operates, barring the payments bank. But it is the original disruptor across many businesses, including payments, and that is solid proof of the organisation it has built. Undoubtedly, it holds a significant position that is difficult to ignore across the domains it operates.

Paytm’s well-spread presence across categories and its interesting position in the business life cycle — that of the near-maturity stage but far from the peak — offers enough avenues to scale up. With a serious dearth of fresh thinking in the country’s banking sector, Paytm could metamorphose into a totally different entity a decade from now, thanks to its highly potent payments-bank business.

Paytm’s IPO is for those who can foresee and believe in such transformation. It requires a different mindset to appreciate the public issue. Investors with an appetite for risk and ability to venture out of conventional business models may consider it.

(Graphics by Sadhana Saxena)

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