Paytm – Flywheel or Doom Loop

Paytm revolutionized the payment landscape in India in the year 2010.  It was awarded the most innovative start up in 2012 and the company has won many more accolades in the ensuing years and has come a long way since then.

Paytm has leveraged its first mover advantage in the payment business to other line of business where audience captivity has a significant role to play. In today’s day and age scaling up the business where consumers can be touched and captivated is a goldmine for any company.

Over the last decade Paytm has offered a variety of solutions to its discerning customers like recharge, bill pay, market place, paytm wallet, Buynsell and incorporated itself into a payment bank.

In any industry, growth is the engine and backbone of any business but that may not be the best driver of shareholder value/ returns. Focusing on ROIC (Return on Invested Capital) is the key to growth and this one big picture most start-ups fail to grapple with. The Industry structure forces the entrant to look for growth ignoring concerns on ROIC and solely focusing on revenue growth, hoping catching up will happen at a later stage.

Cash burn is a reality and the big issue is cash burn never stops. Most businesses forget that to grow you need capital and capital needs compounding to generate value to the firm and shareholders in general.

Focus shifts to valuations, in its true sense, its pricing of the company and raising capital thinking that with every round the pricing can be taken higher and becoming a unicorn becomes an obsession. Cognitive biases like availability heuristics created by immense media hype surrounding the company makes them turn a blind eye to basics. If you think it’s too basic think again there have been numerous blunders by so called high IQ people in this field.

Fundamentally, if we dig deeper the financial statements of a lot of listed companies globally are under stress. It optically looks great till the party last and eventually the worst nightmare befalls its investors. Take the classic case of the so called unicorn WeWork where Softbank had invested money and we all know what happened. Uber is also a disrupter burning huge cash. Unfortunately, persistence does not seem to work in the market place where the business itself is not build on sound fundamentals.

Paytm has displayed immense hunger to grow and dominate the market. Paytm has invested close to 500 Mn US$ in acquisitions to ramp up its offering viz Balance, Night stay, Cube 26, Ticket New, Near Buy, Insider.in, Shopcity, eduKart, Shifu in all close to 11 companies till 2018. (Source: Crunch base)

The marketing of Paytm has been really high decibel and focusing singularly on its unique proposition. Media has been high impact and dominant – leveraging partnership with BCCI with title sponsorship for Home series from 2015 through 2023 and IPL (umpire sponsorships past 2 years), dovetailed with huge marketing promotions with cash back offers to drive usage. To back it up it has also worked on the highest level of encryption to safeguard the customer interest and protection.

Please find the table of Marketing Investments:

Source Annual Report 2018-19, One-97 Communications Ltd.

A 50% jump in Marketing promotion in FY 2019 is mainly due to impact of competition.

Paytm had 140 million MAPS and 14 million retail outlets in 2019 and is targeting close to 250 mn users and 25 mn merchant outlets by the end of the fiscal 2020 to ramp up GMV’s and overall payment transaction numbers. (Source: Company media release)

It has also launched Paytm First, its subscription based loyalty program to offer exclusive benefits to its patrons.in the process trying to coagulate and create a network effect.

It is pertinent to look at the macro numbers of the company 2008 onwards till 2010.

Source: RHP ROC Filing

The company earned a meagre revenue of Rs 119 CR and a profit of 16.24 CR in 2010. The moot point is the firm had a net margin of 13.6% which is robust for a small cap company.

Dial forward to the latest data of 2018 and 2019

Source: Annual Report 2018-19

Revenues have exploded by 3000% (119 CR in 2010 to 3580 CR in 2019) but profits have vanished totally. Last fiscal the loss was pegged at Rs 4173 CR which is more than its topline.

The firm has been raising capital and the valuation(pricing) was pegged at US$ 15 Bn a year ago. Its free cash is still negative and competition is catching up – Google Pay, Amazon Pay, PhonePe, Reliance, Wassap Pay as they are expecting the market to mushroom from US$ 200 Bn to close to US$1 Trillion by 2023.

Paytm operates in competitive environment and the industry structure in which it operates is on a high growth mode. Growth lowers the barriers to entry for new entrants to come and become sustainable as growth takes care of revenues, profits of an industry is a matter of pricing power.

It is pertinent to note that in the payment business, its customer captivity which will give any firm a huge advantage. Think who does not search on Google (barring China). Now, this is a MOAT which an incumbent has and its close to improbable to match the consumer captivity. Take an example of Coke globally, every cola drinker is a devotee of his own drink and has strong preferences. This kind of advantage is huge for any firm to build and retain. In the payment business this kind of consumer captivity is hard to achieve but not impossible. American Express, Google and Facebook have championed this through Network Effect a proven way to create a MOAT.

In competitive strategy, Growth in real terms is an enemy of the incumbent. Growth attracts new incumbent and shifts the consumers, the lead dwindles and the variable costs rise tremendously leading to blunting competitive advantage as a proportion of fixed cost declines as compared to variable cost.

Paytm also need to focus on Economies of Scale, rather than size of the market. Size of the market has got little to do with Economies of Scale, scale is achieved when any firm can spread its fixed cost over its rivals effectively. For Paytm, it has just begun and the overall financial indicators are looking out of place. One can always argue that Amazon being a growth company never paid profits for over a decade but its pertinent to note that Amazon turned free cash flow positive long before it turned profitable. Any business is worth Free Cash discounted to its present value.

Paytm is burning cash every year.

Source: Annual Report 2018-19

Free cash has almost dropped negative by 73% in the last fiscal. The market is still growing and competition from giants will compound its cash needs and stress its operational effectiveness. We strongly believe that it is going to be a herculean task as Paytm is pitted against global players like Google, Amazon & Wassap pay and other domestic players like Jio, BHIM and large banks who have a huge customer base and UPI interface.

Currently, Paytm is in a space where it has become essential to focus on financial discipline, operational effectiveness enabling to create a flywheel and then focus on growth as growth sucks capital and its currently in that loop where it has to make hard choices of growth with value or growth at any cost.

Authored by : Ramaswamy Ranganathan & Sudarshan Rajan

Ramaswamy Ranganathan & Sudarshan Rajanare Value Investors who also teach the valuation craft at leading business schools