Paytm investors should look beyond UPI incentives blip

The stock has been in focus lately in anticipation of this development. Under this scheme, the total incentives for the UPI industry stood at ₹3,268 crore for FY24, up by nearly 80% over the previous year. Consequently, the bar for FY25 was high. Currently, there is no confirmation of the company’s share in incentives and a concern is that it may decline drastically. Paytm earned ₹288 crore under the scheme for FY24, which was accounted for in Q4FY24. This announcement usually comes during Q4 of the financial year.

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As Paytm’s market share in volume and value of UPI payments has come down since January 2024 when the Reserve Bank of India took action against Paytm Payments Bank and the government cut overall allocation, there could be a fall of about ₹150 crore in the company’s income from UPI incentives for FY25. For perspective, the company has reported a loss of ₹772 crore at the adjusted Ebitda level (Ebitda before Esop) in 9MFY25.

While this development is sentimentally negative, investors should not focus solely on UPI incentives because Paytm is not looking at income from payment processing alone and exploring other revenue streams. The idea is to build relationships with merchants and UPI users to cross-sell other financial services. Paytm and others are hoping to monetize the database by offering loan distribution, insurance, stock broking and other services.

Default loss guarantee

In fact, Paytm’s revenue from financial services, including loan distribution fees, stood at ₹502 core, surpassing the net payment margin of ₹489 crore in Q3FY25. For the first time in FY25, quarterly earnings from financial services could exceed the net payment margin as there was nearly 33% sequential growth in the income from financial services.

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Growth in revenue from financial services has been strong, led by a slew of partnerships with banking giants such as HDFC Bank and ICICI Bank, but has come on the back of offering default loss guarantee (DLG). The DLG provider, i.e. Paytm in this case, guarantees to compensate the lender for a loss due to default up to a specified percentage of the loan. The loan distribution becomes more lucrative as there is a possibility of earning more commission by offering DLG, but it also increases the risk exposure of the guarantor i.e. Paytm in this case.

Paytm’s take rate or commission rate as a percentage of loans disbursed, increased from 7.1% in Q2FY25 to 9% in Q3FY25. But its outstanding assets under management (AUM) under DLG has also increased from ₹1,651 crore to ₹4,244 crore, highlighting increased risk. Paytm is clearly in a strong position to offer better DLG terms compared to its competitors by virtue of its strong cash position of ₹12,850 crore at the end of Q3FY25. Though exposure to DLG risks is not a concern as of now, it could become a problem if there is an acceleration in loan default rate owing to macroeconomic factors or client-specific issues.

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Going ahead, loan distribution should be the key monitorable as the reduction in UPI incentives should not matter much with its contribution to Ebitda likely to become minuscule in future. Though Paytm's strategic cost management bodes well for its long-term profitability, valuation is pricey at a P/E of 43x and EV/Ebitda of 36x based on Bloomberg consensus earnings estimate for FY27.