The puzzle of Paytm's path to profitability

Garg is in her late 20s. She made listing gains from the initial public offerings (IPOs) of Zomato and Nykaa last year. Encouraged, she invested in Paytm next—over ₹38,000. Each share came at ₹2,150.

As India’s second biggest IPO, with an issue size of ₹18,300 crore, bombed, panic gripped small retail investors like her. Paytm’s shares continued to tank over the next several days. After waiting for a fortnight, Garg exited the stock, selling them for around ₹1,500 apiece.

Garg, who also uses Paytm’s wallet, felt betrayed.

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“Why did they overdo it?" she asked, adding that the company needn’t have hyped the issue as much or priced the IPO this high.

There are investors who held onto the stock. Vivek Pattaje, a 30-year-old chartered accountant from Bengaluru, is one of them.

He bought close to 50 off-market shares for around ₹3,000 apiece, well before the company listed. Thereafter, he purchased a similar amount when the stock was trading at around ₹1,000 – ₹1,200.

“The idea was to invest on the theme of digitization. However, we did not expect the stock to crash 70% below the issue price," he said. Pattaje sees the stock bouncing back over a 10- year period. The company, he added, will benefit from greater clarity on its business and revenue model.

At the time of the IPO, One97 Communications had 15 domestic subsidiaries and 17 international subsidiaries. It was angling for an insurance licence and was also poised to seek a small finance bank licence for its payments bank. Besides, the company was trying to aggressively grow its wealth management business via Paytm Money as well as the games businesses via Paytm Games. Separately, it had started Paytm Mall—an e-commerce play. Brokerage firm Macquarie Group dubbed this as “too many fingers in too many pies". Retail investors, perhaps, were even more confounded.

Now, Paytm appears to be hard at work simplifying what it does—what’s at its core; what services could help achieve profitability.

“Paytm is in the business of payments, and it sells loans," Paytm managing director and chief executive officer Vijay Shekhar Sharma said in an interview to Bloomberg on 28 July. Paytm’s priority, according to a company executive who didn’t want to be identified, is to make this core business profitable.

Profitability is on every investor’s mind, too. This metric is intricately linked to how the stock performs in the future. While Paytm has demonstrated encouraging progress in its business, the timeline to achieve profitability is less clear.

“The number of loans disbursed grew 224% y-o-y to 9.2 million in the quarter ended September 2022, while the value of loans disbursed grew 482% y-o-y to ₹7,313 crore ($894 million)," the company stated in a statement on 10 October.

In April, Sharma told shareholders in a newsletter that the company foresaw profitability in six quarters—or by September 2023. To be clear, Paytm is talking about achieving break-even in earnings before interest, taxes, depreciation, and amortization or Ebitda and before accounting for employee stock option plan (Esop) costs. The company had announced additional Esop grants in October 2021, which would be granted over several years.

This is not the first time the company offered ‘guidance’. And its timeline for profitability has shifted as its business evolved. For instance, in April 2020, Sharma told Mint that the company would be profitable ahead of 2021-22.

That brings us to the billion-dollar question: Is the September 2023 deadline realistic? The answer depends on who you speak to.

Before we get to that, let’s take a quick peek into Paytm’s core business.

The core

One97 Communications broadly relies on its two-sided payments vertical, which caters to both businesses and retail consumers. A second revenue stream is the lending portfolio. Through partnerships, Paytm offers working capital loans to merchants and post-paid (buy-now-pay-later) loans to consumers. The third vertical is a commerce and cloud services business.

The company’s broad game plan is to acquire retail customers through its payments business. More retail customers attract more merchants. The company can then upsell its financial services products such as loans to the merchants.

In the September quarter of 2022, Paytm had 80 million transacting users. In addition, it has 28 million merchants (as of June). Of the 28 million, about four million are paying customers and this number is growing—Paytm says it is monetizing its merchant base by selling payment devices and then extending working capital credit after analysing their transaction behaviour. Payment devices include ‘sound boxes’ and point of sale devices and they are offered as a subscription service.

Over the past two years, Paytm has positioned the growth of its sound boxes across the merchant segment as a key growth indicator. Each time a digital payment is made at a store, the sound box announces the transaction and also offers additional services such as reconciliation.

“We continue to strengthen our leadership in offline payments, with deployment of 4.8 million devices at merchant stores across the country. With our subscription as a service model, the strong adoption of devices drives higher payment volumes, and subscription revenues, while increasing the funnel for our merchant loan distribution," the company stated in its operational update in October.

Meanwhile, Paytm has pegged its loans business as one of its fastest growing divisions. It has around 11 million merchants who provide buy-now-pay-later loans. These loans are not on Paytm’s books– the fintech firm is a distributor. But Paytm gets a commission on the loans from its banking partners.

The encouraging numbers have now needled analysts to change their narrative on the company.

2023-24?

Analysts from Goldman Sachs, a multinational financial services company, are among the more optimistic lot. They hold that 2023-24 could be the year Paytm’s business turns adjusted Ebitda profitable on a full-year basis.. This is two quarters ahead of the consensus estimate, according to Visible Alpha Consensus Data, Goldman Sachs said.

“In the last few quarters, Paytm has been able to rapidly increase cross-sell on its platform, resulting in improving profitability," a Goldman Sachs report from 22 September stated.

The report further underlined the rise in revenue from high margin financial services and device rentals to 27% of total revenue in June 2022 versus 12% in March 2021. During this period, Ebitda margin has improved to -16% from -51%.

“We forecast non-payments revenues for Paytm to grow from 36% of total revenues in Q1FY23 to 44% by FY26E (estimated), driving adjusted Ebitda margin from -16% to +14% over the same period. Paytm has been consistently adding new lenders/partners on its platform (three new lenders in the last 12 months, including India’s largest private sector lender HDFC Bank), which suggests to us lenders’ confidence in Paytm’s ability to expand their TAMs while keeping loan losses low," the report added. TAM is short for total addressable market.

2024-25?

At the other end of the spectrum is Macquarie—the brokerage house is the least optimistic about Paytm’s prospects.

Analysts from Macquarie, on Paytm’s listing day, had said that the company could not make significant money unless it began lending on its own. It wouldn’t be cash-flow positive before 2029-30. Positive cash flow implies that a company has more money moving into the business than out of it.

“Paytm has to lend, i.e., use its own balance sheet to make loans and do that profitably for which it needs a banking licence, credit underwriting experience and collection infrastructure, all of which are lacking at present in our view. Despite factoring in an aggressive ~50% CAGR increase over the next five years in non-payment business revenues led by distribution business, we expect Paytm to generate positive cash flow only by FY30E," the Macquarie report then had stated.

Other analysts fall somewhere in between. In November last year, JM Financial said Paytm could report break-even Ebitda in 2026-27. In August this year, JM Financial revised its Ebitda breakeven forecast to 2024-25 because of the growth in the financial services business.

ICICI Securities, in a February 2022 report, stated that adjusted Ebitda margins (excluding non-cash Esop charges) could turn positive by 2025-26. However, in a subsequent report, published in August, the brokerage firm said that breakeven was possible in 2024-25. Axis Capital’s report, on 10 October, also predicted breakeven by the same time frame.

A JP Morgan analyst report from 29 September stated that investors were “right to be skeptical" of Paytm’s September 2023 operational profitability deadline, but added it expected adjusted Ebitda profitability by 2024-25.

Nevertheless, JP Morgan offered a note of caution on the company’s indirect expenses. “Paytm has been reinvesting gains in contribution margin back into marketing and its device business buildout has limited its Ebitda margin improvement," the report stated.

Contribution margins are sales revenue less variable costs. Marketing costs (such as sponsorships) and employee costs (such as appraisals) are categorized as indirect expenses. Repairs of soundboxes and POS devices are also indirect expenses.

‘Directionally on track’

Let’s circle back to what Paytm thinks of its own prospects.

Two executives familiar with the company said that the path to profitability was less of a mirage this time as the company has reported sustained increase in revenue over the past three quarters—across payments and lending. That’s also true of the commerce segment where services include sale of tickets for movies and travel. On the cost side, the company has been able to reduce some transaction costs and renegotiate lower processing costs with lenders because of the volumes it brings to the table, the executives added.

“At this rate, whether it is four more quarters or eight more quarters, it does not matter—as long as the company is directionally moving towards profitability," one of the executives added.

“If the contribution margin continues to grow by approximately ₹100 crore per quarter, Paytm could become operationally profitable, after accounting for Esop costs, three or four quarters after September 2023," the other executive said.

This sort of a path to profitability would cheer institutional investors such as the Ant Group, Elevation Capital and Softbank. Also, thousands of retail investors like Vivek Pattaje who bet on the Paytm story and are now waiting patiently.

“It may take time. Even Amazon took a lot of time to achieve profitability," Gaurav Shrishrimal, an entrepreneur who invested in Paytm shares, said. “My belief is that he (Vijay Shekhar Sharma) is doing it."

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