The Paytm Phenomenon – Decoding Its Journey to Operational Profitability

Winds of Change 

Paytm’s share price has quietly moved up by almost 60 percent from the beginning of this year. For a company that went from proudly launching what was to be the biggest-ever public listing in India, to recovering from its share price experiencing India’s biggest-ever first-day falls, this represents a much-needed aura of optimism around its future prospect. 

Sceptics have long dusted Paytm off as another venture capital-fuelled experiment doomed to fail – for good reasons. Launched in 2010 as an online mobile recharge platform, it has experienced years of losses and multiple business pivots, culminating into a confusing, cluttered fintech application. Considering that it offers 90+ services (50+ on its home screen alone), ‘confusing’ might be an understatement. 

Paytm’s cluttered application is representative of the criticism the company has been facing for a while – a seemingly directionless, cash-burning business model with its hands into many pies. 

But it seems that the winds are finally changing – for the first time ever, Paytm declared operational profitability. 

Paytm’s Adjusted EBITDA, net of share-based payments (the seemingly favourite metric of listed tech startups) has been consistently positive and rising for the last three quarters. Net income margin has improved from -38 percent to -15 percent in just five quarters.

Zooming out, we see a similar pattern of operational improvement across the past few years. Revenue, which stagnated between FY 2018 and FY 2021, has more than doubled since then.

Naturally, here we ask – what’s driving this turnaround? 

Two things – doubling down on a high-growth, high-margin business segment. And much-needed financial discipline. 

Let’s dive in. 

Payments: Wafer-Thin Margins Amidst a Buyer’s Market 

The bulk of Paytm’s revenues (~60 percent) are derived from its core business of processing payments. The below chart provides a succinct breakdown of its key revenue drivers, which have been yielding a healthy CAGR of ~20 percent since FY 2019. 

Payment services seem to be doing good. Paytm’s average monthly transacting user base more than doubled from 4.5 Cr in FY 2021 to 9.4 Cr today. Merchant subscriptions increased by eightfold from 8 lakh to 79 lakh today. Years of extensive marketing campaigns, cashback offers, and the lowest technical decline rate for UPI transactions have made Paytm a household name. 

However, despite the healthy growth, payment services do not generate enough margins to sustain Paytm’s operations. After netting the cost of processing these payments (paid to other financial institutions such as card networks, banks, and NPCI), this segment provides around INR 1,900 Cr for Paytm, amounting to between 0.07 – 0.09 percent of its gross transaction value. Not enough to cover Paytm’s employee costs.

And margins are unlikely to increase much – as long as UPI remains free, transactions processing will remain a buyer’s market.

Paytm’s first-mover advantage for PoS devices and soundboxes (~estimated 25 percent of payments revenue) is being challenged by low-cost substitutes released by PhonePe, Google Pay, BharatPe, MobiKwik, and even banks like IndusInd Bank and AU Small Finance Bank. 

Paytm’s payment gateway service faces intense competition from the likes of Razorpay, Payu, CCAvenue, and Billdesk. Moreover, with the RBI blocking Paytm’s application for a payment aggregator license, the company has been barred from onboarding new customers for the time being.

Utility payments and top-up services are fickle sources of revenue, with users often shifting loyalties between applications based on rewards, discounts, and cashbacks. 

In short – payment services are good for acquiring users, but not for monetizing them. 

Acquiring Customers for Payments, Cross-selling them Credit

So Paytm is cross-selling credit – a more lucrative, higher margin product – to its extensive user and merchant base. This now accounts for ~20 percent of Paytm’s revenues, up from 5% in FY 2021, yielding a whopping CAGR of 64 percent.  

To be clear, Paytm is not a lender – it does not extend credit from its balance sheet. Rather, it’s a distributor, linking 8 partner banks and NBFCs, to its extensive user base through buy-now-pay-later and personal loans, as well as business loans to its merchant base. In the process, it collects a cool 2.5-3.5 percent of the loan value as its fees, with limited risk on its balance sheet. 

For consumers, the Paytm application itself is the hook, and postpaid (buy-now-pay-later) loans are the bait. Postpaid customers are subsequently upsold higher-ticket and higher-margin personal loans, and even co-branded credit cards.  

For merchants, PoS machines and/or soundboxes are the hook – 85 percent of merchant borrowers subscribe to Paytm devices. The key here is transaction data – devices open up the minutiae of merchants’ financial flows to Paytm, which can then utilize alternate data points to assess merchants’ default risk, predict liquidity/ working capital requirements, and thus target previously unbanked segments like Kirana stores. 

All three of its loan categories are growing exponentially and have considerable scope for further expansion – only 4-6 percent of Paytm’s monthly users and merchants have converted to borrowers till date. 

What’s interesting here is that between 50-65 percent of borrowers are repeat customers, across all three lending categories. This could lead to greater comfort for Paytm’s lending partners, and encourage an increase in ticket sizes in the future. 

Another source of comfort for Paytm’s lender partners, and a potential point of differentiator for its offerings, is the fact that Paytm bundles loan collection services along with its distribution services. Paytm utilizes Creditmate, a debt collection platform it acquired in 2021, to send app notifications, undertake direct calls, and hire third-party agencies for door-to-door collections. It earns an additional 0.5-1 percent of outstanding amounts for successful collections. 

Paytm’s pivot towards financial services somewhat explains Paytm’s affinity for a super (cluttered) app. It wants to attract a large number of users, by offering a large number of use cases and upselling them personal loans. 

Using its large monthly user base, and an ever-expanding salesforce (having increased sixfold, from 5,000 in FY 2021 to 30,000 in FY 2023), it wants to attract a large number of subscribing merchants, and upsell them business loans. 

Okay, let’s summarize. Payments are high-volume but have thin margins. Cross-selling credit yields a high-growth and high-margin business segment. So when does Paytm break even in ‘non-adjusted’ terms? 

ESOPS Charges To Continue Overwhelming EBITDA 

Three expense items constitute ~85 percent of Paytm’s revenue – payment processing charges (37 percent), employee costs excluding ESOPS (29 percent), and ESOP charges (18 percent).  

And all cost buckets, except ESOPS charges, have been falling as a proportion of its revenue over the past three years, with the latter having grown by 185 percent over the same time period. This is indicative of effective cost-cutting and improving financial discipline across the board. 

However, ESOPS charges are expected to be quite significant in the near future. Paytm also has around ungranted 10 million ESOP shares (approx. market value INR 800 Cr) available for distribution, which would further increase costs. 

The quantum of these charges, suggests that EBITDA is likely to continue being overwhelmed by ESOPS, at least until FY 2026(E) – unless Paytm’s Adjusted EBITDA jumps up from its current INR ~80 Cr quarterly run rate to a run rate of over INR ~250 Cr per quarter.  

Moats to Build, Regulatory Hurdles to Overcome 

Detail-oriented readers would have noted the complete absence of Paytm’s third and final segment, Cloud & E-Commerce, in this piece. For good reason – a lackluster CAGR of 4 percent between FY 2019 to FY 2023 has seen its revenue share dwindle from 45 percent to just 19 percent during the same period. 

The segment amalgamates a bunch of smaller user traffic monetization channels, such as offering marketing, distribution, and e-commerce services. The only notable aspect of this segment is the launch of co-branded credit cards by Paytm. With only ~5.5 lakh cards issued till now, it’s a small space, but worth keeping an eye on. 

FY 2024 marks the beginning of an interesting period for Paytm. While a potential turnaround is in the books, both its payments and credit plays need considerable scale to have a worthwhile impact on Paytm’s bottom line. Currently, it’s hard to attribute any moats to Paytm that can ensure fast, sustainable growth for the coming years. 

Until it can construct clearly defined moats, its success will depend on how hard, and how fast, it ‘sells’ – its application’s brand as India’s defacto online payment portal, its devices, and its loans. 

One of these moats could look like a small finance bank license. Despite having completed 5 years of operations as a payments bank (and therefore be eligible for a small finance banking license), its plan for the same was put on hold in 2022 due to regulatory issues. 

The Reserve Bank of India directed Paytm’s payments bank vertical to stop onboarding new customers due to concerns about its IT processes. This is not the only time regulatory hurdles have spoilt Paytm’s ambitions. IRDAI previously blocked Paytm’s acquisition of a general insurance company, and the RBI put on hold its application for a payment aggregator license.

It has been speculated that amongst other issues, the historic presence of Chinese shareholders in Paytm could be the reason for these regulatory hurdles.

It seems that the problem was solved in August 2023, with Ant Financial transferring a 10.3 percent stake to Paytm’s cofounder, Vijay Shekhar Sharma, making him the largest shareholder in the company. 

Remove the regulatory barriers and you see the outlines of a possible moat – obtaining licenses/approvals for small finance banking, payment aggregator and insurance could propel Paytm it into a full-fledged app-based financial services provider, with one of the largest user bases in the country. 

Will this move kill two birds with one stone? 

Writing and Design: Shreyas Vatsayan, Tools: sankeyart.com