Last week, Walmart-Flipkart announced PhonePe's hiving off, allowing PhonePe to raise up to $1Bn of external capital. 

Acquiring your Acqui-Hire

After spending 4 years at Flipkart, senior executives Sameer Nigam and Rahul Chari decided they would start off on their own again. The two had joined Flipkart after their previous startup Mime360 was acquired by Flipkart in 2011.

In August of 2015, the two left, and along with Burzin Engineer, began working on a payments platform. The idea of the product was a payments solution, built on IMPS, that would pivot into the Unified Payments Interface (UPI). The National Payments Corporation of India would launch the ambitious project to help transfer inter-bank. 

UPI  was expected to launch in April of 2016, and PhonePe was incorporated in December 2015. The company would be well placed to launch a solution by the time UPI would be live. 

Within 4 months of PhonePe's operations, Flipkart acquired Mr Nigam and Mr Chari's company yet again, at a deal valued at $10MM. In what was Flipkart's fastest acquisition, that felt more like an internal promotion, PhonePe arrived at Flipkart's stable. 

With PhonePe's product yet to be launched, Flipkart was betting on seeing significant traction through this payment platform.

Going with the Flow

Why would an e-commerce player acquire a payments solution, that was yet to even start? 

Online e-commerce was stifled by the payments infrastructure, having to rely on expensive credit cards or high friction bank account transfers. By enabling people to pay and transact smoothly, the ability to shop online would become easier. 

While this may seem like a robust enough reason, there was an even larger success that emboldened Flipkart to take the leap of faith.

Alibaba's Alipay had, 2 years ago, become the world's largest payments platform. With Alibaba providing Chinese consumers seamless access to products, it also began to operate a gatekeeper for payments. 

The rationale was compelling - if you sit in the flow of money, you can make even more money.

Snapdeal's (now botched) acquisition of Freecharge, and PayTm's (now struggling) evolution into PayTm Mall were both inspirations from Alibaba. Alibaba's shareholder Softbank is common to both Snapdeal and PayTm, and it would have likely pushed to replicate Alibaba's success in India.

Growing Pains

With new access to 40MM+ customers and Flipkart's infrastructure, PhonePe's 20 member team continued to build the platform in earnest. 

Within 4 months, the PhonePe app was launched on Android, being the first app to integrate with UPI. Utilizing Flipkart's resources, the app crossed 10MM downloads, being the first UPI focused app to do so. It grew 100% month on month, as it scaled rapidly across consumers and merchants.

Then in early 2017, the first spanner in the works appeared in the form of ICICI (and PayTm)

In a classic competition muscling move, ICICI blocked any transactions for its users from the YesBank UPI VPA. ICICI had assigned its VPA to PayTm, while PhonePe was with YesBank. For two months, PhonePe struggled with ICICI, even temporarily halting UPI services until the matter was resolved. 

The matter, though, would put PayTm and PhonePe at loggerheads, in a battle that would become increasingly direct as PhonePe scaled. 

Elephant in the Room

While PhonePe raced to 10MM downloads at a rapid pace, PayTm was already doing 1.5Bn transactions a year in 2017.

With $5Bn GMV, 200MM+ users and more than $2Bn of capital PayTm was the elephant in the payments ecosystem. In comparison, PhonePe was doing just $40MM of annualized transactions at the beginning of 2017, almost 1/100th of PayTm.

The pressing question, and the real elephant in the room was which model would really succeed.

While both PayTm and PhonePe facilitated payments, their approach was entirely different.

PayTm is primarily a semi-closed wallet, with payments that can only be made from the wallet. PhonePe is primarily based on UPI and accesses bank accounts directly to make payments. Both have wallet/UPI features, but the distinction in incompetencies is important. 

Wallets require you to add money, given they are not the primary "store" of wealth. Wealth is usually stored in bank accounts, and UPI directly draws from bank accounts. Wallets would need KYC, which UPI would not. Prima facie, UPI would be easier to use than wallets. PhonePe could potentially challenge PayTm.

But with 100x the volume and 200MM+ customers, PayTm could easily blow away PhonePe, even on the UPI game. 

Ant in the Trunk

PhonePe's proxy fight with Ant Financial backed PayTm, through ICICI, would not be lost on the company.

PhonePe, though it started with 1/100th of Paytm's volume, began to grow rapidly. Driven by the transactions on Flipkart, ironically like Ant Financial was driven by Alibaba, PhonePe would onboard millions of customers and thousands of merchants through the year.

From 10MM downloads, PhonePe would scale to 55MM downloads, but the push through Flipkart would scale it beyond expectations. The transaction volume would grow 82x in the space of just a year, and from being a small player, it would soon be one of the largest. Like the fable of the ant and the elephant, the "ant" PhonePe would challenge the "elephant" and end the year with $5Bn of GMV.

The fight would not end just there. 

In early 2018, PayTm would claim that it was the market leader in UPI payments. PhonePe, tongue-in-cheek, released an article taking a dig on PayTm's Gold and UPI "lead". It would also claim that PayTm's transactions were 38 INR on average ($0.5), v/s PhonePe's INR 1,116 ($20). It would also claim that most of these transactions were for cashbacks. 

The race was on.

Show me the Money

While transaction volumes and users grew, how was PhonePe operating as a business?

PhonePe is essentially a value-added matchmaker, that connects two transacting parties by facilitating a financial transaction. When one of the parties is a merchant, which would be defined by transaction volume, PhonePe would take a commissionon transactions.

It is interesting to know that the company was supposed to be built on IMPS pivotedto UPI. This is critical because NEFT requires paying banks a fee, while IMPS does not. 

In 2016-17, the company would earn INR 3Cr ($400K), while in 2017-18, the company would scale to INR 42Cr ($7MM). The bottom line would be in deep red, with 2016 seeing losses of 129Cr ($20MM), while 2017 would see losses of 791Cr ($100MM).

A large portion of the expenses would be spent on marketing and onboarding customers, showing why PhonePe grew so quickly. Due to being matchmakers, payment solutions display network effects, and winner takes all behaviours. This is essentially they require a considerable investment before they begin to monetize. 

By mid-2018, the company had scaled to $20Bn of gross transaction volume. To get into offline transactions in a deeper manner, the company would acquire Zopper, which had access to 300K merchants. 

PhonePe was building to win, at scale. 

Evolving into Ecosystems

The Alipay story, which PayTm was executing to a very large extent, was building an ecosystem. 

The wallet, or payment gateway, was just the proverbial "honeypot" for customer acquisition. After a user was onboarded, the "four walls" of the application could be utilized to upsell and crossell various other financial solutions. 

PhonePe rapidly expanded into a variety of transactional services such as buying travel, food, transport, retail or entertainment. Leveraging its user network, the company tied up with Ola, OYO, redbus and many other service providers. 

The goal was to, of course, become an ecosystem. 

PhonePe soon entered wealth management, with curated investment packs and digital gold. Reminiscent of its dig on Paytm's gold, the company was in complete lockstep with PayTm.

With the ecosystem being built out, PhonePe was ready to launch. 

Releasing the Dark Horse

Just 4 years ago, PhonePe had joined Flipkart's stable and had been nourished with its infrastructure. 

As both PayTm and PhonePe show, payment ecosystems are money guzzlingmachines. As defined earlier, these ecosystems acquire customers today (acquisition cost) and generate value over a lifetime (lifetime value). To get to generating lifetime value, it requires a significant amount of capital. 

Walmart has already brought in fiscal discipline and looks to create equity value. It makes a lot of sense to take money-guzzling entity off Flipkart's income statement, while still having exposure through the balance sheet. Having Flipkart focus its operations on e-commerce, along with getting the upside of PhonePe's growth is Walmart's strategy. 

With PhonePe looking to raise $1Bn from investors external to Walmart, the future looks bright for PhonePe. Its higher transaction value indicates it has acquired high-value users and merchants, who are likely to generate considerable value in the future. Their new Daddu and Gublu campaign for the IPL is a direct challenge to PayTm. 

Seen as a small in-house entity just two years ago, PhonePe is now the dark horse of the payments ecosystem.