Last week, payments decacorn Paytm raised $350MM from Warren Buffet's conglomerate holding giant Berkshire Hathaway. 

The deal valued Paytm at upwards of $10Bn, preserving its status as a decacorn and establishing it as the most valued Indian startup. There was an unusual amount of coverage for a deal that is ~0.3% of Berkshire's holding, and one that did notinvolve Warren Buffet. This is highly unusual for Berkshire, it rarely invests in tech, private or non-cash flow generating entities. Paytm is all three, and might explain why Buffett categorically distanced himself from this deal (for now) - it might very well just be a "punt". Paytm, though, leveraged this investment to the hilt, and most media sources called this various forms of a "ringing endorsement" for Paytm and India's startup ecosystem. When an investment from an investor, rather than the robust output of a viable business model, is taken as an endorsement - we must take it with a pinch of salt. That also begs the question - what exactly is Paytm's business model?

Paytm started off as a wallet (technically, a semi-closed wallet) in 2010, and was one of the first in the Indian ecosystem. The Paytm product is solid and adds value to both individuals and businesses. In case of broken/absent payments infrastructure, Paytm is boon. The frictionless transfers that Paytm allows for made it an extremely popular product with individuals. Paytm did very well to acquire businesses, so that individuals began to transact with businesses. Individuals don't pay any fees on transactions, while businesses pay approximately 1-2% for transactions. Effectively, Paytm is a two sided matchmaker that subsidizes the individual via the merchant. As you would notice, for the wallet, the customers are not individuals but businesses. This is a fairly good business model, but one should bear in mind that this is appealing for merchants with low ticket sizes (i.e. disorganized small merchants). Subsequently, the volume per user is lower (behemoths like McDonalds will not use Paytm), and Paytm is going after small merchants. As the customer is the business (and not the individual), Paytm is suddenly capped by the spend individuals make on small businesses. It is no wonder Uber is such an important relationship for Paytm, being one of the sizable partners that Paytm has, and is actually used by individuals.

Over time, with the $2.2Bn of capital that Paytm has raised, Paytm has got into a myriad of businesses. Paytm has an Amazon like Mall, Freecharge like Recharge, Gold seller like Gold, BookMyShow like Movie Ticketing, MakeMyTrip like Flight Ticketing, Payments Bank like Payments Bank - you get the drift. As the saying goes, a business that does everything is likely doing nothing well. Each of the verticals is a massive business, with each dominated by a large and focused player. Let's thus revisit Paytm's original business. Paytm does roughly 5 million transactions a day, VISA does 500 million a day. In its "core" business, Paytm is miles away from a market leader - yet it is already diversifying rapidly. Challenging on multiple fronts may result in winning some battles, but what about the war? Additionally, what really is the war Paytm is fighting? You need to look no further than China. 

The battle amongst Tencent and Alibaba is telling as to what war Paytm is fighting. Alibaba started off as a B2B marketplace player that moved into C2C and hammered eBay. It has now grown into a B2C marketplace giant, closely followed by the Tencent partner Jingdong (JD.com). Alibaba's huge volume of transactions (upwards of $500Bn annually) made a payments system a natural segue. Alipay was soon born to handle all transactions that were done on Alibaba. Tencent started off with a communications platform for desktop communication called QQ. It's "digitization" of desktop communication made it well positioned in the mobile ecosystem when it started with WeChat, and created a community that grew like wildfire. People began to transact, buy, sell all on the WeChat community - and commerce become its natural segue. This resulted in the development of trusted "ecosystems", ergo those run by Alibaba and Tencent. Knowing that both Alibaba investor Softbank and Alibaba are majority stakeholders in Paytm, what war is Paytm trying to win? You guessed it right - it wants to be an ecosystem (see this highly suggestive article on an ecosystem play by Paytm in 2017).

It is telling when Mr. Sharma, One97's CEO, says that we are going to "keep acquiring users". This is the tone/strategy of an ecosystem player e.g. Facebook, Whatsapp, Alibaba, Tencent. What Paytm has done incredibly well (assisted by capital) is acquiring the users for the ecosystem. What is trying to do now is make engagement and transactions happen in the ecosystem. The trouble is, these two were the core value propositions of WeChat and Alibaba, but not Paytm. Paytm's core value proposition was that of a wallet, something that Alibaba and WeChat added later. A user's behavior on the wallet is simply a small ticket size transaction, while Alibaba had product purchases and WeChat had highly engaged users. Making a Paytm user make a transaction (or chat?) is non-intuitive behaviour. It is no wonder Paytm offers such deep discounts, it is trying to make user behaviour change through incentives. 

The real question thus is - can Paytm become a large business (and value capturing ecosystem)? Investors value the company at ~$10Bn, for a company that made a revenue of ~$100MM in 2017. Let's assume it grew at the previous year's ~30%, it would peg the revenue for this year at ~$150MM. For a 300MM user base, that is effectively $0.5 per individual user or $20 earned per merchant (for 7 MM merchants). Additionally, the company is valued at 100x its revenue.  For comparables, VISA, has a revenue of ~$20Bn and is valued at $320Bn (16x), Amazon has a revenue of ~$177Bn and is valued at ~$950 Bn (5x). Even at VISA's fairly rich revenue multiple (due to its high margin), Paytm needs to at least 10x its revenue to "justify" its value if it was a public company. To achieve this over a 5 year period, this would imply at least 60% growth. There is thus some serious growth expectation of Paytm. In terms of earnings, Paytm loses ~$140MM a year, almost equal to what it spends on marketing. For now, given that the customers are largely merchants, let's spread marketing expenses on the 6 MM merchants added in 2017-18. The customer acquisition cost (CAC) works out to be 140/6 = $22. As I mentioned earlier, the annual revenue per merchant is $20. Assuming there is no other direct cost, the CAC gets recovered in 1 year. That is a fairly long payback period, and likely a very high CAC. 

Paytm has done a great job in acquiring a huge mass of customers and merchants. The question is - will this be a viable business model? Paytm's success will be in its progress from being a marketing company to a really valuable business. Paytm has clearly done a fantastic job in building a customer base, but will it generate enough value (and capture it) in the long term? Paytm investors (incl. Buffett run Berkshire) and participants in the ecosystem like myself have great expectations from the business, because its success could have game-changing consequences.

Will Paytm meet its great expectations?