Can Paytm turn a profit with razor-thin fintech margins?

One97 Communications (Paytm’s parent company) raised a humongous ₹18,300 crore in its November 2021 IPO at a price of ₹2,150 a share. The stock listed at an opening price of ₹1,950 and slumped to ₹1,560 by the end of its first trading session. Since then it’s been mostly downhill for the stock, which hit a low of ₹438 in November 2022, a year after listing.

The IPO was clearly overpriced. But there are signs the company’s business is hitting its stride. The management guidance was that operational performance would hit breakeven by Q2 of 2023-24 – that is, September 2023. One97 has actually exceeded this target by turning an operational profit in Q3 of 2022-23 – three quarters ahead of schedule. Moreover, all of its major business lines are performing quite well.

An operating profit – known in accounting jargon as earnings before interest, tax, depreciation and amortisation (EBITDA) – is calculated by deducting operating expenses from revenues. It indicates the core business is turning a profit, even though it may or may not be earning enough to cover the costs of funding (interest), or to replace equipment as it depreciates. Paytm has achieved EBITDA profitability if we ignore the very substantial employee stock options (ESOPs) it hands out.

Revenues in Q3 of FY23 were up 40% year-on-year (YoY) at ₹2,140 crore. The gross merchandise value (GMV) handled was about ₹35,000 crore, up 40% YoY. EBITDA before deducting ESOPs was a positive ₹31 crore. The net loss after deducting ESOPs, interest, depreciation, etc, was ₹392 crore, much lower than a loss of ₹778 crore the year before.

So, what does Paytm do, and how does it make money?

It offers payment services to consumers and merchants and charges fees from both. It leverages data to cross-sell financial services. It offers point-of-sale (PoS) devices to merchants and credit cards to consumers, and other services like personal loans. It also offers software and cloud services to other businesses.

The fintech space is extremely crowded and hyper-competitive, with several dozen players. Margins are tiny. Paytm and others like it need network effects – the larger the network, the more useful it is. They also need to understand the data their customers and merchants throw up to figure out what can be best sold or offered.

Paytm has a network of over 31 million merchants using its PoS devices. The number of active monthly users was 85 million by December 2022, up from 79.7 million in September and 64 million in December 2021. The company is pushing out around a million PoS devices a quarter.

Paytm earns tiny convenience fees, and the margin on the payments business works out to something like seven basis points – a mere 0.07%. Moreover, management believes this will stabilise at closer to five basis points.

On average, it makes around ₹100 a month on one of its PoS machines. By contrast, a conventional credit card vendor makes upwards of 1% per transaction. But this is why a grocer is comfortable receiving ₹10 payment on a Paytm PoS device while discouraging the use of credit cards for transactions under ₹400.

Paytm hands out loans as well. It disbursed close to ₹10,000 crore in loans in Q3 – up around 28% from Q2, when it gave out ₹7,300 crore in loans. Most of the loans are small and short-term. The typical borrower is someone with a low income who borrows a small sum for a couple of days at the end of the month.

Paytm handed out 1.5 lakh credit cards in Q3 and has less than five lakh credit card users in total. It saw a massive growth in the commerce segment in Q3, which may have been partly seasonal. People travel more in the Oct-Dec period and the festive and wedding seasons lead to more transactions.

Long ago, a management guru called C K Prahalad wrote an influential book about ‘The Fortune At The Bottom Of The Pyramid’ in which he theorised that companies could become successful by targeting low-income populations and servicing their needs.

This is a ‘white space’ – a market so low-margin and small-ticket that it was ignored by traditional financial service providers. But it is very high volume. Paytm and its competitors have entered that space, driving financial inclusion with technology and surviving on razor-thin margins.

This is a very new business. It’s likely the stock price will remain volatile. After its stellar Q3 results, Paytm’s stock shot up 35% in four straight sessions before falling 9% in a single session after AliBaba sold its stake. Various analysts offer valuations ranging from ₹700 to ₹1,150 a share. This wide range indicates that nobody is sure what a fintech business is worth.