Paytm Valuation, Macquarie Report and Damodaran’s Analysis

Date : 31/12/2021                                 Paytm’s Share Price – 1336

Over 63 IPOs came in 2021 (in India) raising over 119,882 cr. An IPO which really stands out is Paytm, probably the biggest IPO in the history of the Indian Stock Market with an IPO size of 18,300 cr.

An IPO and company of such a size is hard to ignore,especially when marquee  names like Alibaba and Softbank are involved. Companies like Paytm are  “new age” businesses that might go on to become very big or  may simply burn away. 

To be a successful investor in today’s stock markets , understanding business models of new age tech companies and developing related analytical skills is very important. 

Macquarie came out with a research report calling Paytm a “cash guzzler” and with a share price target of 1200 rupees. We will go through Macquarie’s findings and try to make some sense out of it. 

We will also  try to understand what “The Dean of Valuation” ,  Aswath Damodaran has to say about Paytm’s IPO in his blog and video presentation. Aswath Damodaran is a Professor of Finance at the Stern school of Business at New York University.

Let us go through Macquarie’s findings first – 

• The company lacks a proper business model and the company is a “cash guzzler” 
• Dabbling in multiple business lines inhibits Paytm from being a category leader in any business except wallets , which are becoming inconsequential with the meteoric rise in UPI payments. 
• Competition and regulation will drive down unit economics and/or growth prospects in the medium term.
• The question is its ability to achieve scale with profitability.
• Unable to turn profitable unless Paytm starts lending and converts into bank.
• Due to high Chinese ownership , difficult to get banking licence.
• 75% of the board members are based out of India. 
• Positive FCF possible only by FY30.
• RBI can come up with unfavourable regulations in buy now , pay later BNPL space and cap the fees which can be extremely negative for the company. 
• Macquarie estimates 66% of Paytm’s GMV has come from UPI payments in FY21 and by FY26 , the share of UPI payments in GMV will reach 85%. Presently, there are no fees for UPI payments and they are very hard to monetise. This will lead to substantial erosion in the take rate going forward. 
• Macquarie also notes that Paytm has little experience in credit risk analysis in lending business and very little infrastructure on ground is available for execution.    
• Macquarie values the stock at 1200 rupees using 0.5 times PSG multiple annualised sales. While justifying this valuation , Macquarie says global peers are available at 0.3 to 0.5 times PSG and we have given PSG multiple in the higher band. 
• Macquarie also comes up with a second case of valuation and says even if 10 basis points fees are levied on UPI payment , the fair value shoots up to 2900 – 3300 based on PSG / DCF. 

Our take – 

Let us understand PSG multiple –

PSG multiple is utilised to analyse high growth companies which are cash burning and generate negative cash flows. During last few years , software applications and internet stocks have been major gainers across the globe. Conventional valuation metrics was inadequate to value these kind of stocks and justify valuations. That is why , a concept of PSG has been widely used now a days to value such stocks. 

It has two components – price / sales ratio and expected growth. 

PSG = price/sales / growth 

Let us take the case of Paytm. The present market cap is 86,720 crore. 

Let us assume expected sales of about 3,100 crore. Therefore , the price/sales ratio is – 27.97. 

Let us assume growth of 50% , then , 

PSG = 27.97 / 50 

        = 0.56 

 As per Macquarie , the base value of 0.5 , still it is expensive and there is a further scope of stock price reduction. 

Now, let us try some peer comparison – 

Company	PS Ratio Min.	PS Ratio Max.	PS Ratio Mean	Growth	PSG Max.	PSG Min.
Paypal	4.2	16.52	7.15	20%	0.826	0.21
Zoom	14.15	108.95	39.57	136%	0.801	0.104
Shopify	6.86	59.14	17.87	50%	1.18	0.13

If we study the above table ,

•  We can find that there is a very wide range of PSG Ratio for a same company at different points of time. 
• PSG Ratio or PS ratio in particular largely depends upon the growth and has to be interpreted along with growth and size of opportunity
• It will be improper to assign a certain fixed base value to PSG ratio for a particular company and value company entirely based on that. 
• Assigned PSG Ratio of 0.5 doesn’t capture Paytm’s number of users , brand value and size of opportunity

Also we went through the key points of  RBI paper on regulating digital payments in India. It appears the focus is on regulating high margins on mobile wallet business and to some extent, card related business. As per Macquarie’s own report , wallet based transactions would form a very small fraction of Paytm’s GMV in future . Hence, we don’t read too much negative into it. Also , it will be worthwhile to note as UPI  gains traction , how long can it remain free ? At some point of time , in future , all the stakeholders would be forced to charge certain amount of fees for UPI based payments otherwise the entire ecosystem built around UPI will become unsustainable or unviable.  

Also , most of the key red flags raised by Macquarie just appear to be rational opinions which appeal to the popular sentiment of the common market participants. Only genuine concern is the ability to convert GMV into actual revenues. 

After this report came out , Paytm’s CEO did an unthinkable act and  went into defensive mode and started defending the company on various public platforms . This made the situation even worse and further negative sentiment started building around Paytm. Macquarie as an analyst firm , had every right to question a publicly listed company. The prudent thing to do for Paytm’s management was to answer a cynical analyst with better and better results quarter on quarter basis and genuine improvement in  actual balance sheet. 

Now , let’s focus on a object oriented , probabilistic and mathematical model driven valuation exercise conducted by Professor Aswath Damodaran and try to find out what he really wants to say. 

We have taken the slides , figures from Damodaran’s own blog and presentation which are available on public platform and internet.

Slide 1 (from Damodaran’s presentation)-

The Indian Smartphone Revolution:Paytm’s “Coming of Age” IPO – 

Referring to this slide , 

• Professor basically talks about india’s appetite for young growth companies , even if they are burning money.
• He also refers to his analysis about Zomato and how it doubled very quickly.
•  He describes Paytm as a company that has taken advantage of the growth in smartphones market  in India. 
• Drivers of Paytm’s value and investment decisions.

Our take- 

This is probably the simplest part of his video but “drivers of Pytam’s value” is a key phrase here.Drivers of value are basically factors which increase the worth of a company or differentiating factors that make us think about investing in that company.

Slide 2 (from Damodaran’s presentation) – 

Referring to this slide , 

• Professor basically talks about the growth of  the Indian cell phone market driven by twin factors of cheap Chinese mobiles and Reliance Jio offering services at affordable rates.
• Here he quotes a figure of 500 million (50 cr) smartphone users in India.

Our take – 

Here we can see that after China, India is the second largest growth market for smartphones worldwide. With this slide , we can understand the size of opportunity this sector is offering .

Slide 3(from Damodaran’s presentation) – 

Referring to this slide , 

• Professor talks about, after Indonesia and Brazil , Indians spend most number of hours per day on smart phones. We can clearly see , from 2019 to 2020 , Indian users smartphone use time has increased from about 3.7hrs to 4.3hrs per day. 
• He also makes a very important comment that the probable reason behind such a high use is most of the Indians can only afford a smartphone to connect to the Internet as it is the cheapest option available(tabs and laptops are more expensive). 

Our take – 

This is one of the important slides in the presentation. After talking about the increased number of smartphone users , here, professor highlights about increasingly high amount time spent by Indians on smartphone. Considering these two factors, it can be clearly observed that companies operating in this particular sector have been benefited in the past and will continue to benefit in the future. 

Slide 4(from Damodaran’s presentation) – 

Referring to this slide , 

• Here , he talks about rise in mobile payments over a period of last 2-3 years and how covid situation has helped this rise.
• He also talks about, external factor , the introduction of UPI(Unified payments interface) which has pushed this trend forward. UPI is a low cost and quick money transfer system across people and merchants.

Our take – 

The rising use of smartphone for making payments is the main foundation on which the whole thesis is based. As the technology evolves and a cheaper and better alternative arises , this whole analysis stand corrected. 

Slide 5(from Damodaran’s presentation) – 

Referring to this slide , 

• Here , he directly links Paytm’s rise to the increase in use of smartphones for making payments. 
• Here he refers to Paytm’s history to modest 2010 start as a mobile wallet company, as the target market was very small at the time.
• Almost every year of its existence , Paytm has added a new product or service and continuously evolved. 
• Here , he makes a remark about how Paytm mall is a replica of successful Alibaba’s Taobao Mall model.

Our Take – 

It can be observed that from a modest start , Paytm has evolved into a major Fintech company over a decade. Ability to add almost a new service and product every year indicates the technological strength , vision and deep understanding of markets on management’s part. From an investor’s point of view , especially when we analyse tech companies , this particular ability of a company to adapt and evolve with changing market conditions and technology is very important. It is prudent to note that Paytm has displayed both these abilities. 

Slide 6(From Damodaran’s presentation) –

Referring to this slide , 

• Here he talks about strengths and weaknesses of Paytm’s financial history. 
• He draws our attention to the first three columns and highlights that both number of users, user transactions and gross merchandising value (GMV) have increased considerably over a period of last 4 years. This is the strength. 
•  Thereafter , he immediately points the weakness – Revenue. He explains how the revenues have been almost flat from 2018 – 2021 despite an increase in the number of users,user transactions and GMV.
• Next, he makes a killer observation that “the company is a money losing machine with stagnant revenues.”
• The next important observation relates the last column – Take rate. He points out how the take rate has come down from 2.18% to 0.79% over a period of last 4 years. 
• Next important observation comes as , this is company which is adding new customers , able to increase the transactions but cannot extract revenue out of that.
• Another key observation is that the management is kind of stuck and is too focused upon user count and not enough on business metrics.
• Professor uses the corporate life cycle analogy and places the company in the category of adolescent with attention deficit , unable to focus on things that matter and too distracted. 

Our Take – 

Professor is at his best in this slide and minces no words in describing the management shortcomings and at the same time , indicating some strengths.

Here we come across a ratio called take ratio. Professor describes  take ratio as – Revenue as a percentage of GMV. In payment processing companies , this is a very important ratio as it indicates what part of GMV really belongs to the company. Going forward , this becomes the key factor in valuing the future growth of the company. Take Ratio basically indicates the pricing power of a payment processing company. In order to simplify the concept of Take Ratio , consider following example – 

Paytm’s Take Ratio is 0.79% which means if Paytm processes total 100 rupees of payments , it generates a revenue of 79 paisa only. Out of this 79 paisa, Paytm has to carry out it’s business expenses.So we can see what tiny fraction actually comes to the company but as the total amount transacted is very large and growing , in future, revenues can increase significantly. 

Also , GMV(Gross Merchandising Value) is again an important term while analysing payment processing platforms.GMV along with Take Ratio forms a base on which a discounted cash flow analysis model is built for valuing such firms. 

It is important to note that Damodaran usually places companies into three categories – born , attaining maturity and declining stages of the corporate life cycles.Damodaran feels that more value is destroyed in young companies acting like old companies and old companies try to reinvent themselves as young companies. He feels that companies should act according to their age. So Paytm , being a young company , acting like a distracted adolescent is not too negative here. If attention deficit problem is taken care off(proper management) , then there is a reasonable chance of this distracted adolescent turning into mature adult. 

Slide 7 (from Damodaran’s video) – 

Referring to this slide , 

• Professor points out that Paytm has basically depended on two companies for funding – Alibaba(Ant financial) and Softbank.

Our take – 

As on December 2021, Alibaba has a market cap of 303.8 billion USD. Also , roughly,  total fair value of Softbank’s both tech funds is about 154 billion USD. These are not small companies and they have very deep rockets. Considering the size of and opportunities in  Indian market ,it is unlikely that these companies will stop funding Paytm. That is why , in future , it highly unlikely that Paytm will fail or growth will taper down substantially just  because of lack of funds. 

Slide 8(from Damodaran’s video) – 

Referring to this slide – 

• Professor points out as company goes for  IPO , the promoter Mr. Sharma owns only 15% while Alibaba and Softbank together own more than 51% of the company. 

Our take – 

Here we can clearly see that the two big funding companies have clear management control over Paytm. Both Alibaba and Softbank are extremely experienced and successful companies in the field of e-commerce and tech-based payment platforms / fintechs. Going forward , they can bring their vast and professional technical expertise into play. They will be able to implement their strategies easily as they have clear management control. When we carry out discounted cash flow analysis for future 10 years, it is very important that the underlying company should stay financially viable for period of analysis and it has to be run by a proven and reputed management. Both these conditions are getting fulfilled here so to a large extent we can believe the DCF valuation Damodaran carries out in the subsequent slides. 

Slide 9(from Damodaran’s presentation) – 

Referring to this slide,

Here professor talks about 5 factors which drive Paytm’s value. Let us understand them one-by-one. 

• Value driver 1-  

Our take – 

Here he assumes that over a period of next 5 years , the Indian mobile market will increase five-fold at the rate of 40% each year. Going by the past history , this looks highly probable.

• Value driver 2 – 

Our take – 

It is likely that Paytm will maintain its market share in the person-to-merchant payment market as Paytm is highly focused here.However, this is one segment where  an investor has to monitor Paytm’s market share on year-on-year basis. If this market share is declining , then whole hypothesis needs to be recalculated. 

• Value driver 3 – 

Our take – 

In August 2021 ,Paypal has increased it’s Take Rate from 2.9% to almost 3.49%. Also taking into consideration  global Take Rate averages, as Paytm’s business matures, Damodaran’s assumed value of 2%(after 5 years) doesn’t seen unreasonable. In Indian context, even Phonepe has started charging Rs. 1 on Rs. 51 to 100 and Rs. 2 for Rs. 100 to 200 as a fee for phone recharge. 

• Value driver 4- 

Our take  –

Justifying this ,professor says that Paytm’s two biggest expenses –  employe costs and sales and marketing expenses , should decrease as the company matures. If we check global peers , Paypal’s operating profit margin is about 17% , Visa’s about 53% and Mastercard’s about 43%. We feel professor is a bit aggressive here in assuming 25-30% margin by 2030.

• Value driver 5- 

Our take – 

Professor assumes over a period of time , in line with global peers, Paytm will generate about 2.5 rupees for every rupee of capital invested.In subsequent slides, we can see that due to IPO money raised and increased operating income , Paytm should be able to reinvest in technology to fuel  its future growth. Word of caution here – if Paytm is to spend high amount of money on overvalued acquisitions , then the company may not be able to reinvest adequate  capital in the core business to fuel its future growth. 

Slide 10(from Damodaran’s presentation) – 

Referring to this slide , 

• Professor points out that if you look at UPI based payments , Paytm has only 11% Market share and looks like a looser. But simultaneously , he highlights that a large percentage of UPI based transactions are person-to-person. 
• He points out that Paytm is a significant player in the person-to-merchant transactions and wants to focus in this category. 
• He also points out in non-UPI based transactions, Paytm dominates the market and has a market share in the excess of 50%. 
• He also expects Paytm to maintain it’s significant market share in future also as both consumers and merchants are comfortable with using its platform . 

Our take –  

For a competitor ,  effective cost of consumer acquisition(taking away market share)  and subsequent cash burning is extremely high in this sector . Hence , there is a reasonable ground to believe professor’s point of view about Paytm maintaining its market share. Our key takeaway is Paytm is a dominant player in person-to-merchant transactions(both UPI and Non UPI) as this is category which actually can create revenue and affects the take rate positively. Also, it is comforting to know that Paytm has focus in this category in the future also. It is prudent to note here , that mobile wallet based payment business has been on steady decline and this is a major revenue generating category for Paytm. RBI can come up with negative regulations in this sector.

Slide 11(from Damodaran’s presentation) – 

Take Rates and Margins: Peer Analysis

Referring to this slide, 

• Professor points out that amongst the peers , Ant financial is the closest one as Paytm has modeled itself on Ant(Ant is a large investor in Paytm also). 
• Professor also points out that over a period next five years, Paytm will mostly follow Ant Financial’s footsteps and Take Rate will reach around 1% and margins will reach to about 5%. 
• Professor highlights over a longer term period , Paytm’s Take Rate will stabilise at around 2% and operating margins will stabilise around 30%.

Our take – 

This is one of the most important slides in the presentation as the whole valuation exercise is based on the assumption that over a longer period of time , Take Rate will stabilise at around 2% and margins will reach at around 30%. Any deviation from these figures can skew the valuation model asymmetrically both upwards and downwards. 

Here , it is important to note that Paytm is also planning to offer other financial products (some of which they already offer)  like debt , insurance and wealth management products etc. These products carry higher margins and spreads which might affect the Take Rate positively. But at the same time ,these products carry credit risk which might erode net value significantly in case of default. So this strategy by Paytm is like double edged sword and needs to be monitored closely.  

Slide 12(from Damodaran’s presentation) – 

Referring to this slide , 

• Professor points out that cost of capital for a business like Paytm is around 10.43%.
• On the risk front , he points out both Alibaba and Softbank will keep on backing Paytm as they have too much to loose if they let it fail. It is worthy to note that both Alibaba and Softbank have significant financial muscle.
• He also points out that Paytm has raised 16,600 cr. rupees through IPO and half of which almost 8,300 cr. will stay in the company and will help the company to meet its cash flow requirements. 
• He highlights- considering these two factors , risk of failure for Paytm is very low, about 5%. 

Our Take – 

It is important to note that Paytm has ventured into banking through Paytm Payment Bank which over a period of time will get converted into a small finance bank first and then a regular universal bank. C.A.S.A funds accumulated through this bank can bring cost of capital down in future. This will help in boosting the operating profit margins. 

Also , since the risk of failure in future is very low(5%) a discounted cash flow analysis model can be built for valuation.

Slide 13(from Damodaran’s presentation) – 

Referring to this slide , 

Our take – 

In this section of the valuation sheet , professor summarises all the past assumptions. 

1. GMV will grow at 40% for first 5 years and then at 4.19% for next five years. 
2. Take Rate to reach at around 1% for first 5 years and then to stabilise at around 2% over the  next five years. 
3. Operating margins to reach about 5% for first 5 years and then to stabilise at 30% over next five years. 
4. He has considered 25% flat tax rate , although company might get benefits for past accumulated losses. 
5. Reinvestment, he has assumed due to past heavy investments initially ,company will turn out 3 rupees for every 1 rupee deployed and over a period of next 10 years , it will stabilise to around 2.45 rupees per rupee deployed. 
6. Cost of capital will decrease to 8.91% over a period of time from present 10.44%

Our take – 

As explained by professor , here in cash flow analysis , we can see that the company will turn out negative cash flows for first seven years. But , the huge amount of cash raised through IPO will help the company to meet its cash requirements for about next 3 to 5 years.

During this time , growth will level out , reinvestment will reduce and company will turn positive cash flows from 8th year onwards. 

It is very important to note that in this model , professor does not talk about company raising additional money through fresh equity issue which means without further equity dilution , company would be able to fund its growth .This will result in a very high growth in EPS from 8th year onwards.

Our Take – 

He basically calculates value of equity and divides it by number of shares and arrives at a figure of 2,190.24 rupees per share. 

This is the figure where most eyes will be fixated on but as  pure value investors , we have tried to focus and understand the process of valuation rather than actual calculated price per share to avoid price anchoring effect. 

Slide 14(from Damodaran’s presentation) – 

Referring to these slides , 

Our take – 

Professor points out that he has run almost 100,000 simulations for calculating Paytm’s valuation and the 50th percentile market cap comes at 1,24,682.4 lakh crore. This lower than the DCF value of 1,45,670.8 lakh crore. The corresponding share price would come out to be 1874.66 rupees. 

We can also observe that even while considering growth rate , operating profit margin , take rate and capital reinvestment ratio , professor has run extensive mathematical probability models.  

Purely on mathematical basis , this looks highly credible. 

In the same slide , professor also points out these kind of businesses could be a part of diversified portfolios with about 5% allocation. 

Slide 15 (from Damodaran’s presentation) – 

Referring to this slide , 

Our take – 

Here , again the emphasis comes back on take rate. There is no doubt that Paytm’s GMV is going to to grow at very high growth rates. The real value driver would be an increase in the take rate which needs to be monitored closely in future by potential investors. 

Final summary of our takes – 

If we go through the entire analysis , 

Paytm present price – 1336 rupees

Macquarie target price – 1200 rupees

Macquarie best case  price range – 2900 – 3300 rupees

Damodaran DCF valuation share price – 2190.24 rupees

Damodaran mathematical model price – 1874.66 rupees

We can see Paytm is presently trading nearer to the lower range of the price band. If one believes in the ability of management to convert GMV into actual revenue , Paytm can be a good portfolio company , especially , for  large diversified portfolios. If we compare risks associated with Paytm and that of medium size public/private banks and NBFCs , Paytm looks a better play to play the growing financial/fintech sector in India. Present market cap is around 86,720 crore. Can it grow 10 times in a span of 10 years and reach 8,67,200 crores , looks quite possible. Also, during present period of negative sentiment , can the stock price dive to a three figure mark ? The answer is – it’s quite possible.

People with proper risk appetite and understanding of Fintech sector can consider Paytm in their core portfolio with a smaller allocation. At what price to buy is a liberty of every individual and depends upon on his / her valuation method. 

“In investing, what is comfortable is rarely profitable”  – Robert Arnott