A few weeks ago, I valued Zomato, the Indian online food delivery company, just prior to its IPO, and argued that the excitement about its potential was tied to the potential for growth in India and the shifting habits of Indian consumers.

Since its public offering, Zomato’s stock price has reflected that excitement, more than doubling from its offering price of 74 a share. Waiting in the wings for its public debut, is Paytm, a company that in many ways is even more closely tied to India’s macro story, drawing on the growth of online commerce in India and a willingness of Indian consumers to use mobile payment mechanisms.

In this post, I will look at the levers that drive Paytm’s value, and you can make your judgments on where you think this offering will lead in terms of valuation and pricing.

As the Paytm IPO speeds to offering date, it is worth looking back at its relatively short history as a company, and how much change has been packed into that period. Since so much of Paytm’s success has been driven by the rise if smartphone usage among Indian consumers, and the concurrent rise in mobile payments for goods and services, I will start with a review of that rise, before looking at how Paytm has put itself in position to take advantage of that market shift.

The Rise of the Indian Smartphone User

India was late to join the smartphone party, held back both by the relative expensiveness of these devices, as well as the absence of affordable and reliable cell service in much of the country. In 2010, fewer than 2% of Indians had smartphones, with most of them being well off and living in urban areas. In the decade since, that has changed, as the smartphone market has exploded to reach hundreds of millions of Indians in 2020.

Entering 2021, more than 500 million Indians had smartphones, making it the second largest smartphone market in the world (after China), but its penetration rate of less than 50% of the market gave it more room to grow. There are multiple forces that have contributed to this shift, but two stand out.

As smartphones have become ubiquitous in India, their usage has soared, partly because they are the only digital devices that many Indians have available to them to get online, and thus use to access social media, entertainment and shopping. By 2020, Indians ranked third in the world in how much time they were spending per day on their phones, with Covid-19 contributing to a surge in that year.

Access to these smartphones, in conjunction with poor banking outreach in India, has created the perfect storm for a surge in mobile payments in India, and this graph bears out this trend:

Within the mobile payment space, there was also an external development that added to its acceleration, and that was the advent, in 2016, of United Payments Interface, a real-time payment interface devised by the National Payments Corp. of India, and regulated by the Reserve Bank of India, facilitating and speeding up inter-bank, person-to-person and person-to-merchant transactions.

The rise of Paytm (Pay through Mobile) as a company parallels the rise of mobile phones in India.

When it was founded in in 2010 by by Vijay Shekhar Sharma, it operated as a pre-paid mobile platform, but its market then was small both in terms of numbers and services offered. As mobile access improved, Paytm has relentlessly added to its suite of products.

In 2014, it introduced Paytm Wallet, a digital wallet that was accepted as a payment option by leading service providers and retailers.

In 2016, it added ticket booking to movies, events and amusement parks, with flight bookings soon after, and started Paytm Mall, a consumer shopping app, based upon Alibaba’s Taobao Mall model.

In 2017 it added Paytm Gold, allowing users to buy gold in quantities as little as Re 1, and Paytm Payments Bank, a messaging platform with in-chat payments.

In 2018, it added a Paytm Money, for investment and wealth management, and in 2019, it launched a Paytm for Business app for merchants to track payments.

In short, over time, it has used its platform of users to launch itself into almost every online activity. As Paytm’s product suite has expanded, its numbers reflect both its strengths and weaknesses, with four key statistics tracking its expansion.

The table below is my attempt to recreate how Paytm has performed on these key measures in recent years, with the caveat that some of the information (on users and GMV, especially prior to 2019) is cobbled together from claims by corporate executives, press reports and opaque disclosures from the firm.

Looking at the numbers, we start to get a picture of Paytm, warts and all, over its lifetime.

First, it is a growth company, if you define growth as growth in user count and number of transactions done on its platform, and perhaps in gross merchandise value. However, its growth in revenues has not kept track with those larger statistics, leading to a cynical conclusion that the company is adding new services and giving them away for nothing (or close to it) to pad its user/transaction numbers.

Second, this is a company that seems to run on hyperbolic forecasts from its founders and top management, that are not just consistently higher than what the company deliver, but often by a factor of three or four. For instance, just to pick on one of many examples, Vijay Sharma claimed in an interview in 2019 with Business Standard that the company’s GMV would be $100 billion (Rs 7.5 lakh crore) by the end of the year, more than double what the company reported as GMV for that year or the next.

Third, access to capital from its deep pocketed investors, especially Alibaba, seems to have made this company casual about its business model and profitability, even by young, tech company standards. In fact, there is almost never even a mention of profitability (or aspirations towards profitability) in any of the corporate soundbites that I was able to read.

The picture that emerges of Paytm is that of a management that is too focused on racking up user numbers, and too distracted to care about converting those into revenues and profits, while making grandiose statements about its future. Using the corporate life cycle framework to assess Paytm, it resembles an adolescent with attention deficit issues, in its scattershot approach to growth and absence of attention to business details, and if you are an investor, you have to hope that going public will cause it to grow up quickly.

Paytm: Funding and Ownership

Paytm’s ambitious growth plans have made it one of India’s premier cash burning machines, and it has been able to pull these plans off, because it has found ample sources of capital to feed them. In the table below, I list Paytm’s big capital infusions over its lifetime:

Along the way, there have been others who have provided capital to the firm (Reliance, Ratan Tata) who have exited as foreign investors, led by Alibaba and SoftBank, have muscled their way into the firm. Those capital infusions have naturally led to a diminution of the share of the company held by its founder, and the pie chart below lists the owners of Paytm, ahead of its IPO:

Note that while the company’s origins and business are in India, it is primarily a Chinese-owned company ahead of its IPO, with Ant Group, Alibaba and SAIF Partners (a Hong-Kong based private equity firm) collectively owning more than 50% of the shares, with the SoftBank Vision fund as the next largest investor with 18%. Sharma’s holdings in the company have dwindled to 15% of the company, and his tenure as CEO depends on whether he can keep his foreign shareholder base happy.

Paytm: Story And Valuation

With that lead in, the pieces are in place to value Paytm and I will start by laying out the value drivers for the company and follow with my valuation. In making this assessment, I will draw on the company’s stated plans to raise money from the offering, though they may be altered as the company gets to its offering date

The company’s history provides some insight into the Paytm’s value drivers, starting with a large and growing mobile payment market in India, and working down to the company’s operating metrics.

The value story for Paytm starts with a large and growing digital payment market in India, one that has surged over the last four years, and is expected to increase five-fold over the next five years, as smartphone penetration rate rises for India and more merchants accept mobile payments. While Paytm has the advantage of having been in the Indian mobile payment market the longest, and having the largest user base, PhonePe and Google Pay have outmaneuvered Paytm in the UPI app ecosystem, claiming the lion’s share of that market, though the bulk of the transaction in that ecosystem are person-to-person. Paytm’s large user base, close to 350 million, and the wide acceptance of its wallets allow it to dominate the person-to-merchant (P2M) market in India, giving it a market share of close to 50% in early 2021.

The growth in the Indian mobile payment market will provide enough of a tailwind for Paytm to continue to grow its user base and transactions, but the bigger challenges for Paytm will be on the business dimensions where it has lagged in the past.

There are other Paytm businesses that may augment revenues in future years, but each one comes with caveats. The money deposited in Paytm wallets by users can potentially earn interest for the company, but restrictions that this money be kept in escrow accounts at banks, not always paying close to market interest rates, can crimp that income stream. Paytm Bank could expand from its very limited presence now to more traditional banking (taking deposits, making loans), but that is a capital and regulation intensive business. I believe that Paytm’s core value comes from being an intermediary, in the payments business, and the story reflects that belief.

If you buy into my story of Paytm continuing to maintain a dominant market share of the mobile payment market in India, while also increasing its take rate over time and improving operating margins to those of an intermediary business, you have the pieces in place for a valuation of Paytm, captured in the picture below:

I know that there are many on both sides of the value divide who will disagree with me on my story and valuation, and that is par for the course.

On one side, there will be some who view a value of close to $20 billion (₹1.5 lakh crore) for a company with a pittance in revenues, a history of operating losses and distracted management as insanity. On the other side, there will be some who feel that I am not giving the company credit for all of the new businesses it can enter, using its vast platform of users, and thus undervaluing the company. To both sides, my defense is that this is my story and valuation, and it will drive my investment, but that you are welcome to download the spreadsheet, change the inputs that you disagree with and come up with your own valuations.

In making my assessment, I fully understand that there is substantial operating and execution risk in this story, since this value presupposes that Paytm will remain a dominant player in the Indian mobile payment space as it grows, and that Paytm’s management will pivot from growing users to growing revenues and from growing revenues to growing profits, over time, with nothing in their history to back that up. Needless to say, if I invested in Paytm, it would not only have to be at the right price, i.e., trading at less than ₹1.5 lakh crore, but also with the acceptance that this cannot be a passive (buy and hold) investment, but one that will require active engagement and monitoring of the company’s actions and performance. To assess how this uncertainty will play out in my estimates of overall equity value, I did a Monte Carlo simulation, with my point estimates on total GMV, take rate, operating margin and sales to invested capital replaced with distributions:

There are lessons, albeit some obvious, that emerge from this simulation. First, given that almost all of the value of Paytm comes from expectations of the future, and there is significant uncertainty on every single dimension, it should come as no surprise that the range on estimated value is immense, with a 3% chance that the company’s equity is worth nothing to more than ₹2 lakh crore at the 90th percentile. Second, with this range in value, the potential for your priors and biases to play out on your final valuation are strong. Put simply, if you like the company so much that you want to buy the stock, you can find a way to make the assumptions that get to that value. Third, even if you strongly favor the company and find it under valued, it would be hubris to concentrate your portfolio, around this stock. In other words, this is the type of stock that you would put 5% or perhaps 10% of your portfolio in, not 25% or 40%.

As human beings, it is natural for us to categorize choices we face into broad groupings, because those groupings then allow us to generalize.

In the 1980s, when technology companies first entered the market in big numbers, we classified them all as high growth, high risk investments. While that categorization would have worked at the time, it is quite clear that the technology sector today is not only a dominant segment of the market (accounting for the largest slice of the S&P 500 market capitalization pie), but is also home to a wide array of companies. In fact, at one end of the spectrum, there are many older tech companies that are now mature, and perhaps even in decline, and several are stable, cash earning machines, akin to the consumer product companies of the 1980. At the other end, you see new sub-segments of technology-based companies that have emerged to claim the “high growth, high risk” mantle, deriving more of their value from the number of users on their platforms, than from conventional financial metrics.

A few weeks ago, when I valued Zomato, I argued that it was a joint bet on the company’s continued dominance of the food delivery market and the growth in the Indian restaurant/food delivery business. Paytm is also a joint bet on an early entrant into the Indian mobile payment market, continuing to maintain market share, in a growing digital payment market in India. That said, the companies have very different business models, with Zomato’s 20% plus take of every dollar spent on its platform vastly exceeding Paytm’s less than 1% take of every dollar spent on its platform. They are both big market bets, but the Paytm bet is much more dependent on management figuring out a way to grow, while improving take rates at the same time.

Aswath Damodaran is a Professor of Finance at the Stern School of Business at New York University. This article was originally published on his blog Musings on Markets.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.