A couple of days ago, Paytm went from being a ‘own at any cost stock’ to a ‘avoid at any cost stock’.

In a dramatic turn of events, Paytm — touted, by the punters, as the IPO you could bet your house on — closed its first day as a publicly-listed company 27% lower than its issue price. Retail investors experienced a hard-landing as the market rudely tipped the stairway sideways. A stairway, you say? To where? This metaphor needs some explanation. You see, these are stairways to those magnificent castles-in-the-air (also known as blitz-scaled companies) : with magical gardens where unicorns, with pristine ivory-like horns, prance around.

Retail investors, who had waltzed up these stairways earlier this year, with Nykaa and Zomato, thought they had the “hot-hands” going into the listing (“hot hands” also known as the “hot hand fallacy”, is a cognitive bias that a person who experiences a series of successful outcomes has a greater chance of success in their further attempts. The concept is often applied to sports and originates from basketball, where a shooter is more likely to score if their previous attempts were successful, i.e. while having “hot-hands”).

Paytm’s allure could also have been due to the massive step-up in stature, the company’s founder wanted this to be India’s largest listing and for the merry, wave-surfing retail investor it was the perfect moment to transition from ‘bet your car on Zomato’ to ‘bet your house on Paytm’. As we know by now that did not go well. The stock’s plunge wiped out INR 38,000 crore from the firm’s market value by close of its listing day! You can be certain that tens of thousands of retail portfolios would have tripped through margin and liquidation triggers — since these sell-on-listing tactics are usually fuelled by heavily leveraged subscription bids — and losses would have been realised. Retail investors who went into their subscriptions without borrowed funds would not have fared any better. Most of them will now continue to hold onto their loss-making positions hoping the stock price improves to their anchor points: Say, INR 1900 – 2150 levels across time. As a result, if institutional investors and mutual funds decide that the best course here would be to ‘HOLD’, then you may notice a significant drop in the trading volumes as well over the short-term.

The most obvious reasons for the bust are: the stretched valuation going into the listing and a proliferation of non-core businesses.

There has been a lot of press on Paytm’s ‘inability to generate profits’ going into the listing. This is true but not really out-of-the-ordinary when looked at, in the context, of IPOs over the last few years globally. In the US, the rapid ascent of SPACs means “product readiness” may be enough for a firm to IPO (In February 2021, Lucid Motors struck a SPAC deal to go public with $24 billion valuation. The company aims to deliver 577 units — yes, that is 577, I haven’t omitted any 0’s at the end of that number — of their flagship-product Lucid Air by this year end). A lack of profitability shouldn’t be worrying if long-term investors are seeing clear runways of growth.

These runways of growth may be quantified through either non-linear top line growth — at least 40% compounded — or an exceptionally large Total-Addressable-Market (TAM).

Paytm — and rivals Google Pay and Walmart-backed PhonePe — operates in a payments market that is, according to a Credit Suisse report, expected to be worth $ 1 trillion in the next 3 years, up from $ 200 billion in 2020. This means the addressable market — despite the presence of deep-pocketed rivals and the entry of new players like Facebook — isn’t as much of a concern. The elephant in Paytm’s payments arena appears to be its flat-lining topline. Revenue from operations barely moved the needle: from INR 32.3 billion on March 31, 2019 to INR 32.8 billion on March 31, 2020. Revenue from operations slips further considerably on March 31, 2021 to INR 28.02 billion.

To attribute this decline in “Revenue from operations” effectively, it is useful to look at how Paytm segregates its revenues

Paytm segregates its revenue from operations under two revenue lines:

For its payment services, its generate revenues from:

For its financial services, Paytm primarily generates revenue from the distribution of services and products — insurance and wealth management — through its platform. Additionally, through Paytm Money, Paytm earns float income on funds that its customers keep in their brokerage accounts. The financial services business is a recent one, operates in an intensely competitive environment with practically non-existent barriers to new entrants, and currently constitutes a small percentage of Paytm’s total revenues.

Paytm’s revenues from “Commerce and Cloud Services” has also declined considerably from INR 15.36 billion in 2019 to INR 6.9 billion in 2021. (While Paytm hasn’t split this figure between Commerce and Cloud, I suspect the severe compression in revenues here has come from a significant contraction in the Commerce GMV).

The Gross Merchandise Value (GMV) is an incredibly important metric for payments and e-commerce firms alike since it is the clearest indicator of the size of the prize. Paytm’s sluggish GMV growth on payments — note that this is different from the Commerce GMV I referred to earlier — appears to be the weakest link in the long term narrative for this stock. The firm cherry-picked the growth in payments GMV for the three months ended June 30, 2021, highlighting 110.6% growth when compared to the same time in the previous year. You may well remember that the 3 months ended June 30, 2020 period perfectly captures the time-slice when consumers and businesses alike were locked up by governments worldwide. A look at the annual growth figures shows how actively competition — and possibly the increase in cash transactions, more on this later — is whittling away the Payments GMV pie. Annual Payments GMV growth has dropped like a stone: from 95.9% in 2019 to 33% in 2021.

If demonetization was the tailwind that propelled Paytm out of the blocks in 2016, then the return of cash could be the kind of headwind that long-term Paytm investors may need to be wary of. Cash in circulation as a proportion of GDP was at 14.5% for FY 2020-21, as per RBI data released on October 29, 2021. This is significantly up from 10.7% of GDP in FY 2017-18. The spike could be temporary if this ‘dash to cash’ is a result of the pandemic; and not due to the consumer and the merchant colluding to evade the GST. However, if this trend — of rising cash in circulation — shows signs of permanency, then not just Paytm but the Payment Industry in general will need to revise their hyper-growth projections downward.

Paytm remains a promising stock and nothing can take away from their meteoric rise and the exceptional role the firm played in a post de-monetized India. While the flat-lining topline is a cause of concern, the firm looks very good on its expense management. The firm has smartly moved into the green on Contribution Profit — A non-GAAP financial measure. Paytm defines Contribution profit as revenue from operations less payment processing charges, promotional cashback, incentives expenses and other variable expenses. This implies the firm is on top of its variable expenses. Sustained higher Contribution Margins — Paytm has turned around a negative 61.8% Contribution Margin in 2019 to a 12.9% Contribution Margin in 2021 — will help the management focus better on managing fixed costs over the medium term. Anchor Investors need to be anchored in for longer

Coincidentally, as I write this, a news alert pops up on my news terminal — SEBI likely to quiz investment bankers on Paytm’s listing fiasco. The regulator is reportedly keen to probe irregularities in the trading pattern on listing day. Alongside this investigation, SEBI is also looking to review some of the current regulations around IPOs. Interestingly, SEBI published their discussion paper on 16th November, 2021 (a couple of days before Paytm listed) proposing a raft of measures including this proposal: at least 50 per cent of the anchor book have a lock-in of 90 days. Paytm had allotted shares worth INR 8,235 crore to Anchor Investors a day before its IPO opened. Under current regulations, these Anchor Investors are free to sell their shares after a lock-up of 30 days. This could intensify price-weakness, in the comings days, in a stock that’s already under the pump.