Paytm IPO: Case of Deliberate Overpricing?
“A higher valuation could have been achieved but we decided to price it at a level where everyone makes money,” said Madhur Deora, group chief financial officer at Paytm, after the public issue. The stock was issued at Rs2,150, got listed at Rs1,950, hit a high of Rs1,955 and then went into a relentless decline. Closing at Rs944.50, the stock has more than halved. Mr Deora’s comment of pricing at a level where 'everyone makes money', has turned out to be a joke. On 4th February, Paytm announced its December quarter results. It reported a loss of Rs780 crore against a loss of Rs520 crore for the same period of the previous year. Paytm has turned out to be the poster boy of overvaluation, with the company, investors and even the regulator now being asked to be accountable for the massive losses inflicted on shareholders.
 
There is always a variance between the price of the stock, which the investee company seeks, and its market value. Hence, the performance of investee companies is constantly analysed in order to identify undervalued stocks for buying and overvalued stocks for selling. Apart from this, technical analysts seek to time their buy-sell decisions. Securities evaluation has been a fertile ground for research from the days of Benjamin Graham in the 1920s, followed by John Burr Williams’s Theory of Investment Value, followed by the pathbreaking Markowitz Portfolio Theory in 1952, Capital Asset Pricing Model (CAPM) in 1960s and Three Factor Fama French model (1993), etc. The CAPM model is now universally employed for estimating expected return on equity. How does all of this apply to the Paytm valuation? Was the stock significantly overvalued at the issue price?
 
Estimate of the earning per share (EPS) divided by the expected return on equity gives the share price based on no-growth scenario. The difference between the market price of the share and the price based on no-growth scenario represents present value of growth opportunities (PVGO). No wonder, the well-managed growth-oriented companies have high PVGOs reflected by high P/E (price-to-earnings) ratios. For example, the trailing P/E ratio of Infosys Limited and TCS Limited remain high at 34+, whereas commodity companies such as Tata Steel and JSW Steel are a faction of that. The PVGO is discernible for well-established listed companies but poses a challenge for start-ups such as One 97 Communications Limited, particularly before they break even.
 
One 97 Communications Limited, better known by the brand name Paytm, made initial public offer (IPO) of Rs18,300 crore in November 2021. A major part of the issue, i.e., Rs10,000 crore was offer for sale from the existing shareholders who used the IPO to harvest their returns. Before the IPO, the company split the face value of the shares from Rs10 each to Rs1 each. So, IPO price of the share at Rs2,150/share was equivalent to Rs21,500/share of the face value of Rs10/each. The size of the IPO and pricing for a start-up with history of losses was path-breaking.
The selling shareholders who received Rs10,000 crore included promoter Vijay Shekhar Sharma who diluted his paltry pre-IPO shareholding from 9.1% to 6%. While the selling shareholders are having a ball, new investors have suffered a whopping value loss of Rs10,073 crore with a 56% fall in share price in just three months since its listing on 18 November 2021. Is it due to overpricing? Let’s figure out.  
 
 
 
 
Paytm’s business segments include payment services, financial services, and commerce and cloud services. Its large consumer / merchant base of approximately 333mn (million) / 21mn, aided by large payments platform handled gross merchandise value (GMV) of Rs4.03 trillion in FY20-21 clocking a two-year compounded annual growth rate (CAGR) of 33%. This resulted in a two-year CAGR of 11.5% in its revenue from payment and financial services. However, the revenue from commerce and cloud services clocked a negative two-year CAGR of 32.8%. Thankfully, aided by a two-year compound average operating cost reduction of 22.4%, the company had the lowest negative earnings before interest, taxes, depreciation and amortisation (EBITDA) during FY20-21.
 
The key to Paytm’s profitability is substantial increase in revenue and reduction in operating costs. However, while revenue has grown, the downward trend in operating cost has been reversed in second quarter of FY-21-22. It is unclear how and when the proposed strengthening of Paytm's ecosystem and acquisition / retention of consumers, etc, with the IPO proceeds will help the company to induce efficiency, turnaround and catalyse return on equity.
 
The digital payment ecosystem powered by India’s robust Unified Payments Interface (UPI) is expected to continue to hold the sway due to the economics, security and efficiency it provides. UPI, which had started with a pilot launch in April 2016 has emerged a preferred mode of digital transactions (see the figure below).
 
 
On the UPI platform, Phone Pe and Google Pay have marched ahead of Paytm with market shares in value, of 46.6% and 37.8%, respectively, against 8.7% of Paytm. With almost 20 UPI third- party apps including Phone Pe, Google Pay, Amazon Pay and WhatsApp Pay, and those of large finance companies and banks, the competition is set to intensify. 
 
Share Value
The offer for sale of shares from 21 shareholders, including eight global PE funds / investors and the solitary founding promoter aggregated about 46.51mn shares (7.63% of the shares pre-IPO outstanding) at a price of Rs2,150/shares. Average acquisition cost by these investors was Rs816.90/share with a maximum of Rs1833.30/share and minimum of Rs. 0.50/share belonging to the founding promoter. The share prices paid by the global PE funds / investors must have been preceded by intense negotiations as usual. Such investors often use the formula:
 
 
The fund / investor invests “I” for an investment horizon of “N” years during which it seeks a return of “R” depending upon the business risk profile. Hence, the value of the investment must swell to I*(1+R)N at the end of investment horizon. The value I*(1+R)N divided by the estimated market capitalisation i.e., PAT * PE Ratio constitutes the fund’s ownership (“S”) part in the investee company for investment “I”.
 
Thus, if value of “S” works out to say 30%, share pricing must ensure that the investor / fund with investment of “I” has a 30% ownership in the investee company. Estimation of market value of equity for an unlisted firm entails discounted cash-flow modelling which is finalised after intense negotiations. Often, the initial investment is in convertible debt and eventual conversion into equity depends on the actual performance which is constantly monitored by the investor. 
 
Thus, the pricing of shares placed by Paytm with the several PE funds / investors over the past few years must have been based on the DCF model. Yet the RHP’s (red herring prospectus) basis for the offer price was perfunctory, and carried no basis whatsoever and seems to have been drafted to avoid inconvenient questions. Surprisingly, the mandarins at the Securities and Exchange Board of India (SEBI) accepted polite nothings in DRHP (draft RHP) without a murmur.  
 
Paytm’s outstanding equity shares of 648,273,659 had IPO value of Rs1,393.79 billion (US$18.58 billion) on November 8, 2021. At close on the listing date, its price was Rs1,560.80 and, currently, the share price is Rs944.50 reflecting loss to the investors of Rs10,072 crore (56%) in just three months. 
 
With low trading volumes of just 0.02% of the shares outstanding and deliverable quantity of around 30%, the share price may see sawtooth fall, if the company fails to break even and demonstrate EPS (earnings per share) growth that can justify even the current depleted value, soon.  
 
Though promising, the digital payment landscape has not evolved profitability parameters which typify this industry. Assuming that this turns out to be a growth-oriented industry which justifies P/E ratio of, say, 25, based on (i) EBITDA margin of say 15% (from the currently negative 35%), (ii) 5-year growth phase till FY-26-27, a steady state phase thereafter with a robust perpetual growth of 10% per year, weighted average cost of capital of 20% (assuming marginal debt levels), clocking a P/E ratio (based on issue price) of 25 would require five-year CAGR of over 25% in revenue.
 
Growth in revenue is evident in first half of FY21-22. But the operating cost reduction which is crucial for positive EBITDA is not evident. To correct this anomaly, substantial reduction in payment processing charges and other expenses is a must. Whether this will happen in FY22-23 will be clear in first quarter of FY22-23. Whether Paytm manages to reduce the payment processing charges, 49% of which were remitted to related party is to be seen. If such reduction with a related party is a zero-sum game the wait for positive EBITDA could turn longer, and the market will discover the true value of Paytm share by first quarter of FY22-23.
 
It is obvious that the IPO was grossly overpriced. Out of the unrealised loss of Rs10,072 crore as on date, the Indian subscribers have a share of Rs15,018.7 crore with individual subscribers accounting for a major part of Rs9,949 crore (table below). 
 
 
At the pre-IPO marketing stage, a few buy recommendations were for listing gains. So, the market had gauged the aggressive pricing. Yet it is amazing how even three mutual funds, insurance companies and finance companies each invested in the IPO. 
 
Variance between valuation and market cannot be wished away. So good companies often buy back shares whose market price is perceived to be lower than intrinsic value. If the Paytm’s IPO price was fair, will it buy back share when it starts earning profit?
 
For a fairly-priced IPO, a minor negative variance on listing is understandable. The fall which Paytm has experienced confirms unfair overpricing. It is hoped that SEBI will insist on the issuers sharing most likely, upside and downside valuation details in basis for the offer price so that the investors are not in kept in dark. The merchant bankers should also be required to do market-making for a certain period after the IPO listing. This will induce fair IPO pricing and the intermediaries will not be able to get away with mere disclaimers. 
Comments
coi19002
6 months ago
Brilliant Post sir. Can you PLEASE give the SOURCES for the data of the tables (other than UPI) ? I am doing a research on this case study and it will greatly help me. Thank you.
rmganatra
Replied to coi19002 comment 6 months ago
Sorry to have seen your message today. I had used the company's RHP and some research reports. I can forward you the research reports. Just send me WhatsApp message on 7666744953.
somashekhar.rlpura
8 months ago
Look at the shareholding pattern of Paytm as shown in NSE's website wherein promoters holding is zero. Entire shares are with public. In such a case, one should be very careful while subscribing to such a overpriced stock in which promotes have no interest. There has been a lapse of scrutiny of IPO papers. SEBI could have rejected the said IPO in the interest of investors. Investors too should take due care before subscribing to such overpriced stocks.
sundar411
8 months ago
SME IPOs are burdened with market making mechanism for 3 years. Start up companies making IPOs with huge valuation without having earned a single rupee as profit should also be similarly subjected till they turn profitable. But Paytm original investors and promoters have made merry at the expense of ever greedy but stupid retail investors. And SEbI the watchdog keeps mutely watching as it has done over the years in the matter of IPO pricing ever since CCI was abolished.
saharaaj
10 months ago
Deora seems to have political linage Political optimism
arnobmondal
10 months ago
Incisive article but a tad one sided. The article lambasts the promoters, the early and late stage pre-IPO investors, the merchant bankers and SEBI. Yet it has soft pedalled the greed of retail investors who subscribed to the issue, a majority of whom were surely financially illiterate - and who were driven solely by greed and delusions of instant financial gratification on listing day. Would they have done similar scanty due diligence if they were buying a house? No Siree, certainly not! Yes, the promoters, etc were certainly to blame for over pricing the issue but all those 'helpless, innocent retail investors' only have themselves to blame.
good.shah999
10 months ago
Was the issue overpriced? YES, Did the promoters and Merchant bankers act dirty? YES. Did they make money due to the IPO frenzy? YES. Was it a fraud? NO. The disclosures were very clear, the company was not profit-making and was losing cash hand over the fist was well known. If not known, then they should not have invested. If known then they invested knowingly. No sympathy for the so-called small investor who was greedy. It is high time that the investors in the stock markets are told that this is not for immature people who cannot take responsibility for their own behaviour and actions. In fact, there should be a part II of the article blaming the investors also, giving all the disclosures given in the RHP.
adheer
Replied to good.shah999 comment 9 months ago
PayTM decided to close their Canada and Japan operations afterIPO listing. - stating that operations in these two countries are losing making.
In their IPO prospectus they stated their business prospects in Canada and Japan are excellent.

This is fraud. The public was clearly lied to in this case.
sha79
10 months ago
Excellent and insightful. Thank you for writing this article.

Sir, you have provided clear details about the offer for sale, the pricing and also some basic recommendations to make the pricing more transparent.

The only way for investors to avoid such losses is by being more skeptical about these IPOs.

Kudos to Moneylife editors for such quality articles. As usual, Moneylife's IPO review for PayTM was balanced, honest and clearly highlighted these risks. They clearly mentioned that the IPO price values the company at 39 P/S.
SRS
10 months ago
So, who held a gun to any IPO investor's heads and said "Buy PayTM at the IPO, or else I will shoot"?

All the above information was available to IPO bidders too. They instead were salivating at the prospect of a huge IPO pop, and many purchased shares without due diligence. They have now received their comeuppance. Caveat emptor.

This happens in many markets. Recently, a large number of SPACs that went public as cash shells in the US markets and then did a reverse merger with a private company to give them a public listing are trading at 50-80% below the price at which they went public. Except where fraud HAS actually happened (like in Nikola), no one is alleging criminality. They all know that they should have been smarter about their diligence, not get caught up in a frenzy, etc. and that they are paying the price for it now.

Freshworks, a great Indian SaaS story, went public on the Nasdaq at $36/share last year. It is now trading at about $22.5, down around 40% from the IPO and down 50% from the peak of $47. No one is alleging fraud there either, because there was no fraud. Just overenthusiastic buyers then, and remorseful sellers now.

That's how markets work. Don't whine fraud when you should be cursing your own folly and naivete. Why can't investors behave like adults rather than spoilt brats?
tlrchandran49
10 months ago
CFO was very right. The promoters made tons of money by fooling greedy investors and our great SEBI sitting eyes closed with a simple disclaimer. Nyakaa is perhaps another case
chandragupta
10 months ago
If my money doubles on listing, it is my brilliance. If it halves, it is SEBI's fault. Nice !
wjesudas123
10 months ago
The figures shown here are all wrong and misleading. None of the original promotors got any money back. In fact they had to bring in fresh money to get the issue subscribed. The only people made money are Sharma and other lot of employees. All PE funds like Alibaba Soft bank Ant group and others are sitting on huge losses.
rmganatra
Replied to wjesudas123 comment 10 months ago
Figures in this article are from BSE website, company's audited accounts and RHP. None of the figures is wrong or misleading. Present your figures and analysis before giving conclusions.
kpushkar
10 months ago
It means Paytm floated shares at more price than shree cement or MRF!! What a joke
gurujifanclub
10 months ago
Ganatra ji
This shall be an open & “shit” case and shall be remembered as biggest day light robbery in the IPO market!!
was there SEBI ‘s role in this ??
Was there top rated merchant bankers role in this ?? Successful robbery?

I believe. Non other then
Sebi and MB should know/ question on the valuation methodology applied on this ipo , which was “OF COURSE “ conspired and compromised
common men the mango ???? people are always lured with complex jargons which they can never ???????? understand
Your article has once again propelled Q’n on SEBIs blind ???? eyes approach and exceeding greed of merchant bankers for only money making motto
rmganatra
Replied to gurujifanclub comment 10 months ago
I agree. Unfortunately, the lay investors' greed leads to the smart market operators selling worthless issues for fat fees.
rameshwar1105
10 months ago
After reading such an exhaustive note.... I don't think any enquiry committee is required to be formed. Immediate arrest of all concerned including the fund managers etc who are supposed to evaluate the investment have blindly invested. This is a clear case of big fraud by many sections.
SRS
Replied to rameshwar1105 comment 10 months ago
This is a case of criminal stupidity by the investors. Rather than the sellers, the ones who should be arrested and barred from ever buying a stock again are the fools who purchased shares in companies like this and are now whining like stuck pigs. They should only be allowed to buy FDs at nationalised banks because they don't understand anything about risk and return in financial markets.
tusharsingla55000
10 months ago
I think before permitting such a high price of Rs.21500 for face value of Rs.10 of a loss making company SEBI is the real culprit.
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