Buy One 97 Communications (Paytm) for target price of Rs 1285 (156% Gain): ICICI Securities

One 97 Communications (Paytm) BUY Maintain

Management expects positive FCF generation in 12-18 months; no onerous outcome of regulatory observations

One 97 Communications (Paytm) during its analyst meet yesterday (1st Dec’22) reiterated its continued focus on improving profitability. Management stated that the journey to attain operating profitability (EBITDA before ESOP cost) via consistent margin improvement has exceeded its expectations in the past few quarters. It further emphasised its target to become an FCF-generating company in the next 12- 18 months. Management also enhanced clarity around the company’s business model by providing additional disclosures with respect to net payment take-rate of 7-9bps, average subscription fee (of Rs100 per month per active device), 2.5-3.5% take-rate on loan sourcing and 0.5-1.5% on collections, etc. Besides, the management pointed at growth drivers in the various business segments and threw light on how it plans to generate free cashflow (FCF). Lastly, clarifications provided around regulatory developments with no onerous outcome provide further comfort. Maintain BUY with an unchanged target price of Rs1,285 based on customer lifetime value methodology. We discuss key takeaways from the analyst day below:

► Ahead of the guided timeline to achieve operating profitability; company to even start generating free cashflow (FCF) in next 12-18 months: Paytm has been delivering better than our expectations as reflected in its operating performance over the past 2-3 quarters. EBITDA (before ESOP) reduced to -(9%) in Q2FY23 from -(39%) in Q2FY22. This gives visibility around the company turning EBITDA-positive (before ESOP cost) ahead of the guided timeline (Q2FY24). In addition, the management is confident about becoming an FCF-generating company (net of capex) in next 12-18 months driven collectively by improved profitability across payment and financial services distribution, cloud, etc.

► Payment processing + subscription revenues on devices = Net payment margin: Through payment processing, Paytm makes a net payment margin of 7-9 bps of GMV. Of this, 3-4bps are earned from UPI transactions and 15-18bps from transactions through other instruments (such as wallet, debit card, credit card, etc). On expectations of faster growth in UPI transactions, management foresees blended margin to stabilise at 5-7bps going ahead. The other margin driver in payment business is subscription revenues earned through device deployment wherein Paytm charges around Rs100 per month per active device. Charges on some high-end devices are higher (up to Rs250 per month). Furthermore, select installations get additional incentives from partner banks, RBI, NABARD, etc. Paytm designs and manufactures the devices through an Indian company in which it has a minority shareholding and which is exclusive to Paytm. This gives Paytm the advantage of being less dependent on other companies and also being more innovative with devices. For example, it is planning to launch a soundbox with card payment acceptance. Paytm takes aggressive depreciation (2 years for soundbox and 3 years for EDC) and expects to generate enough cash in next 12-18 months to fund net capex.