Phonepe clicks to go back

The Walmart-owned digital wallet has to grapple with regulatory changes restricting its expansion that coincide with its IPO plans in 2023

If demonetisation popularised digital payment apps for India’s one billion-plus mobile phone-using population, the pandemic induced lockdown fast paced their relevance and consumption by at least 40 per cent, going by reports. Under normal circumstances this should lead to a windfall profit for the fintechs. But for the homegrown digital payments leader Phonepe, that may not be the case just yet.

The Bengaluru-based start-up is an entrepreneurial venture of two former Flipkart employees, Sameer Nigam and Rahul Chari. In 2016, a year after it was incorporated, it was acquired by Flipkart and quickly became the first UPI (Unified Payments Interface)-based app to cross 10 million downloads. Currently, it has over 100 million active monthly users and has emerged as the number one player by value in the digital transaction space.

With such rapid progress, Phonepe had every reason to ensure that the years leading up to a planned 2023 initial public offering (IPO) would be focused on financial consolidation, and profitability. After all, despite ~184 crore of operating revenue in FY19, it ended up with a net loss of ~1,905 crore (FY20 numbers have not yet been published). But that timetable may have been disrupted, thanks to serial regulatory changes.

Implemented from January 1, 2020, the zero merchant discount rate (MDR) rule on debit transactions on UPI and Rupay, National Payments Corporation of India’s (NPCI’S) international card payment service, forced digital payment apps, including Phonepe, to rework their revenue strategies. In short, cashbacks and promo offers, which form the base of fintechs’ revenue model, had to be scaled back to manage costs.

Despite this challenge, Phonepe continued to grow its business and market share with 868.4 million transactions as of November 2020 translating to ~1.75 trillion in value. Phonepe and Google Pay together account for 82 per cent of UPI transactions by volume, according to NPCI data and this duopoly may have prompted the NPCI to bring in a regulation unique to India — restricting players’ market share in November.

Known as antitrust laws in the West, experts question NPCI’S move. “Markets have to grow on their own; artificial restrictions go against the principle of a free market,” said an industry veteran in the fintech space.

NPCI’S contention is that by imposing a 30 per cent cap on the total volume of transactions that can be processed by a third-party app (on a threemonth rolling basis) it was addressing risks and protecting the UPI ecosystem as it scales up.

Phonepe and Google Pay have two years starting 2021 to comply with this norm and this period exactly coincides with Phonepe’s run up to its IPO. Google Pay can dig into the deep pockets of its US parent Alphabet; it is unclear whether Walmart, which acquired over 87 per cent in Phonepe in 2018, will bankroll its Indian fintech subsidiary.

Phonepe declined to respond to queries but industry sources said the start-up’s initial reaction to this stricture was that its market share could shrink automatically as the market expanded, so the new norms aren’t so much of a worry. But industry observers point out that Phonepe held 39.2 per cent market share in the UPI space in November 2020, which roughly means it will have to reduce its volumes by nearly 200 million a month or about ~40,000 crore of transactions in value. “This could lead to a reasonable degree of destabilisation,” said a partner at a consulting firm requesting anonymity.

Not that the move caught fintechs by surprise — the threat of a market share cap had been hanging over the industry since March last year and led to some players, including Phonepe, to fast forward their diversification strategy. Paytm took the first leap. From wealth management to insurance and lending, fintechs began working hard to break their dependence on payments.

In 2020, Phonepe forayed into mutual funds, health and general insurance, including coronavirus insurance, gold loans and also small-ticket loans. Reports suggest a positive early trend for these launches, but being a cost-effective financial products distributor implies playing the volume game. And the ultimate acceptance of these products is a function of the overall market conditions. “If an app goes beyond a point to push products, fatigue may set in and the customer could move to another platform,” said an analyst tracking the fintech space.

Some also point out that for transaction pioneers such as Phonepe, entering new segments to solve an issue should not entangle them in other problems. For instance, the Reserve Bank of India has asked Phonepe to reveal the identity of the bank on behalf of whom it is offering a retail loan, a move that could potentially see a customer approach a bank directly for a cheaper loan.

“The interest rate parity between banks and digital lenders has motivated fintechs to enter the credit space and the differential could gradually reduce if regulations increase,” said a CEO of a fintech lender. Here again, with Phonepe having to compete with dominant players such as Paysense, Cashe, Dhani and Moneytap, meaningful penetration won’t be easy.

As Vivek Belgavi, partner & leader, Fintech, PWC India, put it, “Players in each specialisation need to focus on their unique right to win and craft a customer value proposition aligned with regulatory direction.” With the fintech industry moving to the next level of maturity, he said companies will have to choose their positioning wisely. For Phonepe, with at least three of its new verticals — insurance, wealth management and credit products — still at a nascent stage, the question is whether it can achieve growth without hurting its valuations by 2023.

Since Walmart’s 2018 acquisition of Flipkart — which is also headed for an IPO — Phonepe has received roughly $ 730 million from the Bentonville-based retail giant, implying a valuation of $5.5 billion. But valuations are essentially subjective in pre-ipo funding rounds. When companies prepare to go public, the focus shifts from revenue building to profitability for a successful listing, whether in India or overseas.

“With increasing regulatory pressures, it is important for fintechs to build and demonstrate viable business models that are sustainable over the long-term,” said Fali J Hodiwalla, consulting partner–fintech, EY. At present, the headwinds against Phonepe appear strong. But if it does manage to prove critics wrong, that’s some way of securing a bumper listing. The absence of fintechs in the bourses could secure it a scarcity premium when it goes public.