Warren Buffet Invests in Paytm - Has he departed from his 12 Principles?

"Warren Buffett in talks for a slice of Paytm" read the headlines of Newspaper today. Click here

It made me question whether Warren Buffett is changing his Investment Strategy. Traditionally he had shied away from investing in tech companies saying it is out of his "circle of competence".

So what factors did Paytm have which made it come under warren buffets investment radar? 

Before I begin answering the question let me give you a brief on warren buffets strategy of Investing.

Early in his legendary investing career, Buffett said, "I'm 85% Benjamin Graham." Graham is considered the godfather of value investing and introduced the idea of intrinsic value – the underlying fair value of a stock based on its future earnings power. However, Warren buffet improved the strategy of Benjamin Graham. Warren Buffet invests using a more qualitative and concentrated approach than Graham did. Graham preferred to find undervalued, average companies and diversify his holdings among them; Buffett favours quality businesses that have reasonable valuations and the ability for large growth.

To guide him in his decisions, Buffett uses twelve investing tenets, or key considerations, which are categorized in the areas of business, management, financial measures and value. 

Now let us analyse the 12 Investing considerations buffet uses before investing in a company and where does Paytm stand.

Business Tenets

1. "Circle of Competence"

After avoiding technology stocks for decades, Buffett said last year that not investing in companies like Google-owner Alphabet and Amazon had been a mistake. Since 2016, Berkshire has also been a big buyer of Apple, where its stake is now worth over $50 billion, making it the firm’s largest holding.

The legendary investor seems to have improved his competence to identify the value of Tech companies. The valuation of Tech companies are quite different than other companies and there requires a tremendous change in mindset. Since this is not the first time that Warren buffet has ventured to tech stock we can fairly assume that he is on a path to improve his competence in identifying value stocks in the tech sector.

2. Analyze the business, not the market or the economy or investor sentiment

Paytm has been diversifying its business across financial services and offline payments after acquiring customers through services such as mobile recharge, rail and air bookings, movie ticketing and utility bill payments. But this has not hindered the aggressive expansion plans of its broader payments business. Paytm is building a hyperlocal online-to-offline business under its New Retail strategy. This will increase footfalls for offline stores by offering discounts on payments through Paytm’s app using QR codes. The company has set a target of 20 million customers in the next three years. It has also set up subsidiaries for life and general insurance.

So going by the above trends in Paytm warren buffet has not deserted his criteria since the business model of Paytm looks considerably good

2.  Look for a consistent operating history

The Noida-based company said last month that it conducts 5 billion transactions worth $50 billion in gross transaction value (GTV) on an annualised basis based on its performance in June. It saw total income increase by 38% to Rs 828 crore with losses of Rs 899.6 crore in the year ended March 2017, according to Registrar of Companies (RoC) filings.  Paytm has consistent operating history since 2010 though the income is increasing the company has not made consistent profits.

3. Use that data to ascertain whether the business has favourable long-term prospects.

With intense competition from Flipkart-owned Phonepe and Google’s Tez besides potential competition from Facebook-owned WhatsApp and Reliance Jio Paytm has withstood the competition by diversifying their services.

Another thrust area for the company is Paytm Money, where customers can start investing their savings in products like mutual funds. The company has set a target of 20 million customers in the next three years. It has also set up subsidiaries for life and general insurance.

So generally the outlook for Paytm is good though it is burning cash at a rapid rate. Increasing penetration of internet in India is an added advantage. Overall the growth forecast looks good thereby meeting Buffets criteria.

Management Tenets

4. Is management rational?"

Specifically, is management wise when it comes to reinvesting (retaining) earnings or returning profits to shareholders as dividends?

well, the management of Paytm is rational in reinvesting their earnings and there is no question of paying a dividend at this point in time. The right strategy seems to be to be ahead of the competition and increase their market share.

5. Management's honesty with shareholders. That is, does it admit mistakes?

The shareholders are basically big PE investors and have understood the risk involved in investing in cash guzzling companies like Paytm and there is no report of any disputes among shareholders reported. However recently there were reports of a data breach, but the issue has since died down. click here to know more on it.

Honesty with shareholders mainly comes into picture when there are several other investors involved since these PE investors have done adequate due diligence before investing the true picture of Paytm business is Known to investors and scope to hide is less.

6. Does management resist the institutional imperative?

This tenet seeks out management teams that resist a "lust for activity" and the lemming-like duplication of competitor strategies and tactics.

Well Paytm seems to have slightly failed in this criteria but since the market is huge and one who is a pioneer in the sector cannot meet the entire demand it is quite natural for others to come in and fill the supply gap. But Paytm has made valuable additions to whatever it has copied or duplicated.

Tenets in Financial Measures

7. Buffett focuses on return on equity (ROE) rather than on earnings per share.

Most finance students understand that ROE can be distorted by leverage (a debt-to-equity ratio) and therefore is theoretically inferior to some degree to the return-on-capital metric. Here, return-on-capital is more like return on assets (ROA) or return on capital employed (ROCE), where the numerator equals earnings produced for all capital providers and the denominator includes debt and equity contributed to the business. Buffett understands this, of course, but instead examines leverage separately, preferring low-leverage companies.

One97 Communications, which is the parent company of Paytm, has reduced its losses to Rs 899.6 crore in the financial year 2016-17 compared to the previous fiscal, as per regulatory documents. Paytm has made its early investors lots of money in the past as well. Back in 2004, CEO Vijay Shekhar Sharma had given up a 40% stake in Paytm for a mere Rs. 8 lakh, because he had loans to repay. The investor who’d invested Rs. 8 lakh later cashed out at Rs. 87 crores, netting him a nearly 1000-fold return on his investment. A 40% stake in Paytm would be worth nearly Rs. 20,000 crore today.Nikhil Vora, a former banker with IDFC, has sold his 0.35% stake in One97 Communications to Alibaba for Rs. 150 crores. Vora had purchased the Paytm stake in 2011 after the company’s aborted IPO during which it had sought to transition from a mobile value-added services provider to a mobile internet firm. Vora sale nets him a 75 times increase over his initial investment.

Though the companies early investors have gained handsome profit by selling their stake, Paytm is yet to see a real return on equity. The company doesn't have much external debt which meets buffets criteria.

8. Owner's earnings," which is essentially cash flow available to shareholders, or technically, free cash flow to equity (FCFE)

There is no cash crunch in Paytm and their income is rising steadily. And fund infusion through fresh issue has improved their cash flow. This has kept them afloat in a competitive environment.

9. What is the market value of a dollar assigned to each dollar of retained earnings?

This is a tricky question to answer with Paytm. It is similar to Market value added (MVA) which shows the difference between the market value of a company and the capital contributed by all investors, both bondholders and shareholders. In other words, it is the sum of all capital claims held against the company plus the market value of debt and equity. This is definitely positive in case of Paytm which has seen its valuations touching $10 bn and make their investors rich.

Value Tenets

10.intrinsic value

Buffett projects the future owner's earnings, then discounts them back to the present.

At some point in time Paytm will make a profit. Though the present intrinsic value may not sound promising Paytm will definitely be a valuable company for the investor.

11. Buffett ignores short-term market volatility and focuses on long-term returns. He only acts on short-term fluctuations when looking for a good deal. If a company looks good at $50 per share and drops to $40, do not be surprised to see him pick up additional shares at a discount. In a bit of theoretical heresy perhaps available only to Buffett himself, he discounts projected earnings at the risk-free rate, claiming that the "margin of safety" in carefully applying his other tenets presupposes the minimization, if not the virtual elimination, of risk.

Though it is difficult to estimate the projected earning in this sector Buffet would have definitely considered the aspect of the margin of safety. But finding a risk free rate is absolutely difficult in a sector which he once avoided.

12. Buffett also coined the term "moat," The moat is the "something that gives a company a clear advantage over others and protects it against incursions from the competition."

Paytm has diversified and innovated their services and definitely have a clear advantage over others which will help them stay ahead of the competition.

Conclusion

warren buffet has definitely stretched his core investing principles to suit the modern needs. Though he would not have bothered about Paytm 5 years ago he has openly admitted having missed the bus when it comes to Google. He is clearly determined not to avoid the same mistake and is exploring opportunities to invest in promising tech companies.

He has always innovated on the principles of value investing of Benjamin Graham. It is an open question as to the extent to which these tenets require modification in light of a future where consistent operating histories are harder to find, intangibles play a greater role in franchise value and the blurring of industries' boundaries makes deep business analysis more challenging.

At the end of the day Principles will be of No use if you don`t adapt to the changing circumstances.

The author can also be reached at www.avilsalins.wordpress.com and avilraksalins@gmail.com

Credits:

• 1. 'Oracle of Omaha,' Warren Buffett in talks for a slice of Paytm. Click here
• 2. Warren Buffett's Investing Style Reviewed Click here