Paytm is returning excess cash before it even has it
If youâre the management of a publicly listed company, and you make a nice profit at the end of the year, thereâs a couple of things you can do with those profits. You
could, of course, invest that money back into your company. Thatâs how your business would grow, after all. But you could also return some of that cash back to the investors in your company.
Depending on the company, market prospects, competition, past investments, etc., etc, both of these are valid choices and you can make a well-thought out, calculated decision by considering all these factors and speaking to your investors and getting their opinion. The bottom line is that if you have profits and excess cash, you also have the luxury of making a choice about what to do with that money. If your company doesnât make a profit, there wouldnât be excess cash to âreturnâ to your investors. Youâre surviving off the money they gave you in the first place!
Well, last week, Paytm upended this very simple model I just described above by being an unprofitable company that decided to return money to its investors. Theyâre planning on giving back up to âš850 crores ($102 million) [1]. This is a company that had a net loss of more than âš2300 crores ($280 million) last year and is on its way to losing even more this year. From the company blog:
Our Board has approved the proposal for buyback of equity shares on Tuesday (December 13, 2022). All directors present voted unanimously in favour of the proposal, including independent directors. We will undertake a buyback of up to âš850 crores (excluding buyback taxes and other transaction costs) at a maximum price of âš810 per share, and have opted for the open market through stock exchanges method, which is to be completed within a maximum period of 6 months. Our Board has determined that a buyback of the companyâs shares would be accretive for its shareholders, citing strong financial performance, clear path to cash flow generation and excess cash as a result.
Paytm doesnât have excess cash, its management just sees a âclear pathâ to excess cash sometime in the future which they feel is a good enough reason to start returning money. Usually itâs a good idea to actually having excess cash before you start returning that cash.
Two buybacks, this is neither
If a company invests a ton in research and development, pays its employees top salaries, ensures itâs a notch above competition, and still ends up with excess cash, returning that money is usually nice. Apple is a great example, it invests billions in research and still ends up with money remaining. Paytm is obviously no Apple.
Alternatively, if a company has genuinely, wholly run out of ideas, if itâs just tired and yet ends up with money every year, returning money is still nice? No point investing it back into the company. IBM is a great example. But Paytm is no IBM eitherâif anything itâs a company with too many ideas. It began with payments, now itâs got stocks, shopping, movie tickets, bus tickets, loans, and it doesnât seem to stop!
So why really does Paytm need to go through all this bad PR and announce a buyback? (Iâm grateful to have a sweet topic to write about, though. Thanks, VSS.)
Some investors are more equal than other investors
Now that Paytm is a publicly listed company, its responsibility towards all its shareholders (investors) is the sameâincrease the companyâs share price so that all shareholders can benefit equally. Sure, sometimes a companyâs investors might disagree with each other and the company will obviously listen to whoever owns a larger stake, but ultimately the benefits will go to all investors.
And yet, we know that a company would probably like some investors more than others. If you were an early venture capital (VC) investor who invested in a company while it was just a baby, youâre bound to have a strong relationship with the founder and management [2]. The founder probably came to you for advice. You might call them over to give motivational talks to other entrepreneurs. Maybe even retweet each otherâs tweets. A company is more likely to like them more than its new investors who bought shares after it was all big and fancy.
When Paytm decided to do a buyback, it had two options.
- Buy shares from the open market. Whoever sells shares when Paytm is buying gets to sell their shares to the company. This is what Paytmâs going to do
- Run a âtender offerâ. Decide on a fixed price. Ask investors interested in selling shares to apply. If there are more shares being sold than Paytm can afford to buy, it has to buy an equal number of shares from every investor, and pick them at random. It canât pick and choose which specific investors to buy from
If youâre a VC investor in Paytm looking to sell your stock, youâd want the buyer to be Paytm itself. Because Paytm would pay more than whatever else any investor would (the whole point of the buyback). But if Paytm ran a tender offer, you might not get to sell any of your shares, and even if you did, it would be a small number at best. If Paytmâs buying shares from the open market, though, you might get âluckyâ and sell a lot more than the companyâs post-IPO investors.
And âluckâ can be manufactured, of course. As a VC investor, youâre buds with the founder. Even the company might like to buy the stock from you instead of from a normie investor. But Paytm canât pick a particular seller when itâs buying stock from the open market. Itâs got to buy from whoeverâs selling.
Now, Paytm is a fairly liquid stock. Thereâs a lot of buying and selling happening constantly. Even if Paytm wants to favour its VCs, it wouldnât be easy. But itâs definitely possible! There are some days when there are just fewer investors trading in the market [3]. Paytm could turn up in the market right before, say, New Yearâs day and dump its entire chunk of âš850 crores while most regular investors are chilling in Goa or Thailand, and VCs could just happen to be selling at the same time.4
Iâm not suggesting that this is what Paytm has in mind. This would require that Paytm communicate with their VCs and tell them exactly when it would buy stock, and that would be insider trading. Which is very illegal! Iâm not saying that Paytm plans to do illegal stuff, all Iâm saying is that this buyback makes sense only if they do plan to do illegal stuff.
Yesterday, Indiaâs markets regulator SEBI approved its proposal from last month to gradually do away with open-market buybacks entirely [5] :
Under the stock exchange route, there is a possibility of one shareholderâs entire trade getting matched with the purchase order placed by the company and thus depriving other shareholders to avail the benefit of buyback. This runs contrary to the underlying principle of equitable treatment which forms the basis of all the corporate actions.
Itâs almost as if Paytm read this proposal and rushed to do an open-market buyback while it still had the chance.
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Footnotes:
[1] An unprofitable company returning its future excess cash to investors is weird. Whatâs weirder is that Paytm had quite the IPO just last year. It raised âš18,300 ($2.2 billion), then the largest ever in India! A bit more than half of this went to Paytmâs older investors, and âš8,300 ($1 billion) to the company to invest in the business.
[2] Obviously VCs can have bitter, bitter conflicts with founders in which case a companyâs management would rather not listen to them. This usually never happens for large companies, though, and would much likelier happen during a companyâs early days.
[3] I checked the total trade value for Paytmâs stock and even though it is a liquid stock, there is a lot of variance on a day-to-day level. The minimum traded value on NSE in the last 3 months was just about âš13 crores ($1.5 million) on 24 October, Diwali day. The highest was about âš3,158 crores ($380 million) on 17 November (the average is about âš287 crores). If Paytm were to buy shares worth âš850 crores on a day with low trade volumes, whoeverâs selling can get a much higher price for their shares.
[4] Paytm wouldnât only buy the VCâs shares if this were to happen. But the VCs would get to sell a lot more shares than otherwise this way. Oh also, if Paytm actually started buying up shares on New Yearâs Eve it would be extremely suspicious. Usually these things are more subtle.
[5] Additionally, here are two papers that assess whether insiders (such as VCs) benefit from open-market buybacks. Both of them think, yep, they do.
