India’s digital payment market is getting more competitive with PhonePe spin-off

Global giants like Alibaba, Amazon, Google, and Facebook are keeping a close watch on Indian digital payments opportunity, which is very much untapped since half of the Indians are yet to come online.

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India’s digital payment segment is set to become ultra-competitive with Walmart looking to raise stakes in the space.

The American retail giant is planning to demerge its Flipkart’s payments arm, PhonePe, local media Economic Times reported citing sources.  The unit is reportedly raising USD 1 billion at a 10 billion dollars valuation through primary and secondary sale of shares. It’s currently valued at USD 7 billion.

This will intensify the competition among the payment heavyweights like Alibaba and SoftBank-backed Paytm, Google Pay, Amazon Pay, and WhatsApp Pay which have been locking horns to grab a bigger pie of India’s USD 200-billion-plus digital payment industry.

A rosy market

The segment is expected to see a 10 times growth in India, crossing USD 500 billion by 2020, up from USD 50 billion in 2016,  according to a report by Google and Boston Consulting Group (BCG).  The global digital payments market is projected to reach USD 21 trillion in the same time period.

The Reserve Bank of India, the country’s central bank, estimates that India has 100 million active digital payment users per month, and expects it to grow to 300 million in three years. In the financial year 2018-19, as per the government data, India witnessed 31.3 billion digital transactions. Considering there are over a billion Indians, who are still not transacting online, the industry is set to see explosive growth in the coming years.

The growth in online payments is fuelled by rapidly rising smartphone users and more consumers opting for digital transactions. The South Asian country has over 450 million smartphone users at present, and the number is expected to reach 900 million by 2020, accounting for almost a third of smartphone users globally, per a 2018 report by Data Security Council of India, an industry body for data protection.

Alibaba, SoftBank, Walmart, Google, Amazon, and Facebook are already keeping a close watch on the Indian digital payments opportunity, which is very much untapped since more than half the population in India still doesn’t have smartphones.

Walmart’s serendipity

PhonePe, founded by three former Flipkart executives–Sameer Nigam, Rahul Chari, and Burzin Engineer– in 2015, was the first mobile wallet service to integrate Unified Payments Interface (UPI), a government-backed payment mechanism.

Within a year of starting operations, the early-stage payment startup was acquired by homegrown e-tailer Flipkart. Apart from offering peer-to-peer transfer, recharge, utility and bill payments, gold purchases and insurance, PhonePe has been ramping up its peer-to-merchant transactions, bringing small retailers on its platform.

In 2018, when Walmart acquired 77% Flipkart for USD 16 billion, PhonePe came along as an unnoticed part of the deal. According to a recent Bloomberg report, after investing USD 300 million in PhonePe and debating for months on “whether to keep funding the payments business internally or whether to separate the operation so it could raise outside funds”, Walmart decided to go with the latter. In March 2019, Flipkart board agreed upon creating a separate board for PhonePe and raising money from external sources by divesting shares.

The Economic Times report states Walmart, which now owns 82% of Flipkart, following the de-merger, will have 82% stake in PhonePe separately, and the combined entity  (Flipkart-PhonePe) will have a valuation between USD 27 billion and 30 billion.

A page from Ant Financial

Walmart seems to be taking the same route as Alibaba, which made its payments arm Alipay into a separate entity in 2011 when it created Ant Financial.

Considering how Ant Financial has emerged as one of the biggest financial services company, Walmart may be looking at making PhonePe independent as a growth strategy, said Neil Shah, partner, and research director at Hong Kong-based Counterpoint Research.

“Unbundling PhonePe from Flipkart will help grow the company really fast. Under Flipkart, there would be friction and delays while deciding how much funds to allocate and how to pay for PhonePe’s strategy and growth,” said Shah. “Direct backing from Walmart would keep things more transparent and streamlined because then it would be a horizontal structure rather than vertical.”

“The growth prospects would be higher if it becomes more independent and that can get it additional funding because then Walmart can show more value to the investors,” Shah explained. “Over a period of time, it can sell the stake, keeping a controlling stake. That way Walmart can also recoup a lot of money it has invested in the company. So for PhonePe, it is a growth strategy.”

“Walmart can also use PhonePe’s IP (intellectual property) and launch a similar platform in the US and other markets. So this will help them scale globally as well,” he added.

The direct Walmart support would also benefit PhonePe at a time when the online payments industry is going through significant changes. Till few weeks back, all the top payment services players were fighting for retail customer market share–wooing users to do more UPI transactions on their platforms. However, the focus is now shifting towards offline retailers, now that Indian regulators are reportedly working on guidelines that put a 33% market share cap on payments apps that use UPI.

“It would be good for PhonePe because then Walmart will be able to infuse more money. PhonePe is not lagging behind its rivals, but it will have more resources to compete against the likes of Google, Amazon, and WhatsApp,” said Arnav Gupta, analyst at Forrester. “Now that the regulators have come up with the guidelines on how much market share players can have of the industry, the natural route for the expansion would be towards the small offline merchants, because that is going to be a deal-breaker for all the payment services.”

Over the last two years, PhonePe has been targeting small merchants and businesses, trying to bring them on its platform. In June, PhonePe claimed that it had acquired 5 million offline retailers, playing catchup with rival Paytm, which has 13 million offline merchants onboard.

“It’s not just Paytm, Google and Amazon, BharatPe is an equally good competitor although it is a B2B provider offering payment services and payments-backed lending services to merchants. Because there is nothing stopping PhonePe from doing the same,” said Gupta. “PhonePe already has payment gateway service and PoS (point of sale) devices, and will naturally look at providing merchants more value-added services like basic billing and invoicing systems, ERP (Enterprise Resource Planning) software, and eventually credit,” he added. “Because that is where the money lies.”

“Merchants also prefer to engage with someone offering all the services because these companies come with a lot of investments and are heavily funded. Hence they can provide more benefits such as cashback to them,” said he.