Zerodha, the Groww revenue puzzle

The question often arises: where are the profitable startups? Three recent examples come to mind, all coincidentally from the same segment and from Bengaluru. We’re talking about Zeroda, Grow and Dhan.

In fact, the ‘success rate’ in the investment technology space in terms of profitability is quite high compared to other segments of the broader fintech sector – even Upstox achieved profitability in FY23. And this may be why many fear that this year’s changes at SEBI may in disrupt this profitability to some extent.

Last week, Zerodha revealed that SEBI’s new derivatives framework will definitely have an impact on futures and options (F&O) volumes. For SEBI, these rules are crucial to protect investors from getting too caught up in the F&O madness, but will the changes result in Zerodha, Groww, Dhan, Angel One and other discount brokers returning to profitability as many fear?

Let’s try to answer this question by taking a look at the most important stories from our newsroom this week:

• The end of the BharatPe-Ashneer Grover saga? After two years of bad blood, mudslinging and court battles, BharatPe and Ashneer Grover have reached an agreement, but its timing has raised many questions. Was it an agreement or a compromise?
• The valuation game: Prominent investors are now saying that the era of high valuations and unicorns is over for the Indian startup ecosystem and the focus is now on value, not valuation. What explains this change?
• Battle of the Holiday Season: Fast trading has an advantage when it comes to online grocery stores, but can companies like Blinkit, Zepto and others disrupt the festive expectations of Amazon India, Flipkart and Meesho? Here’s the breakdown

Regulatory hit for Zerodha, Groww & Co

As of July this year, discount brokers and investment technology platforms have a lot to worry about, and more major changes are on the way

It started when SEBI decided to ban market infrastructure institutions from offering discounts based on members’ trading volume, effectively hitting the business model of discount brokerage platforms like Zerodha, Groww, Upstox, among others. The move was largely seen as a way to stem the frenzy in the F&O market.

The second failure was brought by the Union Budget, which increased the capital gains tax and the tax on securities transactions. Common sense suggests that retail investors are more likely to think twice about how much they want to invest now.

The latest disruption is due to SEBI’s new regulatory framework for derivatives, which will come into force in November. These changes include weekly expiration of only one index derivative per exchange, upfront collection of option premium from buyers, increase in minimum contract size for index derivatives to INR 15 lakh.

Collectively, these changes have made it somewhat more difficult for platforms to predict investor and trader activity, made it more difficult for them to attract new users, and forced them to look for other sources of revenue to compensate for a potential decline in profits.

Zerodha, Groww and other investment technology platforms that have grown significantly on the back of the F&O boom over the last 18 months will feel the heat.

We’re going into an F&O frenzy

According to SEBI data as of May 2024, equity derivatives and trading and spending volumes on BSE and NSE have witnessed a massive 71% YoY growth to INR 9,504 Lakh Cr.

Continue according to FIA World Trade Monitor data, between April and June 2024, over 36.8 billion stock index options were traded on these two exchanges. This represents 100% year-on-year growth and accounts for two-thirds of all F&O transactions on every exchange worldwide. In other words, India is F&O crazy.

This growth has coincided with a mass of investors using discount brokerage platforms. Groww currently boasts of over 11 million active investors as of May 2024, while Zerodha boasts of 7.8 million as of August 2024. However, these leading platforms view the impact of the new SEBI rules differently.

Last week, for example, Zerodha CEO Kamath said the platform would not change its zero-brokerage model in the structure, even though most industry observers expected the opposite. And a few days later, Zerodha put on a brave face in light of another potential setback with SEBI’s new derivatives framework, claiming that 30% of its futures and options (F&O) orders would be affected.

To put this in context, Zerodha has reported INR 8,320 Cr or approximately $1 billion in revenue for FY24. This is undoubtedly a milestone for the company, but currently, other industry observers believe that the current year (FY25) revenues will decline by 30–50%.

Groww, on the other hand, has distanced itself from F&O as a category. In the past, the company has said that its growth and revenue generation is not highly dependent on F&O trading. During a recent interaction at a media conference, co-founder and CEO Lalit Keshre also said that Groww has a different perspective on investment technology.

“Groww is not an F&O company, but a financial services company. Only 15% of our customers are engaged in trading. Trading is a zero-sum game. Investing is a win-win game. We encourage responsible trade,” Keshre quotes.

Kamath also said that the actual impact of SEBI’s changes in the F&O framework will become clear only in November this year when the regulations come into force. And this could be a big blow to the profitability streak of Groww, Zerodha and others.

Talking about profits, as we reported this week, Groww is likely to see its net profit quadruple in the financial year to Rs 297.8 cr. INR in FY24. Among the startups, Groww is closest to Zerodha, which had a significant lead over the former with a profit of INR 4,700 ($562 million) for FY24. This is despite Groww having significantly more active investors.

As for the other profitable players, Angel One, the discount broking arm of full-service Angel Broking, posted a net profit of INR 1,126 Cr. INR, while Dhan ended FY24 with a handsome profit of Rs 177 cr. INR after only about three years of operation.

As per a report by The Arc, Dhan expects the impact of SEBI changes on gross revenue to be around 25-30%, which would certainly eat into these profits.

Diversification is a game

It’s no wonder that most players want to diversify their sources of income. The clearest example is Groww, which has seen steady growth in its lending business over the past year.

The Bengaluru-based unicorn has also added UPI payments and an asset management company to fully leverage its advantage in terms of active investors.

Groww Creditserv, an NBFC arm, Groww Creditserv’s loan book as on June 30, 2024 stood at INR 965.44 Cr, up 32% from INR 731.1 Cr in the previous quarter. Personal loans accounted for 98% of the total loan portfolio, the rest were durable consumer loans. However, Groww Creditserv is not yet a profitable entity. In FY24, it recorded a loss of INR 24.1 Cr, almost 10 times higher than the loss in FY23.

Some of them, like Upstox, are using scale to start distributing insurance, but it’s not exactly a high-margin play.

Then there is margin trading financing or MTF – where brokers lend money to investors to earn interest income while holding the financed shares as collateral. This is usually an area where banks have a strong presence. However, Groww has entered this space and Zerodha is also considering a launch, according to sources.

Among discount brokers, Mirae Asset-backed Mstock has cracked the MTF formula to some extent and has built a loan book of around INR 2,000 Cr, according to ET, while Angel One also has strong interest in MTF.

Industry insiders believe that MTF can be a lucrative industry for discount brokers because the main target group is wealthy individuals who are naturally more inclined to invest. This could be a way for Groww, Zerodha and others to nullify the revenue impact of SEBI’s stringent new F&O framework.

Despite the benefits, making the most of these new verticals will be a distraction for Zerodha, Groww and others who have become accustomed to consistently generating revenue and profitability.

But it’s also a chance for Groww to turn the tables on Zerodha in terms of revenue, or for other players to emerge as strong contenders. As always, Indian regulators have added a new twist to the fintech game.

Sunday’s roundup: tech stocks, startup financing and more

• Bullish on its IPO, Swiggy will now look to raise a total of $1.4 billion through a public issue, up from the previously planned $1.25 billion, after receiving shareholder approval for the raise
• Ola Electric stock fell below INR 100 in a week amid lingering concerns over profitability and decline in EV market share