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A further estimate upgrade

OTC Markets Group 24 November 2020 Outlook
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OTC Markets Group

A further estimate upgrade

Q320 results and outlook

Financial services

24 November 2020

Price

US$34.60

Market cap

US$404m

Net cash ($m) at 30 September 2020

28.6

Shares in issue

11.7m

Free float

63%

Code

OTCM

Primary exchange

OTCQX

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

11.7

12.6

2.0

Rel (local)

8.2

6.9

(11.3)

52-week high/low

US$35

US$23.0

Business description

OTC Markets Group operates the OTCQX, OTCQB and Pink financial markets for over 11,000 US and global securities. OTC Link LLC, a member of FINRA, operates OTC Link ATS and OTC Link ECN, both SEC-registered Alternative Trading Systems. Approximately 84% of revenues were of a subscription-based recurring nature in 9M20.

Next events

FY20 results

March 2021

Analysts

Andrew Mitchell

+44 (0)20 3681 2500

Martyn King

+44 (0)20 3077 5745

OTC Markets Group is a research client of Edison Investment Research Limited

OTC Markets Group (OTCM) announced third quarter results with revenue and profit ahead of our expectation, as in Q220. This resulted from strong transaction volumes at OTC Link and higher user numbers and price increases for Market Data Licensing. The diversity of the group’s income was evident as Corporate Services was flat year-on-year, although here a step up in client additions is encouraging for the future. Pandemic-related and political uncertainties may be less acute now, but, in any event, OTCM maintains its long-term focus on developing its cost-effective, efficient markets.

Year end

Revenue ($m)

PBT
($m)

EPS*
($)

DPS**
($)

P/E
(x)

Yield
(%)

12/18

59.3

19.8

1.36

1.23

25.4

3.6

12/19

62.8

18.0

1.25

1.25

27.8

3.6

12/20e

68.9

20.2

1.42

1.25

24.4

3.6

12/21e

70.4

21.3

1.44

1.25

24.0

3.6

Note: *Fully diluted and calculated after restricted stock award allocation. **Including special dividends of 65c each year for FY18–21e.

Q320 results: Transaction and data fees drive beat

Group Q320 revenue of $17.7m was up 13% y-o-y and 6% ahead of our estimate. OTC Link revenue was up 28% y-o-y on strong trading volumes, particularly at OTC Link ECN. Market Data Licensing revenue (+18%) was driven by a combination of price increases for, and usage by professional users, together with sharply higher non-professional user numbers. Corporate Services revenue was up just 1% but this was ahead of our estimate following two more difficult quarters for client numbers. Encouragingly, new client additions for both OTCQX and OTCQB markets increased markedly compared with the first and second quarters, although OTCQB still saw a modest net decline in clients in the period. Operating costs increased by 7% allowing pre-tax profit to increase by 15% to $5.4m and net earnings by 11%. A maintained quarterly dividend of $0.15 and a special dividend of $0.65 (the same level as last year) were announced.

Market background and outlook

Looking ahead, we assume trading activity levels will normalise in due course potentially reducing OTC Link revenues. However, the Corporate Services segment is set to benefit from fee increases of over 15% for corporate clients in both its premium markets in FY21 and may also be able to sustain the improvement in client additions seen recently. Market Data Licensing may see a pullback in user numbers, particularly non-professional users, but professional users account for a much larger proportion of revenue and their number tends to be more stable. The business also continues to develop new product offerings.

Valuation

Our EPS estimates are increased by 9% and 16% for FY20 and FY21 respectively. OTCM’s prospective P/E multiples remain below peers, while our DCF valuation increases from $30.40 to $35.00 reflecting the higher estimates.

Cost-effective transparent markets

The purchase of the National Quotation Bureau (NQB) by CEO R Cromwell Coulson and a group of investors in 1997 began the process that led to the creation of OTCM in its current form. NQB, with a history dating back to 1913, published the Pink Sheets, a printed list of broker-dealer quotes for securities traded off-exchange. Following the purchase, the new management team progressively applied technology to the task of aggregating liquidity and increasing transparency in this over-the-counter market.

A platform providing real-time quotes was launched in 2003 and evolved into the current SEC-registered alternative trading system, OTC Link ATS. Another platform, OTC Link ECN, was launched in 2017, providing dealers with complementary features including an anonymous order-matching engine with an order routing capability – as opposed to OTC Link ATS, where attributable quotes are displayed and messages delivered, enabling direct trades between dealers. OTC Link ATS carries quotes in more than 11,000 companies and has 82 active broker-dealer participants, while OTC Link ECN has expanded its subscriber base and trading volumes rapidly since launch; at end September it had 69 subscribers, an increase of 22 over 12 months.

In order to help investors assess risk exposure, OTCM organises the companies on its markets into tiers, with membership of each subject to the adequacy and timeliness of disclosure, financial criteria and adherence to governance standards:

OTCQX Best Market companies meet high financial standards, have recognised corporate governance standards and provide timely public disclosure.

OTCQB Venture Market is intended to provide a public trading facility for developing companies that meet standards promoting price transparency and public disclosure. OTCQB companies must remain current in their disclosure and provide additional information for investors.

The Pink Open Market comprises those companies quoted on the OTC Link ATS that do not meet the standards of, or choose not to apply for, the premium markets. To help give some differentiation within this market, companies are further categorised into Pink Current Information, Pink Limited Information and Pink No Information.

From the point of view of corporates, OTCM’s premium markets, OTCQX and OTCQB, provide access to public trading in the US at a cost-effective price, compared with a listing on a registered national securities exchange such as Nasdaq. As shown in the charts below, both OTCQX and OTCQB have a substantial number of international corporate clients, notably from Canada.

Exhibit 1: OTCQX Composite Index constituents

Exhibit 2: OTCQB Venture Index constituents

Source: OTCM. Note: % of 383 constituents 28/10/20
(441 companies on OTCQX at end September 2020).

Source: OTCM. Note: % of 723 constituents 28/10/20
(874 companies on OTCQB at end September 2020).

Exhibit 1: OTCQX Composite Index constituents

Source: OTCM. Note: % of 383 constituents 28/10/20
(441 companies on OTCQX at end September 2020).

Exhibit 2: OTCQB Venture Index constituents

Source: OTCM. Note: % of 723 constituents 28/10/20
(874 companies on OTCQB at end September 2020).

The group’s activities are organised in three divisions: OTC Link (trading services), Market Data Licensing and Corporate Services (OTCQX, OTCQB and other services), which in 9M20 accounted for 21%, 40% and 39% of gross revenues respectively. Exhibit 3 sets out examples of how revenues are generated within each division.

While OTC Link revenues are largely transaction-related, subscription-based revenues feature in many activities and for 9M20 subscription-based revenues accounted for 84% of the group total providing a measure of revenue resilience against the background of equity market volume fluctuations. The diversification of revenue streams is also helpful in this respect; in the current year the pandemic initially created difficult conditions for recruiting corporate clients while market volatility caused a jump in transaction levels for OTC Link. It may be that a normalisation of trading activity in due course will coincide with an improving macroeconomic outlook and hence a stronger period in Corporate Services.

Exhibit 3: Revenue generation, examples by division

Segment

Comments

OTC Link

OTC Link ATS

Broker-dealers pay subscriptions and usage fees related to the number of quotes and messaging volume.

OTC Link ECN

Fees are transaction-based with rebates for liquidity provision (maker-taker structure).

Market Data Licensing

Users subscribe to licences for market data, compliance data, company data, and security information collected by OTC Link and Corporate Services. Users include investors, traders, institutions, accountants and regulators. Most market data are sold through distributors such as Bloomberg, to which rebates (c 10%) are paid.

Corporate Services

OTCQX, OTCQB

Corporates pay application and annual or semi-annual subscription fees.

Other

The OTC Disclosure & News Service and Virtual Investor Conferences revenues are usage dependent.

Segment

OTC Link

OTC Link ATS

OTC Link ECN

Market Data Licensing

Corporate Services

OTCQX, OTCQB

Other

Comments

Broker-dealers pay subscriptions and usage fees related to the number of quotes and messaging volume.

Fees are transaction-based with rebates for liquidity provision (maker-taker structure).

Users subscribe to licences for market data, compliance data, company data, and security information collected by OTC Link and Corporate Services. Users include investors, traders, institutions, accountants and regulators. Most market data are sold through distributors such as Bloomberg, to which rebates (c 10%) are paid.

Corporates pay application and annual or semi-annual subscription fees.

The OTC Disclosure & News Service and Virtual Investor Conferences revenues are usage dependent.

Source: OTCM, Edison Investment Research

Exhibit 4 shows the long-term development of OTCM’s gross revenue by division and its operating margin. Total gross revenue grew at a compound annual rate of 11% between 2009 and 2019. Within this, Corporate Services has contributed the fastest growth at 25%, mainly as a result of the development of the premium OTCQX and OTCQB markets both in terms of the number of corporate clients subscribing and the level of fees charged. Market Data Licensing CAGR was 9% and OTC Link 2%.

The operating margin increased significantly between 2013 and 2015 as the scale of the business grew, but was then flat between 2015 and 2018 as investment was made in people and systems to support sustainable growth in the business. 2019 saw further investment in staff and IT infrastructure together with a move to a new office in New York, resulting in a reduction in margin. The current year has seen a small increase in margin.

Exhibit 4: Gross revenue and operating margin since 2009

Source: OTCM. Note: *9M20 annualised, actual revenue $51.5m.

Strategy: Consistent focus on better informed and more efficient markets

OTCM management takes a long-term view of the development of the business and has a consistent mission statement, which is to create better informed and more efficient markets. Flowing from this is a threefold strategy set out as follows:

Share information widely through open networks that foster transparency.

Connect broker-dealers, organise markets and inform investors.

Deliver elegant, reliable and cost-effective, subscription-based technology solutions.

This focus has contributed to the long-term growth in the group set out above and the goals appear to fit well with the requirements of corporates, investors, broker-dealers and regulators involved in the OTC market.

On acquisitions, OTCM has been clear that it is not seeking a high-risk transformative transaction but continues to monitor opportunities for purchases that will provide complementary capabilities. An example is the acquisition of certain assets of Virtual Investor Conferences in January 2019, which has been developed with further investment and has seen strong demand in the current year when in-person meetings have not been possible. The business arranged 19 virtual conferences in 9M20 involving 232 companies and reaching over 18,000 investors.

OTCM continues to work towards further regulatory recognition for its two premium markets, including extending the list of states that grant exemptions under state Blue Sky laws governing secondary trading. The list currently includes 37 states for OTCQX and 33 for OTCQB giving population coverage of nearly 58% and over 53%, respectively. Blue Sky recognition is not directly linked to revenue generation but progress towards 100% coverage should be increasingly positive reputationally, helping to attract a broader range of corporate clients to OTCM’s premium markets. OTCM is also seeking recognition for OTC securities on its OTCQX and OTCQB markets for the purposes of federal regulations dealing with margin eligibility and employee stock ownership plans (an ESOP Fairness Act has been introduced in the House and Senate this year).

Q320 analysis

A summary of third quarter profit and loss figures is given in Exhibit 5 including Q220 and Q319 for comparison. We pick out key points below (comparisons are year-on-year unless stated).

Gross revenue at $17.7m increased by 13% following the 9% y-o-y increase recorded in the second quarter. The largest percentage increase was in OTC Link (+28%) reflecting heightened levels of equity trading resulting from market volatility and increased market share. Market Data Licensing contributed the largest absolute increase ($1.1m or +18%) as a result of increased numbers of data users and price increases implemented at the beginning of the year. Having seen a small year-on-year decline in the second quarter, Corporate Services recorded a small increase helped by strong demand for virtual events from Virtual Investor Conferences (VIC).

Redistribution fees (+14%) increased with higher data user numbers while transaction-based expenses (liquidity-provider payments), linked to the OTC Link ECN business, jumped with the activity level on this platform (+180%).

Operating expenses (before depreciation and amortisation) increased by 7%, mainly reflecting salary and headcount increases (see Exhibit 5 and discussion below for further detail).

As a result, income from operations and pre-tax profit were up 16% and 15% respectively. A return towards a more normal effective tax rate (at 18%) left earnings per share up 12% to $0.37.

A maintained quarterly dividend of $0.15 and a special dividend of $0.65 (at the same level as last year) were announced.

Exhibit 5: Q320 results summary

$000s unless stated

Q319

Q220

Q320

y-o-y % change

q-o-q % change

OTC Link

2,989

3,659

3,816

28

4

Market Data Licensing

6,085

6,858

7,172

18

5

Corporate Services

6,682

6,582

6,759

1

3

Gross revenues

15,756

17,099

17,747

13

4

Re-distribution fees and rebates

(602)

(706)

(689)

14

(2)

Net revenue

15,154

16,393

17,058

13

4

Transaction-based expenses

(219)

(607)

(614)

180

1

Revenues less transaction-based expenses

14,935

15,786

16,444

10

4

Operating expenses (exc depreciation and amortisation)

(9,827)

(10,579)

(10,525)

7

(1)

Depreciation and amortisation

(384)

(415)

(441)

15

6

Income from operations

4,724

4,792

5,478

16

14

Other income / net interest

26

10

(35)

Income before provision for income taxes

4,750

4,802

5,443

15

13

Taxes

(730)

(571)

(984)

35

72

Net income

4,020

4,231

4,459

11

5

Diluted EPS ($)

0.34

0.36

0.37

12

5

Operating margin (%)

31.2

29.2

32.1

Tax rate (%)

15.4

11.9

18.1

Source: OTCM, Edison Investment Research

Exhibit 6 sets out an indicative subdivisional analysis of gross revenue based on management commentary in Q320 and Q319 reports. Within OTC Link this shows the scale of the increase in revenue for OTC Link ECN resulting both from the volatility in equity markets and a continued increase in the number of broker dealer participants. In Market Data Licensing the revenue increase for professional user licences was the main absolute contributor to growth. Non-professional users saw a dramatic 64% increase in number, but because these subscriptions are at a much lower price point the absolute contribution to growth was more modest. The Corporate Services numbers show modest reductions for both OTCQX and OTCQB revenues, reflecting the lower average number of company clients after a challenging period for new client signings (see Background and outlook section for further discussion). Virtual events (VIC) recorded very strong growth and other services also contributed to growth.

Exhibit 6: Indicative subdivisional revenue analysis

$000

Q319

Q320

Change

Change %

Comments

OTC Link

OTC Link ECN

424

1,098

674

159%

Elevated market volatility and subscribers up from 47 to 69

OTC Link ATS and other services

2,565

2,718

153

6%

Fewer broker dealers but messaging up with market volumes

2,989

3,816

827

28%

Market Data Licensing

Professional user licence subscriptions

606

Price increase from 1 January plus 7% increase in users. Accounted for c 54% of segment H120

Non-professional users

419

687

268

64%

Users up 45% reflecting volatility and trend to higher retail participation. 10% of segment

Other

213

Compliance and other data services. c 35% of segment

6,085

7,172

1,087

18%

Corporate Services

OTCQX

2,342

2,304

(37)

-2%

Average number of companies slightly lower

OTCQB

2,860

2,747

(113)

-4%

Average number of companies was 4% lower

Virtual Investor Conferences

61

172

111

183%

Strong demand for virtual events

Other

1,420

1,536

116

8%

Disclosure & News Service price increase and higher activity at News Release service

6,682

6,759

77

1%

Source: OTCM, Edison Investment Research. Note: Subdivisional absolute numbers are nearly all calculated from absolute and percentage changes given in both the Q319 and Q320 reports and are therefore approximate.

Our next table summarises the change in operating expenses with commentary on the year-o-year changes. As noted above, the main contributor to overall expense growth was staff costs. Other points to highlight are that IT costs were flat as prior year one-off costs dropped out balancing ongoing investment in security and other areas, while occupancy costs were inflated in this quarter by the retroactive billing of certain costs.

Exhibit 7: Analysis of operating expenses

$000s unless stated

Q319

Q220

Q320

Absolute change y-o-y

% change y-o-y

Comments on y-o-y change

Compensation and benefits

6,533

7,380

7,052

519

7.9

Headcount and salary increases + higher commissions related to OTCQX and OTCQB sales

IT Infrastructure and information services

1,650

1,560

1,642

(8)

(0.5)

One-off data centre costs dropped out and lower costs following office move offset investment in security and support for ECN and new product

Professional and consulting fees

489

725

586

97

19.8

Higher ECN clearing costs with volume + support costs for VIC business

Marketing and advertising

256

167

138

(118)

(46.1)

Lower travel and entertainment spend

Occupancy costs

569

534

877

308

54.1

Certain building charges retroactively billed by sublandlord in Q320

Depreciation and amortisation

384

415

441

57

14.8

Higher following acquisition of Qaravan, investment related to new HQ and in two data centres

General, administration and other

330

213

230

(100)

(30.3)

Project management costs incurred in 2019 dropped out

Total

10,211

10,994

10,966

755

7.4

Source: OTC Markets Group, Edison Investment Research

Exhibit 8 shows changes in operating data and related revenue data. Under OTC Link the dollar volume of trades was higher year-on-year in each market segment as equity market volatility continued. Sequentially, OTCQB, which had been relatively subdued in Q220, showed a marked pickup in activity, while OTCQX and Pink retreated somewhat from their peak levels probably reflecting sectoral rotation as investors sought to adjust to changing expectations. The number of OTC Link ATS participants saw a further decline but ECN subscribers continued to increase.

Corporate Services figures show sequential and year-on-year increases in OTCQX clients while OTCQB saw a further modest erosion, albeit the rate of new client additions increased significantly (see Exhibit 14 in next section).

For Market Data Licensing the salient feature is the 45% y-o-y jump in non-professional subscribers. OTCM has consistently noted that these subscriber numbers have been much more volatile than the professional subscribers, so it remains to be seen what level will be retained when equity market trading activity normalises. Positively, there has been a longer-term trend for higher retail involvement in the equity market with factors cited by OTCM including robo-investing platforms, fractional trading and zero trading commissions so some portion of the new subscribers may prove sticky. As noted earlier, the larger impact on segment revenues has been the more modest increase in professional users (and price increases).

Exhibit 8: Operating and related revenue data

Q319

Q220

Q320

% change y-o-y

% change q-o-q

OTC Link

Dollar volume traded (millions)

OTCQX

15,277

18,807

17,021

11.4

(9.5)

OTCQB

6,256

5,814

6,942

11.0

19.4

Pink

60,931

82,380

69,988

14.9

(15.0)

Number of securities quoted

10,609

11,336

11,381

7.3

0.4

Number of active ATS participants

90

85

82

(8.9)

(3.5)

Number of ECN subscribers

47

64

69

46.8

7.8

New form 211 filings

77

64

69

(10.4)

7.8

Revenue per security quoted ($)

282

323

335

19.0

3.9

Corporate Services

Number of corporate clients (period end)

OTCQX

436

415

441

1.1

6.3

OTCQB

915

885

874

(4.5)

(1.2)

Pink

749

690

722

(3.6)

4.6

Total

2,100

1,990

2,037

(3.0)

2.4

Revenue per client ($)

3,194

3,303

3,357

5.1

1.6

Graduates to a national securities exchange

14

9

19

35.7

111.1

Market Data Licensing

Market data professional users

21,446

22,533

22,926

6.9

1.7

Market data non-professional users

13,892

16,545

20,102

44.7

21.5

Revenue per terminal (total - $)

172

175

167

(3.2)

(5.0)

Market data compliance file users

38

44

44

15.8

0.0

Source: OTCM, Edison Investment Research

Regulatory developments

Among the regulatory developments highlighted by OTCM in its quarterly report are the SEC’s final rule amending Exchange Act Rule 15c2-11 (26 September) and Consolidated Audit Trail obligations. Rule 15c2-11 deals with information requirements before quotes may be published on interdealer quotation systems such as OTC Link ATS. Positively, the amended rule recognises OTCM markets’ disclosure standards and OTC Link ATS will be permitted to act as a qualified IDQS (interdealer quotation system) reviewing disclosure to determine whether a security is eligible for public quoting. This will enable it to streamline onboarding of securities to OTCM’s markets, removing the risk and administrative burden of certifying the suitability of securities for quotation from broker dealers, which in turn will allow them to focus on their financial advisory role. For companies that do not meet the information requirements there is the potential for an expert market exemption allowing sophisticated or professional investors to continue to trade in the securities. OTCM has already established an Expert Market and is continuing to engage with the SEC with the aim of refining implementation of the amended rule to provide well-informed markets for its corporate clients, broker dealers and investors. The group expects to invest significantly (at a level yet to be determined) in technology and personnel to comply with the rule ahead of the 26 September 2021 deadline.

The initial phase of Consolidated Audit Trail (CAT) obligations for OTC trading began in June 2020 with subsequent obligations taking effect in 2021. The prospective costs for firms such as OTC Link LLC and other FINRA broker dealer members to fund the database of trading activity have yet to be established and there are also costs involved in building the capability to submit trade reports to meet CAT requirements.

Otherwise OTCM continues to work towards increasing regulatory recognition for its markets including the number of states granting Blue Sky recognitions for OTCQX and OTCQB (unchanged in Q320).

Background and outlook

We start with a table of recent equity market index performance. Strikingly, after a period of accentuated volatility, most indices over most of the periods shown are in positive territory, with the bounce since the initial onset of the pandemic particularly evident in the six-month figures.

Exhibit 9: Recent market index performance (total return %)

Period

S&P 500

Nasdaq Composite

OTCQX Composite

OTCQB

Venture

S&P TSX
Venture

US$

US$

US$

US$

C$

3 months

5.5

5.4

20.1

1.5

0.2

6 months

20.8

27.0

32.4

24.5

38.8

1 year

16.6

40.4

16.0

-3.3

41.7

Year to date

11.9

33.3

17.2

0.8

28.5

Source: Bloomberg. Note: Priced on 23 November 2020.

In Exhibit 10 we show the readings from State Street Investor Confidence Index from just before the global financial crisis in 2008/2009. This indicator tracks changes in institutional investor holdings of risky versus safer investments. On this measure, the level of confidence bounced following the financial crisis, later peaking in 2015 then declining to a lower level in 2018/19 coinciding with global trade tensions followed by the pandemic this year. Confidence did recover quite sharply following the initial onset of the pandemic but, as can be seen, the latest readings suggest greater caution and do not capture more encouraging recent news relating to vaccines that may curtail the impact of COVID-19.

Exhibit 10: State Street Investor Confidence Index

Source: Bloomberg, State Street

Another indicator of the environment for corporate decision-making is the Economic Policy Uncertainty Index shown below. The index component selected here reflects daily newspaper coverage related to economic uncertainty and shows the substantial impact of the pandemic compared with the global financial crisis, for instance. Reflecting the nature of its compilation, the index does show a more severe spike with the arrival of the pandemic and more marked subsequent easing than the investor confidence index but remains at elevated levels.

Exhibit 11: Economic Policy Uncertainty Index (newspaper-based, five-day rolling average)

Source: 'Measuring Economic Policy Uncertainty' by Scott Baker, Nicholas Bloom and Steven J. Davis at www.PolicyUncertainty.com.

Next, we show the trends in numbers of IPOs on the Nasdaq, TSX and TSX Venture exchanges. For Q320 the number of IPOs on Nasdaq bounced strongly (Exhibit 12), up 156% y-o-y compared with 27% and 30% y-o-y reductions for the first and second quarters respectively. TSX IPOs to end October were up 37% while in contrast the TSX Venture exchange saw a 48% drop in IPOs; in terms of IPO money raised both were strongly up yearonyear: +392% and +278% respectively. While the number of IPOs in the higher risk TSX Venture market was down, the positive trend in other data suggests an appetite among corporates and investors to take opportunities and look beyond the pandemic and other current market uncertainties.

Exhibit 12: Nasdaq – number of IPOs

Exhibit 13: TSX and TSX Venture – number of IPOs

Source: Nasdaq

Source: TMX

Exhibit 12: Nasdaq – number of IPOs

Source: Nasdaq

Exhibit 13: TSX and TSX Venture – number of IPOs

Source: TMX

We highlighted earlier the increase in the number of corporate client additions for both OTCQX and OTCQB in Q320. For OTCQX there were 44 additions in the third quarter compared with nine and 19 in Q120 and Q220. The net increase in Q320 was 26 to 441 (see earlier Exhibit 8). OTCQX renewals are annual on a calendar year basis.

Exhibit 14 sets out the figures behind the downtrend in OTCB client numbers in recent quarters. Looking at the current year, the number of new additions was particularly depressed in the first quarter, as would be expected, but has improved in the second and third quarters. OTCQB client renewal is annual or semi-annual, based on when companies originally signed contracts, and renewals are spread broadly evenly between quarters. The level of voluntary non-renewals was lower in Q320 (c 3%) and has averaged 5% for 9M20 compared with 6% in FY19. Other departures, including compliance downgrades (which help protect the quality of the market), were at a higher rate in Q320 (c 7%) but the 9M20 rate (5%) was only slightly above the FY19 level.

Exhibit 14: OTCQB corporate client evolution

Q119

Q219

Q319

Q419

Q120

Q220

Q320

Start

934

941

916

915

907

893

885

Additions

68

38

53

43

28

45

62

Voluntary non-renewal

(15)

(15)

(14)

(14)

(14)

(17)

(7)

Other (compliance downgrades, other)

(46)

(48)

(40)

(37)

(28)

(36)

(66)

End

941

916

915

907

893

885

874

Net change

7

(25)

(1)

(8)

(14)

(8)

(11)

Source: OTCM, Edison Investment Research. Note: Start, end and additions (new sales) figures are reported while voluntary non-renewal figures are based on indicated percentages and the compliance downgrade and other figure is a residual.

Beyond the third quarter, OTCM reports that the trends have been encouraging with OTCQB seeing net client additions in both September and October, while there are good pipelines for both OTCQX and OTCQB and high levels of issuer engagement, including international companies. It remains to be seen whether the market background allows this positive trend to continue into 2021 but Q420 appears to have started well.

A positive factor for Corporate Services revenue in 2021 will be annual/semi-annual fee increases for OTCQX and OTCQB of between 15% and 16.7% for companies renewing from January onwards. These are the first increases since 2016 for OTCQX and 2018 for OTCQB. The effect will be immediate for OTCQX but phased for OTCQB with the full benefit seen in 2022 given the incidence of renewals.

Turning to OTC Link, the group indicated that trading levels have continued at very high levels into October and November. Looking further ahead, it seems reasonable to expect a moderation of market volatility and trading activity. OTC Link ECN should nevertheless still benefit from its enlarged subscriber base.

Market Data and Licensing should continue to benefit in the fourth quarter from price increases introduced this year and beyond this from the increased subscriber numbers reported. The subscription-based nature of revenues provides resilience although, in the event of a longer-term economic downturn, subscription numbers could contract again for a period. Compliance data has been an area of growth within the division but OTCM believes it has captured a large part of the available market. Nevertheless, new introductions such as the Blue Sky Data Product, launched in September, should help broaden the market opportunity (the product provides compliance data on 16,000 OTC equity and 80,000 OTC fixed income securities).

Financials

Key figures from our revised estimates are shown in Exhibit 15 and further detail is given in the financial summary (Exhibit 18). For FY20 our revenue estimate is increased by 3% with similar increases for each division. For FY21, where our revenue estimate is increased by 5%, the main change has been an increase in Corporate Services to allow for the fee increases announced in September and also an assumption of a more favourable trend in corporate client additions. As before, we factor in some normalisation of equity market trading activity levels, assuming that OTC Link FY21 revenues are 10% lower than our FY20 estimate. With expense assumptions little changed, our diluted EPS estimates for FY20 and FY21 increase by 9% and 16% respectively.

We note that although there is currently more positive news on potential vaccines for COVID-19, the development of the pandemic and its economic ramifications remain uncertain. Our FY21 estimate would be likely to prove optimistic were a more sustained economic downturn to emerge in place of the recovery consensus expectations point to.

Exhibit 15: Estimate revisions

 

Gross revenue ($m)

PBT ($m)

Diluted EPS ($)

Dividend ($)

 

Old

New

Change (%)

Old

New

Change (%)

Old

New

Change (%)

Old

New

Change (%)

2020e

66.9

68.9

3.0

18.6

20.2

8.4

1.30

1.42

8.6

1.25

1.25

0.0

2021e

67.2

70.4

4.8

18.4

21.3

15.5

1.25

1.44

15.7

1.25

1.25

0.0

Source: Edison Investment Research. Note: Dividends include the special dividend of 65c announced for FY20 and estimated for FY21.

OTCM’s balance sheet remains strong with no debt and cash of $28.6m or $30.2m including restricted cash. Operating cash flow for the first nine months of 2020 (9M20) was $10.3m of which $0.9m was allocated to capital expenditure (IT infrastructure), $5.2m dividends and $3.5m purchases of treasury stock. In addition to the cash held OTCM has an undrawn line of credit of up to $1.5m available.

Sensitivities: Macro, regulatory and IT resilience

From a macro perspective, the economic background will have a positive or negative influence on equity market trends, including investor sentiment towards international and venture equities, the flow of venture company IPOs, corporate interest in accessing liquidity in the US market, and volatility and trading volumes.

Regulation can have a positive or negative influence. For example, regulations facilitating online capital raising are expected to increase the pool of potential clients for OTCM and the amendment of rule 15c2-11 may speed the onboarding of securities to OTCM’s markets, while Regulation Systems, Compliance and Integrity (SCI) requires ongoing technology investment to ensure compliance and introduction of the Consolidated Audit Trail will also entail additional costs.

Reliability of the group’s IT systems is also important from a reputational perspective and OTC Link ATS has established a strong record of uptime in its core systems.

Competition for corporate clients comes from national securities exchanges and could increase if they were allowed to become specialised venture exchanges. For trading, competition includes Global OTC (ICE subsidiary) and direct trading between dealers.

Valuation

We have updated our comparative P/E table in Exhibit 16. This includes information providers MSCI and Markit together with the average multiples for global exchanges. OTCM shares are trading on prospective P/Es below the average for exchanges and noticeably below those for information providers. To some extent the discount can be attributed to the relative illiquidity of OTCM shares and to its exposure to smaller companies through its venture market. Positively, the group is financially strong and has a high proportion of subscription-based revenues.

Exhibit 16: OTCM comparative multiples

P/E ratios (x)

2020e

2021e

MSCI

51.4

47.4

Markit

32.7

28.7

Average information providers

42.0

38.0

Average global exchanges

26.9

25.6

OTCM

24.4

24.0

Source: Refinitiv, Edison Investment Research. Note: Prices at 23 November 2020.

The sensitivity of our discounted cash flow valuation to different discount rates and long-term growth assumptions is shown in the next table. The model factors in our increased explicit forecasts for FY20/21, together with an assumption of FY22–23 cash flow growth of 8%, long-term growth of 4% and a terminal cash flow multiple of 16x. At a discount rate of 10% these assumptions give a value of $35.00 per share ($30.40 previously but with 12% growth FY22–23 from a lower base).

Exhibit 17: Discounted cash flow valuation sensitivity ($ per share)

Discount rate (right)
2024–30e growth

8%

9%

10%

11%

12%

3%

38.2

35.7

33.5

31.5

29.6

4%

39.9

37.3

35.0

32.8

30.8

5%

41.8

39.0

36.5

34.2

32.1

6%

43.7

40.8

38.1

35.7

33.5

Source: Edison Investment Research

Exhibit 18: Financial summary

$000s

2016

2017

2018

2019

2020e

2021e

Year end 31 December

PROFIT & LOSS

OTC Link

10,573

10,074

11,175

11,676

14,245

12,820

Market Data Licensing

21,054

21,922

23,384

24,447

27,967

28,247

Corporate Services

19,254

22,660

24,719

26,716

26,716

29,302

Revenue

50,881

54,656

59,278

62,839

68,928

70,369

Re-distribution fees and rebates

(2,317)

(2,480)

(2,448)

(2,489)

(2,815)

(2,825)

Net revenue

48,564

52,176

56,830

60,350

66,113

67,544

Transaction-based expenses

0

0

(375)

(746)

(2,176)

(1,667)

Revenues less transaction-based expenses

48,564

52,176

56,455

59,604

63,936

65,878

Operating expenses

(30,032)

(32,511)

(35,768)

(40,230)

(42,047)

(42,886)

EBITDA

18,532

19,665

20,687

19,374

21,889

22,991

Depreciation

(1,606)

(1,361)

(1,042)

(1,492)

(1,710)

(1,727)

Operating profit

16,926

18,304

19,645

17,882

20,179

21,264

Net interest

9

47

116

103

0

40

Profit Before Tax

16,935

18,351

19,761

17,985

20,179

21,304

Tax

(6,407)

(5,792)

(3,524)

(3,043)

(3,232)

(4,048)

Profit after tax

10,528

12,559

16,237

14,942

16,948

17,257

Profit after tax and allocation to RSAs

10,252

12,241

15,840

14,588

16,594

16,903

Average Number of Shares Outstanding (m)

11.3

11.6

11.6

11.7

11.7

11.7

EPS - basic (c)

92.4

109.9

140.8

128.4

145.7

148.3

Fully diluted EPS (c)

90.4

105.8

136.3

124.7

141.5

144.1

Dividend per share (c)

116.0

116.0

123.0

125.0

125.0

125.0

EBITDA Margin (%)

38

38

36

32

33

34

Operating profit margin (%)

35

35

35

30

31

31

BALANCE SHEET

Non-current assets

 

 

 

 

 

 

Intangible assets

291

362

312

291

247

174

Property and other

3,267

3,506

4,584

25,034

22,800

22,446

Current assets

 

 

 

 

 

 

Debtors

6,262

6,450

4,942

5,157

5,802

5,802

Cash & cash investments

25,034

23,683

28,813

28,217

29,464

36,542

Other current assets

1,789

2,316

2,998

1,656

1,985

1,985

Current liabilities

 

 

 

 

 

 

Deferred revenues

(14,664)

(15,531)

(16,070)

(15,815)

(15,815)

(17,346)

Other current liabilities

(5,372)

(5,644)

(6,711)

(9,574)

(9,673)

(9,673)

Long-term liabilities

 

 

 

 

 

 

Tax, rent and other

(1,101)

(1,351)

(2,459)

(17,293)

(15,465)

(15,465)

Net assets

15,506

13,791

16,409

17,673

19,345

24,465

NAV per share ($)

1.36

1.21

1.42

1.52

1.66

2.10

CASH FLOW

Operating cash flow

21,752

21,629

24,442

23,044

24,787

26,972

Net Interest

9

47

116

103

0

40

Tax

(6,021)

(5,193)

(1,968)

(1,734)

(4,014)

(4,048)

Capex / intangible investment

(415)

(1,165)

(549)

(5,516)

(1,184)

(1,300)

Financing / investments

(1,157)

(3,407)

(2,716)

(1,933)

(3,760)

0

Dividends

(13,059)

(13,262)

(14,195)

(14,560)

(14,582)

(14,587)

Net cash flow

1,109

(1,351)

5,130

(596)

1,247

7,077

Opening net (debt)/cash

23,925

25,034

23,683

28,813

28,217

29,464

Closing net (debt)/cash

25,034

23,683

28,813

28,217

29,464

36,542

Cash and restricted cash

25,244

24,375

30,534

29,778

31,025

38,103

Source: OTC Markets Group annual reports, Edison Investment Research

Contact details

Revenue by geography (2019)

300 Vesey Street
12th Floor
New York, NY 10282
US
+1 (212) 896-4400
www.otcmarkets.com

Contact details

300 Vesey Street
12th Floor
New York, NY 10282
US
+1 (212) 896-4400
www.otcmarkets.com

Revenue by geography (2019)

Management team

Chairman: Neal Wolkoff

CEO, president, director: R Cromwell Coulson

Neal Wolkoff is a former executive of three exchanges (including being former chairman and CEO of AMEX and an executive officer at NYMEX). He is a consultant and attorney focusing on futures and securities markets, exchanges, market regulation, operations and clearing houses.

In 1997, Cromwell led a group of investors in acquiring OTCM’s predecessor business, the National Quotation Bureau (NQB). He is responsible for the group’s overall growth and strategic direction. Prior to OTCM, Cromwell was an institutional trader and portfolio manager in distressed and value-oriented investments.

EVP Market Data: Matthew Fuchs

EVP Issuer and Information Services: Lisabeth Heese

Matthew Fuchs is responsible for product development, distribution and sales of market data. Prior to OTC Markets he held a number of financial technology roles at National Research Exchange, Bearing Point and Arthur Anderson.

Lisabeth Heese joined OTC Markets in 2004 as director of Issuer and Information Services subsequently building a team responsible for collecting and maintaining corporate and securities data for over 10,000 companies. Prior to OTCM she spent 11 years at Nasdaq as a product manager.

President OTC Link LLC: Michael Modeski

Chief Financial Officer: Beatrice (Bea) Ordonez

Michael Modeski joined OTCM in 2011. He has over 15 years’ experience in the financial markets with a focus on OTC markets. Previous roles include director of broker-dealer execution services and sales at Citigroup, director of execution services at Lava Technology (Citigroup), director of OTC equities at FINRA and several management positions at Pershing.

Bea Ordonez joined OTCM as CFO in 2015. She has more than 20 years of experience in the financial services industry including 13 years as COO and MD at Convergex, a global brokerage and trading-related services provider. She is a qualified chartered accountant (ICAEW) and worked at Arthur Andersen and PwC.

Chief Technology Officer: Bruce Ostrover

Director, OTCM Intl and EVP Corporate Services: Jason Paltrowitz

Bruce Ostrover joined OTCM in 2017 as CTO. He has over 30 years’ experience in the financial services industry with a focus on software development and project management. Before OTCM he served as managing director at Convergex, was a founding partner in a consulting firm and held senior IT roles in the financial services sector.

Jason Paltrowitz joined OTCM in 2013 and manages the group’s international and domestic Corporate Services business, supporting companies that trade on the OTCQX and OTCQB markets. His previous experience includes a range of senior management roles at JP Morgan Chase and BNY Mellon.

General Counsel: Dan Zinn

Dan Zinn joined OTCM in 2010 and is the group’s general counsel and corporate secretary. He leads the company’s regulatory and policy making efforts. Prior to joining OTCM, he was a partner at The Nelson Law Firm, LLC, and was outside counsel to the company. Dan previously worked in the corporate office of the American International Group (AIG).

Management team

Chairman: Neal Wolkoff

Neal Wolkoff is a former executive of three exchanges (including being former chairman and CEO of AMEX and an executive officer at NYMEX). He is a consultant and attorney focusing on futures and securities markets, exchanges, market regulation, operations and clearing houses.

CEO, president, director: R Cromwell Coulson

In 1997, Cromwell led a group of investors in acquiring OTCM’s predecessor business, the National Quotation Bureau (NQB). He is responsible for the group’s overall growth and strategic direction. Prior to OTCM, Cromwell was an institutional trader and portfolio manager in distressed and value-oriented investments.

EVP Market Data: Matthew Fuchs

Matthew Fuchs is responsible for product development, distribution and sales of market data. Prior to OTC Markets he held a number of financial technology roles at National Research Exchange, Bearing Point and Arthur Anderson.

EVP Issuer and Information Services: Lisabeth Heese

Lisabeth Heese joined OTC Markets in 2004 as director of Issuer and Information Services subsequently building a team responsible for collecting and maintaining corporate and securities data for over 10,000 companies. Prior to OTCM she spent 11 years at Nasdaq as a product manager.

President OTC Link LLC: Michael Modeski

Michael Modeski joined OTCM in 2011. He has over 15 years’ experience in the financial markets with a focus on OTC markets. Previous roles include director of broker-dealer execution services and sales at Citigroup, director of execution services at Lava Technology (Citigroup), director of OTC equities at FINRA and several management positions at Pershing.

Chief Financial Officer: Beatrice (Bea) Ordonez

Bea Ordonez joined OTCM as CFO in 2015. She has more than 20 years of experience in the financial services industry including 13 years as COO and MD at Convergex, a global brokerage and trading-related services provider. She is a qualified chartered accountant (ICAEW) and worked at Arthur Andersen and PwC.

Chief Technology Officer: Bruce Ostrover

Bruce Ostrover joined OTCM in 2017 as CTO. He has over 30 years’ experience in the financial services industry with a focus on software development and project management. Before OTCM he served as managing director at Convergex, was a founding partner in a consulting firm and held senior IT roles in the financial services sector.

Director, OTCM Intl and EVP Corporate Services: Jason Paltrowitz

Jason Paltrowitz joined OTCM in 2013 and manages the group’s international and domestic Corporate Services business, supporting companies that trade on the OTCQX and OTCQB markets. His previous experience includes a range of senior management roles at JP Morgan Chase and BNY Mellon.

Dan Zinn joined OTCM in 2010 and is the group’s general counsel and corporate secretary. He leads the company’s regulatory and policy making efforts. Prior to joining OTCM, he was a partner at The Nelson Law Firm, LLC, and was outside counsel to the company. Dan previously worked in the corporate office of the American International Group (AIG).

General Counsel: Dan Zinn

Principal shareholders (source: 2019 annual report and Bloomberg)

(%)

Officers and directors

36.8

Including R Cromwell Coulson

30.0

Cromwell Coulson Family 2012 DE Trust

5.9

T Rowe Price

4.2

ODIN Forvaltning

1.3

Horizon Kinetics

1.0


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1185 Avenue of the Americas

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Level 4, Office 1205

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This report has been commissioned by OTC Markets Group and prepared and issued by Edison, in consideration of a fee payable by OTC Markets Group. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

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Frankfurt +49 (0)69 78 8076 960

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London +44 (0)20 3077 5700

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London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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