OTC Markets Group — Staying on course

Exhibit 1 provides a summary of the OTCM profit and loss account for Q120 compared with Q119 and Q419. We highlight key points below with comparisons against the same period last year unless stated.

Exhibit 2 shows a subdivisional revenue analysis based on indications given in the management discussion of the quarter’s revenue changes. Comments are included referencing the main drivers. The largest percentage gains were at OTC Link ECN (discussed above) and Virtual Investor Conferences. The latter is particularly well placed to capitalise on the current limitations on in-person meetings and provides a cost-effective means for corporates to reach an investor audience when or if the threat of COVID-19 is resolved in future. The largest specified absolute gain in revenue is for professional user licence subscriptions within Market Data Licensing.

The next table provides a summary of changes in operating expenses. As shown, the main driver here was compensation costs reflecting a combination of headcount and salary increases. As noted earlier, there was a reduction in occupancy costs as dual running costs were removed following completion of the move to the new headquarters.

Exhibit 4 collates operating data with related revenues. Starting with the OTC Link metrics, the dollar volume traded figures show the substantial increases for the OTCQX and Pink segments triggered by the pandemic (both over 55% sequentially). In contrast the OTCQB volume was relatively stable sequentially and down 38% y-o-y reflecting the contraction of activity in formerly hot sectors such as cannabis and bitcoin. The rise in the number of OTC Link ECN subscribers has been mentioned above and activity on this platform together with heightened trading activity contributed to overall revenue growth in OTC Link, which is also reflected in higher revenue per security quoted.

For Corporate Services the number of corporate clients in OTCQX at the end of Q120 was flat on Q119 and 6% lower sequentially, while OTCQB was down 5% y-o-y and just 1.5% sequentially. In both cases there was an impact on sales during the quarter from COVID-19 and OTCM flags this as an area that is likely to be more immediately affected depending on the evolution of the pandemic and its economic effects (see discussion in next section).

The Market Data and Licensing metrics show a modest 3% increase in the number of professional subscribers, while the number of non-professional users (a more volatile and lower revenue per head user-base) fell by 22% y-o-y. As mentioned above, increased datafile subscriptions and higher pricing were the main drivers of revenue growth here.

Before discussing the potential impacts of the pandemic on OTCM’s business we provide a brief update on the market background indicators we usually include in our notes. First, looking at a selection of equity indices (Exhibit 5), a substantial rally in markets from their recent lows has reduced the strong negative effect on most indices of the onset of the pandemic, although most are still showing negative three-month and year-to-date performances. The OTCQB Venture Index has shown marked weakness over one year reflecting both a decline in previously hot sectors and the sell-off of stocks deemed to have greater economic sensitivity. The Nasdaq Composite has shown comparative resilience reflecting a higher exposure to technology and healthcare sectors and lower weighting to financials, industrials and oil stocks when compared with the S&P 500, for example. From the perspective of existing or potential corporate clients, the combination of lower equity prices and a need to focus on operational matters within their business tends to create a more challenging environment for OTCM to recruit or retain clients. The company notes that its venture company clients may prove more vulnerable if the economic downturn becomes deeper and more prolonged than currently hoped.

The next two charts show the number of IPOs on Nasdaq and the Canadian TSX and TSX Venture markets as an indicator of corporate activity. The level of IPOs is in any case lumpy, but the Nasdaq figure for Q120 was down 27% y-o-y while the four-month figure for TSX Venture was 52% down on the prior year period. The number of IPOs on TSX was only slightly down over the same period. Currently equity capital markets activity is concentrated on further equity issues to strengthen balance sheets allowing companies to weather the economic impact of COVID-19. When this subsides in due course and companies can eventually focus beyond immediate issues then the environment should improve for OTCM.

Turning to the specific background for OTCM’s three segments, new Corporate Services sales are likely to remain more difficult in the near term, a point compounded by the absence of in person meetings, which normally form an important part of the sales process. The subscription basis of fees is, nevertheless, helpful in providing stability with OTCQX fees renewable annually on a calendar year basis while OTCQB customers renew annually or semi-annually based on when they originally began their contracts. Currently around 75–100 OTCQB customer contracts come up for renewal each month. The renewal rate for April at the time of the earnings call (14 May) was 84% subject to payment extensions to end May granted to some companies (14 percentage points); this compared with an average renewal rate of about 93% for FY19. As further background, new sales in April were three for OTCQX and 13 for OTCQB. On this basis the new sales for OTCQB would have roughly balanced the non-renewals in April but this was only one month and the trend may well fluctuate significantly in the months ahead. In order to help client companies cope with current conditions, OTCM has provided temporary relief from some of its market standards until end June (in line with the SEC’s 45-day extension for some disclosures) and has also offered extended payment terms for some companies. While a longer downturn would be unhelpful, OTCM sees the potential for this to give rise to an uptick in companies delisting from exchanges. These could provide a larger pool of qualified companies for its premium markets.

Since the end of Q120 the level of trading facilitated through OTC Link ATS and on OTC Link ECN has remained above the prior year level although below earlier peaks. Changing views on the progress of the pandemic and the economic background could keep activity at a relatively high level although at some point lower volatility and or economic weakness could lead to a quieter period and encourage a further contraction in the number of broker dealer participants in OTC Link ATS.

Market Data and Licensing has benefited in the latest quarter from price increases and on a longer view from the development of new products including a range of compliance related products that have gained a wide subscription base (44) among large banks, custodians and clearing firms. Prospectively, the largely subscription-based revenue would seem likely to prove relatively sticky, but a sustained economic downturn could see consolidation and withdrawals among the market data subscribers while cost pressures could also impinge on subscribers for its existing compliance and other products. OTCM believes it has captured a large part of the potential market for its compliance products limiting the growth potential here. As a result, the group continues to develop new products to provide new growth opportunities and to offset possible consolidation among these customers as well.

There is greater than usual uncertainty attached to our estimates given the pandemic and associated economic downturn. We have adjusted numbers with the comments above in mind primarily scaling back our revenue assumption for the Corporate Services business on the basis that it has been more rapidly affected already and could potentially take longer to recover in terms of net additions to its corporate client base, subject to how quickly business confidence returns. We now look for revenue here to contract by approaching 4% this year followed by a muted recovery of less than 3% in FY21. We assume that OTC Link will continue to benefit from a higher level of activity as the market reacts to changing views of the outlook. For Market Data Licensing we look for subscriber levels to be sustained with price increases continuing to benefit year-on-year comparisons for the balance of FY20 with new products and potentially some improvement in conditions in FY21 supporting modest revenue growth in that year (+3%). The resulting changes in key numbers from our estimates are shown below (Exhibit 8). Revenue estimates are reduced by 1% and 5% for FY20 and FY21 respectively with the larger reduction for FY21 reflecting the impact of lower average corporate client numbers within Corporate Services and lower growth than previously assumed for the other two segments. At the pre-tax profit and EPS level, these changes have a geared impact which is magnified by modest increases in overall expense assumptions, including a sharper rise in our transaction-related expenses estimates; this results in 11% (FY20) and 19% (FY21). At the time of writing the risks in relation to economic forecasts appear to be weighted on the downside with concern that the structural damage to economies globally may be worse than currently allowed for in projections such as those of the IMF (see World Economic Outlook, April 2020).

The balance sheet remains strong with cash at the end of Q120 of $22.7m or $24.2m including restricted cash. During the first quarter there was a cash outflow of $5.6m. This reflected a roughly neutral operating cash flow and investment position, including a seasonal working capital outflow of $5m as accrued expenses were paid (Q119 outflow $3.8m) and $5.3m paid out in dividends and to purchase treasury stock.

In Exhibit 9 we have updated our table with comparative multiples for information providers and global exchanges. Since our note in March all multiples are higher, reflecting mainly stronger share prices for the peers. OTCM’s share price is modestly higher but our earnings estimate has been reduced as shown above. Even so OTCM stands on lower multiples than both the information providers and global exchanges. In part this can be explained by reference to the group’s exposure to smaller companies through its venture market and also the relative illiquidity of its own shares. Looking further ahead, the group is financially strong and well placed to benefit once the background improves, generating greater corporate and investor confidence and creating the potential for a period of estimate upgrades.

The reduction in our estimates has lowered the values produced from our discounted cash flow model. Our central valuation of $29.50 per share ($32 previously) assumes a discount rate of 10%, factors in our explicit forecasts for FY20 and FY21, together with an assumption of FY22–23 cash flow growth of 12% (increased to allow for a degree of bounce back), long-term growth of 4% and a terminal cash flow multiple of 16x (compared with 22.3x for FY20e).

The sensitivity of our discounted cash flow valuation to different discount rates and long-term growth assumptions is shown in Exhibit 10.