OTC Markets Group — Long term focus remains as volumes spike

Exhibit 1 provides a summary of profit and loss figures comparing the Q121 results with Q420 and Q120. In the comments below we are comparing Q121 with Q120 unless stated.

Gross revenue increased by 57%, with the largest increase coming from OTC Link where trading volumes on OTC Link ECN and messaging volumes on OTC Link ATS drove a 210% increase in revenue (see subdivisional analysis in Exhibit 3 for further detail). The extent of the first-quarter increase in activity is underlined by the sequential comparison, with OTC Link revenue doubling compared with Q420. OTC Link’s commitment to ensuring the reliability of its core systems was validated by this period of exceptionally high activity. Market Data Licensing revenue increased by 17% with the main contributor to this being the growth in non-professional users as retail participation in the equity market increased. Growth in professional users and price increases were among the other factors at play here. Corporate services revenue growth of 21% was generated by a combination of strong additions of new clients for OTCQX and OTCQB markets (see Exhibit 2), price increases and increased demand for Virtual Investor Conferences’ services.

Re-distribution fees, which relate to market data services (+6%) and transaction-based expenses (payments for liquidity provision on OTC Link ECN), up eightfold, grew with the respective activities. Operating expenses (before depreciation and amortisation) were up 22%, with the main contributors being personnel costs and clearing and regulatory costs resulting from the expansion of ECN trading (see further detail in Exhibit 4).

At the pre-tax profit level, the increase was 87% to $8.4m, while a higher tax charge of 19% versus 14% left diluted earnings up 78% at $0.57.

Exhibit 2 shows how the corporate client base for the OTCQX and OTCQB markets has evolved from the beginning of 2019. After a low point in Q120, the rate of new client additions for both markets improved with a markedly stronger second half of the year. Q121 showed a continuation of the strong momentum with 52 additions for OTCQX and 83 for OTCQB, representing 11% and 9% of the opening client base for each market respectively. At the same time, the rate of cancellations and downgrades was lower than in the prior year period at 6.7% (OTCQX) and 2.5% (OTCQB), leaving net additions in the quarter at 21 and 60 companies respectively. Out of the 52 new corporates joining OTCQX, 35 were international issuers, a reminder of the importance of these companies as a source of growth and of the value that OTCM can offer to international companies seeking access to the US capital market without the cost and administrative burden of a listing. International companies account for about 65% and 45% of companies on OTCQX and OTCQB.

Exhibit 3 shows an indicative subdivisional analysis of gross revenue based on management commentary in the Q121 report. The most prominent feature here is the $5.9m increase in revenue for OTC Link ECN from $0.7m to $6.7m. Not shown in the table but the ECN generated revenue of about $2.2m in Q420. Following this substantial growth, OTC Link ECN accounted for 26% of group gross revenue, but after deducting transaction-related expenses this falls to, a still significant, 14% of net revenue.

In Market Data Licensing, the main contributor to revenue growth was the increase in the number of non-professional users, which generated a 138% increase in revenue year-on-year and 38% sequentially (not shown). Increases in professional user licences and subscriptions to other products including compliance data and analytics also contributed.

In Corporate Services, OTCQX and OTCQB followed a relatively stable Q420 with material increases in revenue driven by higher sales and price increases. Virtual Investor Conferences continued to show very strong growth, hosting seven conferences in the quarter with 143 companies participating (Q120: five and 46 respectively).

Exhibit 4 shows changes in operating expenses between Q120 and Q121. As noted earlier, the main drivers of the 22% change were increases in compensation and professional and consulting costs. The former reflected variable compensation and base salary increases and the latter OTC Link ECN clearing and regulatory costs.

Exhibit 5 sets out operating and related revenue data showing year-on-year and quarter-on-quarter changes. OTC Link data shows substantial increases in trading volumes in line with US equity markets generally and the growth in number of ECN subscribers. For Corporate Services, analysis of the growth in OTCQX and OTCQB client numbers has been shown above. Within Market Data Licensing, the rise in non-professional market data subscribers is striking and reflects the increase in retail investor activity seen in recent periods. Historically the number of non-professional subscribers has been quite volatile, and it remains to be seen how a normalisation in equity market activity levels affects user demand. The reduction in the revenue per terminal metric reflects the lower revenue generated by non-professional users.

OTCM continues with its plans to operate a third ATS, OTC Link NBQ alongside OTC Link ATS and OTC Link ECN. The two existing platforms are complementary, with OTC Link ATS providing a network to publish quotes and to facilitate trades between subscribers, while OTC Link ECN operates an anonymous matching engine and acts as an order router, functioning as the execution party on an agency basis. Subject to Securities and Exchange Commission (SEC) approval, OTC Link NBQ will provide alternative functionality to broker dealers enabling electronic matching and execution, but with full disclosure rather than anonymity and allowing distribution of full depth of book data rather than top of book alone as at OTC Link ECN. OTCM hopes to launch OTC Link NBQ before the release of its Q221 results (early August).

On regulatory developments, OTCM continues to focus on its response to the SEC’s final rule amending Exchange Act Rule 15c2-11. This has a compliance date of 28 September this year. As a reminder, 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 is permitted to act as a qualified interdealer quotation system (IDQS) 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. OTCM notes that it does not expect the disclosure rules for companies on its OTCQX, OTCQB and Pink Current and Limited Information tiers will change materially. In December the SEC published a proposed exemptive order that would, subject to approval, allow OTC Link to operate an Expert Market for companies that do not meet the information requirements allowing sophisticated or professional investors to continue to trade in the securities.

The initial phase of Consolidated Audit Trail (CAT) obligations for OTC trading began in June 2020 with subsequent obligations taking effect this year, beginning in April. 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 but OTCM does not expect the impact to be material in FY21.

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 at 37 and 33 respectively).

While its Q121 results were strongly influenced by the surge in trading volume in US equities, OTCM has reiterated its three strategic priorities for 2021 as:

Our first background table shows recent performance from a selection of equity indices (Exhibit 6). All have shown positive moves over the periods greater than three months, reflecting the recovery in market levels as they looked forward to implementation of countermeasures to the pandemic. The OTCQB and TSX venture indices have shown strength relative to the other indices over 12 months, perhaps reflecting a rotation towards smaller cap and more economically sensitive sectors. The OTCQX index has shown a performance profile more in line with the Nasdaq Composite, albeit with a positive three-month performance.

The Economic Policy Uncertainty Index (Exhibit 7) is included as an indicator of the environment for investor and corporate decision-making. 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. The index has subsequently moved significantly lower and now stands at a level within the range seen prior to the pandemic suggesting a more settled background for investor and corporate decisions.

Given the impact of trading activity on recent results, Exhibit 8 is included, showing an index of the average daily volume of US equity share trading. This shows two spikes in early 2020 and from the end of 2020 to Q121. In line with OTCM’s commentary, this appears to have begun normalising in April.

The trends in numbers of IPOs on the Nasdaq, TSX and TSX Venture exchanges are shown in Exhibits 9 and 10. Reflecting more favourable market conditions, the number of IPOs on Nasdaq has bounced strongly with the Q121 number of IPOs substantially ahead of the already increased levels seen in Q320 and Q420. TSX IPOs for the first four months of 2021 were up 38% by number compared with the same period in 2020 and the TSX Venture exchange saw an 83% increase.

Looking at the trend in the number of corporate client additions for OTCM shown earlier in Exhibit 2, the Q121 figures mirrored the favourable movement shown in IPOs above and OTCM indicates that this has continued into the current quarter with a good pipeline of potential clients also in place.

For OTC Link, the high level of trading seen in Q121 may not be sustained, with signs of normalisation already evident, but, on a longer view, OTCM will continue to work on attracting new subscribers and adding additional functionality as exemplified by the proposed launch of OTC Link NQB.

Market Data Licensing may be affected by a reduction in non-professional subscribers in due course if market activity levels do normalise, but professional subscribers have historically proven more resilient and efforts to develop the product offering continue, with a focus on compliance products.

Headline figures from our revised estimates are shown in Exhibit 11 with further detail, including the divisional breakdown of revenues, shown in the financial summary (Exhibit 13). Following the very strong start to the year, our group revenue estimate for 2021 is increased by 17%, including a 65% increase in the estimate for OTC Link, reflecting its first quarter performance followed by the assumption of a progressive normalisation of activity levels. We continue to assume a significant normalisation (-40%) in revenue for the division in 2022. For Corporate Services the increased rate of corporate client net additions has prompted an increase in our estimates (to 18% and 10% for 2021 and 2022) though we do not assume client additions continue at the same rate. Our revenue growth assumptions for Market Data Licensing (10% and -7% for 2021 and 2022) are tempered by the thought that moderation in market trading levels could affect non-professional subscription levels, particularly in 2022. Uncertainty on this point together with the outlook for trading activity levels in US equities should be considered when viewing our estimates. Transaction related expenses have been increased in tandem with related revenue, but changes in assumptions for other expenses are smaller, resulting in an increase in our diluted EPS estimate for 2021 of 23% while for 2022 the increase is only 2%, reflecting the comments about normalisation above.

OTCM’s balance sheet remains strong, with no debt and cash of $33.5m or $35.1m including restricted cash. Operating cash flow for Q121 was $3.6m, of which $0.2m was allocated to capital expenditure, $1.8m to dividends and $1.5m to purchases of treasury stock; other items totalling $0.3m left a $0.2m outflow. In addition to the cash held, OTCM has an undrawn line of credit of up to $1.5m available.

An updated version of our comparative P/E table is shown in Exhibit 12. This includes information providers MSCI and Markit together with the average multiples for global exchanges. OTCM shares are trading on a prospective P/Es below the average for global exchanges for 2021, but slightly above the average for 2022, reflecting the normalisation of trading we have factored into our estimate for that year. The shares trade on markedly lower P/Es than the those for information providers. While the multiple applied to prospective earnings may be limited by the relative illiquidity of OTCM shares, the group is financially strong and has a high proportion of subscription-based revenues.