OTC Markets Group — Revenue beat, positive business mix

Exhibit 1 provides a summary of profit and loss figures, comparing the Q221 results with Q121 and Q220. In the comments below, we are comparing Q221 with Q220 unless stated.

Gross revenue increased by 49%, with the largest increase coming from OTC Link (a FINRA member broker-dealer that operates two Securities and Exchange Commission (SEC) registered Alternative Trading Systems), where trading volumes on OTC Link ECN and messaging volumes on OTC Link ATS drove a 110% increase in revenue ($4m absolute increase, $3.4m was driven by OTC ECN). OTC Link’s commitment to ensuring the reliability of its core systems was validated by this period of continued high activity.

Market Data Licensing (distributes market data and financial information) revenue increased by 25%, with the main contributor being the growth in non-professional users as retail participation in equity markets increased. Growth in professional users and price increases were among the other factors at play.

Corporate Services (operates the OTCQX and OTCQB markets and offers issuers disclosure and regulatory compliance products) revenue growth of 40% was generated by a combination of strong additions in 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, grew by 6% and transaction-based expenses (payments for liquidity provision on OTC Link ECN) were up 310% as a result of higher transaction activities.

Operating expenses (before depreciation and amortisation) were up 19%, 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 90% to $9.1m, while a higher tax charge of 22.7% versus 11.9% left diluted earnings up 65% at $0.59 from $0.36.

Exhibit 2 shows how the corporate client base for the OTCQX and OTCQB markets has evolved from Q219. After a low point in Q120/Q220, the rate of new client additions for both markets improved with a markedly stronger second quarter.

Q221 showed a continuation of the strong momentum with 70 additions for OTCQX (OTC Markets’ premium platform market providing efficient public trading without the complexity and cost of a national securities exchange listing) and 112 for OTCQB (a venture market providing public trading for entrepreneurial and development-stage companies and applies standards that promote price transparency and facilitate public disclosure. OTCQB is also open to international companies), representing 14.5% and 11.6% of the opening client base for each market respectively. At the same time, the rate of cancellations and downgrades was similar to previous quarters at 4.6% (OTCQX) and 5.6% (OTCQB), leaving net additions in the quarter at 48 and 58 companies respectively.

Out of the 70 new corporates joining OTCQX, 56 were international issuers and of the 112 joining OTCQB, 97 were international issuers. Management comments on increased sales in the UK office and a dedicated sales effort focused on the Australian market. This highlights the importance of the contribution by international companies to the group’s growth profile and of the value that OTCM can offer to international companies seeking access to the US capital market at a lower cost than incumbent exchanges.

Exhibit 3 shows changes in operating expenses between Q220 and Q221. As noted earlier, the main drivers of the 19% change were increases in compensation, and professional and consulting costs, a continuation of the trend in Q121. Compensation and information technology costs remain a significant proportion of overall expenses, representing approximately 80% of total operating expenses. Higher incentive compensation combined with higher sales commissions (strong sales at OTCQX and OTCQB) were the key driver.

Exhibit 4 sets out operating and related revenue data, showing year-on-year and quarter-on-quarter changes. OTC Link data show 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 (see Exhibit 2). In Market Data Licensing, the increase in non-professional market data subscribers remains impressive and reflects high retail investor participation, a phenomenon that began during the COVID-19 lockdowns. We note that the number of non-professional users has been volatile historically and, should equity markets correct, we see risk of a pullback here.

OTCM is on track to launch a third alternative trading system (ATS) in Q321 called OTC Link NBQ in addition to 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.

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. Management have stated that it is unable to gauge the financial impact or how successful this new interdealer quotation system (IDQS) will be. However, we believe the launch of NQB will be an attractive proposition to clients and thus should be a positive for OTC Link’s revenue in the medium term.

On 16 September 2020, the SEC published a final Rule 15c2-11. This has a compliance date of 28 September 2021. Rule 15c2-11 governs information requirements before quotes may be published on interdealer quotation systems such as OTC Link ATS. The amended rule will generally prohibit broker-dealers from submitting or publishing quotations for securities on OTC Link ATS unless current information about the company is publicly available. The rule will permit OTC Link ATS, as a qualified IDQS, to perform the required information review to determine whether a security is eligible for public quoting. This will enable OTCM to streamline onboarding of securities to its 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.

In December 2020 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. On 2 August 2021, the SEC’s Division of Trading and Markets indicated that the SEC chair did not intend to approve the order in the short term. Accordingly, while the Expert Market for ‘no information’ securities will continue to operate, the market will only be available for unsolicited quotes representing limit orders from customers not affiliated with the issuer. Expert Market data feeds will continue to be available to broker-dealers and other sophisticated investors.

OTCM has reiterated its three priorities for 2021 as:

Given the impact of trading activity on recent results, we include in Exhibit 5 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 to normalise in April 2021.

The trends in the number of IPOs on the Nasdaq, TSX and TSX Venture exchanges are shown in Exhibits 6 and 7. The number of IPOs on Nasdaq has tempered after very strong activity in Q121. TSX IPOs for the first seven months of 2021 were up 27% by number compared with the same period in 2020 and the TSX Venture exchange saw an 174% increase.

Looking at the trend in the number of corporate client additions for OTCM shown in Exhibit 2, the Q221 figures reflect the favourable development in IPOs highlighted above. OTCM indicates that this has continued into the current quarter, with a good pipeline of potential clients also in place.

Headline figures from our revised estimates are shown in Exhibit 8 with further detail, including the divisional breakdown of revenues, shown in the financial summary (Exhibit 10).

Following a strong Q221, our group revenue estimate for 2021 is increased by 7.6%, including a 15% increase in the estimate for OTC Link (strong quarterly performance followed by an assumed normalisation of trading activity, as discussed above). We continue to assume a significant normalisation (-40%) in revenue for the division in 2022. The higher multiple divisions of Market Data Licensing and Corporate Services also beat our expectations by 9% and 15% respectively.

Our revenue growth assumptions for Market Data Licensing (16% and -7% for 2021 and 2022) are influence by our assumption of lower trading levels possibly affecting 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. Nevertheless, we increase our estimates by 6% for both 2021 and 2022.

For Corporate Services, the strong new client additions have translated into an increase in our estimates (4% for 2021 and 7% 2022), although we do not assume that they continue at the same rate.

OTCM’s balance sheet remains strong, with no debt and cash of $43.0m or $44.6m including restricted cash at the end of Q221. In addition to cash held, OTCM has an undrawn line of credit of up to $1.5m available. This indicates that the capital return profile, mainly in the form of dividends, is reasonably secure in the near to mid-term. The group has paid a special dividend since 2014 and this should continue to feature in the group’s investment case in the near to medium term.

An updated version of our comparative P/E table is shown in Exhibit 9 below. 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 global exchanges for 2021 and 2022 (which also reflects the normalisation of elevated trading volumes). 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. The positive change in business mix in Q221 suggests a higher multiple rating could be justified going forward.