OTCM - OTC Markets: Trading Too High With Limited Upside In The Short Term

2023-09-13 10:57:38 ET

Summary

• OTC Markets Group Inc offers trading systems and dealer systems for financial market business and trades.
• The company's revenues and earnings are largely dependent on economic activity and investor optimism.
• OTCM faces challenges due to reduced market activity and higher interest rates, but long-term prospects remain positive.

Introduction

OTC Markets Group Inc (OTCM) is an interesting company as it engages in the financial sector a bit differently as it offers various trading systems and dealer systems for financial market business and trades happening. The company is valued almost like a tech company with a p/e of 23 on a forward basis. With the recent few month's price movement though, I think that you aren't getting a very good entry point right now into OTCM unfortunately, and will be rating it a hold for now actually.

It doesn't offer a good enough dividend yield to make the current price point justified, but with a strong history with at least of growth to it I would imagine that investors are at least getting enough value here that a hold makes sense.

Company Structure

OTCM offers a different service and product than a lot of other companies in the financial exchange industry in that they have over-the-counter stock exchanges within the United States. While commonly known for the pink sheets it facilitates, it's important to note that the OTCM encompasses a range of exchange platforms, each serving distinct purposes within the financial landscape. Among the suite of exchanges under its purview, the OTCQX market stands out as the most rigorous in terms of listing requirements. This elevated standard underscores the commitment of OTCM to maintaining a reputable and regulated environment for trading. Revenues and earnings are largely coming from strong activity in the economy as investors are becoming more optimistic

The company is highly dependent on managing the operational expenses to maintain strong margins throughout the ups and downs of the market cycle regarding economic booms and busts, or rate increases or rate decreases. Regarding the gross revenues of the company, we saw a 5% increase YoY but with operating expenses increasing by 16% YoY increase. This revenue result also means that OTCM is trading quite high based on p/s, currently at nearly 6 on a forward basis. To justify a buy case here on these premises is quite frankly a little absurd I think. The premium one has to pay for the somewhat lacking growth just isn't justifiable.

Earnings Transcript

On August 5, 2023, OTCM released their last earnings call where they highlighted some key things from the last quarter and the results for it. The CEO of the company Cromwell Coulson had the following to say.

"In the first six months, financial markets saw a risk off environment with lower overall market activity and trading volumes across the industry. These dynamics highlight the strength of our diversified business model. There are over 12,000 securities quoted across our OTCQX, OTCQB and Pink markets".

It seems that higher interest rates are significantly reducing the activity in the markets that OTCM specializes in. Betting on higher revenues and earnings growth will come from interest rates going lower and more risk-averse investors once again entering the market and spending capital. I have the view that interest rates will likely remain largely elevated for the next couple of quarters at least, possibly the better part of 2024 before going lower again. That is a prolonged period of lower activity for OTCM and is likely to result in softer earnings expansions.

"Our expense drivers remain consistent, led by increased headcount, technology operating costs, and the EDGAR Online technology transition. Blue Sky Data Corp and EDGAR Online are each part of our market data licensing business. As a result, market data led our business lines with 20% revenue growth in the second quarter and 23% growth for the first half of the year".

As mentioned before, managing expenses the best they can is crucial in times like this when activity is under pressure. What OTCM has done in the meantime though is close out on several acquisitions to bolster their asset base and portfolio. This I think in the long-term will play out very well for the business.

It seems that OTCM is also able to distribute a decent amount of cash flows to shareholders. In the last couple of years, the total cash returned to shareholders has steadily climbed and for 2023 it's set to be $7.7 million in total. What we can see is that during the market boom of 2021, the free cash flow for the company drastically improved. That was the year when a lot of companies saw high double-digit share price growth. This resulted in strong economic activity as the interest rates were also lower.

Risk Associated

One significant concern is the prospect of tepid earnings growth or, in more adverse scenarios, the possibility of an earnings decline. These uncertainties stem from the intricate interplay of economic factors and consumer behavior, which are subject to ongoing fluctuations and external influences.

As these uncertainties loom, there is a distinct possibility that OTCM's financial performance may be impacted. In particular, the recent rise in interest rates has triggered notable shifts in market conditions. This adjustment has resulted in reduced activity levels, thereby affecting the company's revenues and growth trajectory potentially. The consequences of this shift are multifaceted, impacting not only earnings but also potentially exerting downward pressure on stock prices. For me though, the long-term remains positive but the short-term slight declines in some segments are not something that should be blown out of proportion, OTCM is still solid and will be able to overcome these challenges too.

Investor Takeaway

OTCM is an interesting company as it offers exposure and access for investors to the OTCQX market, where the term pink sheets comes from. These are small and up-and-coming companies that can be incredibly volatile in terms of price. For OTCM, they gain revenues and earnings when the economy is doing good and people are spending and investing a lot. That happened during 2021 when the rates were also lower, we are a fair bit off from those conditions now. But for the long-term, I still believe in the economic outlook of the US and OTCM should be able to steadily grow the top and bottom lines. Until the company reaches a more reasonable p/e of around 10 - 12 though I won't be considering it a buy, but instead issue a hold rating for it.

For further details see: