Cash Machine | OTC Markets Group $OTCM

Why i'm long $OTCM and why I haven't gone longer...yet

OTCM stands for “over-the-counter-markets” and if you’re into nano-cap value or anything like that, then you’ve almost certainly used their “platform” before. “Platform” is in quotes because this is much more than a simple “platform.”

OTCM’s business took me a minute to get my head around, but once it clicked I got pretty hungry to buy at least a little bit. Its my smallest position, but I do own it and really think its quite good a business selling for a reasonable price.

A few financial figures that got me interested:

Gross Margin: 93% (net margin 25%)

ROE: ~70%

Long term debt: $0

Cash on Hand: $32 Million (on a market cap of ~675m and net income ~26m).

TTM PE Ratio: 25 (20 when I bought it). Thats a current pre-tax earnings yield of ~4.8%

Already i’m interested. This appears to be a capital light and well managed company with no debt and fantastic “quality” metrics (high ROE and Margins). There’s also some plausibility that its actually over-looked because its a small company ($675m market cap). But we gotta go way deeper.

So what do they do?

Part 1: The Business

Ok, lets start with the “OTC” markets themselves. For decades, extremely small companies (and many foreign stocks) have traded on something called the “over the counter” markets. These securities were called “pink sheets,” and they were (and still are) somewhat out of the scope of the typical retail or institutional investor. I think of the OTC’s as a sort of thrift store - theres plenty of junk, but there’s also some real treasures if you know what to look for.

My “secret position” (paid subscribers only) trades on the OTC’s - as do many small banks, insurance companies, junior miners, small retailers, and all sorts of other random and small U.S companies. Remember the Wolf of Wall Street? Yeah, in the beginning they’re running penny-stock scams on the OTC’s (Pink-sheets). Why? Because those are the least liquid stocks and the easiest to pump and dump. Its like the Wild West over on the pink sheets - or at least it used to be.

The other sort of business you’ll see trading OTC is the stocks of medium and large foreign companies who don’t want to deal with the expense and regulatory rigamarole of listing on the NASDAQ or NYSE (New York Stock Exchange). Basically, these foreign companies (e.g Samsung, Nestlé, Roche, Tencent, Volkswagen, ect) are already listed on a major exchange in their home country. Under U.S law, since they are already compliant with a major exchange, they are also in compliance with the SEC, and their shares can trade legally in the U.S. That doesn’t mean they can just list on the major exchanges though - nor do they want to. Why?

1. Loads more paperwork and cost. Compliance is expensive! A U.S. listing means Sarbanes Oxley internal-control tests, quarterly SEC reports, and audits that follow stricter PCAOB rules. Even a giant like Samsung would be writing several million dollars a year in extra checks just to stay compliant. Crazy

2. Bigger legal target. U.S. exchanges plug you straight into America’s shareholder-lawsuit machine. One earnings miss or governance slip can trigger a class-action suit - something many foreign boards would rather avoid.

3. Governance rules that don’t match home country practice. NYSE and Nasdaq insist on things like a majority of truly independent directors, specific audit-committee powers, and claw-back policies. Firms that already satisfy tough local rules (say, in Zurich or Seoul) see this as hassle with little upside.

4. They already have deep liquidity at home. Samsung, Nestlé, or Volkswagen can trade billions of dollars a day on their domestic exchanges.

In short, a U.S. listing gives some prestige, but for many huge non-U.S. blue chips, the extra fees, rules, and lawsuit risk usually outweigh the benefit. So basically its just an expensive pain in the ass to “properly” list.

Enter the OTC’s. With the OTC markets, foreign companies can open themselves up to the U.S markets for less hassle and cost. U.S investors can trade those shares in USD instead of a foreign currency (saving money and building in a currency hedge). There are some other advantages to buying foreign stocks on the OTC’s, but suffice it to say its definitely the way to go. Its a win win for everyone.

For the other segment of the OTC markets (i.e small U.S companies), the issue is similar. It costs big bucks to list on a major exchange and most smaller companies just cant afford it. What they definitely can’t afford is the compliance costs. If i’ve learned anything from researching this company its that compliance is expensive. The OTC’s offer small U.S firms a bridge between illiquid private markets and full on public markets. If you’re the CEO of a 100 million dollar company and you want to sell some shares to pay for a divorce or a new house, you aren’t going to take the company to NYSE to get some liquidity. You also don’t want to let the private equity foxes into the hen house, and so the OTC’s are a great middle ground.

All in all ~12,000 individual securities are quoted and traded on the OTC’s. The yearly dollar volume of shares traded is about $475 billion.

Part 2: I said the business damnit!

Ok ok, so now that you know what OTC markets are in the first place, understand this: they are controlled entirely by one company. OTC Markets Group ($OTCM).

OTCM is not an exchange…*wink*

But its just about as profitable and important as an exchange, provides very similar services to society, and ultimately functions like an exchange…but its not an exchange….

So what IS it?!?

OTCM is 3 things.

Thing 1: OTC Link ATS

First up is OTC Link ATS. “ATS” stands for “Alternative Trading System” - a pretty good descriptor of that it is.

This business segment is what enables the trading to happen in the first place. It connects buyers and sellers (broker dealers) and collects all the info from those trades (bids, asks, volume, price, ect). Its the plumbing of the entire operation. Back in the day many phone calls had to be made for these types of securities to be traded. Today, that same process happens in seconds and sometimes automatically thanks to OTC Link. And OTC Link is of course owned by OTCM.

When you go and click “buy” on an OTC stock, your broker shoots that order into OTC Link ATS - an SEC-regulated electronic chatroom where about ninety market-making broker-dealers are already flashing the prices at which they’re willing to buy and sell. The system is not a central exchange; instead it’s a “qualified inter-dealer quotation system,” so every quote is “attributable” (you see exactly which dealer is on the other side). Your broker either hits the best displayed ask or sends a quick message to negotiate; when the market maker answers “done,” the trade is locked, instantly time-stamped, and both firms report it to FINRA’s OTC Reporting Facility so it prints to the public tape - usually within ten seconds. A day or two later the shares settle through the same DTCC plumbing (clearing houses) that listed stocks use, and the position shows up in your account, all without anyone ever touching a traditional exchange floor.

Its not an exchange! ….*wink*

So how does this segment make money?

First is the monthly subscription from broker dealers. About 140 broker-dealer subscribers pay a flat subscription each month to plug into OTC Link, post price quotes, send electronic trade messages and keep the network lights on. Think of it as rent for a trading terminal.

Next is per-share execution fees on its ECN (Electronic Communication Network). When those dealers actually match orders inside the OTC Link ECN, OTC Markets charges them a sort of “transaction fee.” This is relevant because sometimes sheer market activity can move the needle on this portion of the business. More trading = more money.

And finally we have connectivity & reporting add-ons. Dealers that want high-speed FIX (financial information exchange) gateways, dedicated lines or automated trade-report filing pay small à-la-carte fees. These tools and ad-ons help brokers improve their services to clients and make a bigger profit.

The dealers themselves make money the old-fashioned way by earning the bid-ask spread on each OTC trade and pocketing any retail commissions.

All of this together equals about 20 % of OTC Markets Group’s $111 million in 2024 gross revenue.

Thing 2: Market Data Licensing

As you might imagine, all of this trade data is crucial for people to access in order to - for example - know the price of the shares. They also collect financial data about the companies (net income, market cap, shares outstanding, ect). OTCM owns the data (the trade data at least), and they license that access to the data to, well, anyone who might need it.

Customers include Fidelity, Schwab, JP Morgan, Seeking Alpha, Yahoo Finance, and regulators in need of that data for compliance info. The customers fit into 4 main buckets:

For example, I may research a company on Seeking Alpha. Say I do a market screener for a company with P/E below 20 and a market cap below $100m. Right off the bat, that financial data Seeking Alpha, Yahoo Finance, GuruFocus, ect is using to show me the company is OTCMs data. When I click on the company and look at the price chart i’ll see real time big/ask data with a quote for the “stock price.” This is also OTCMs data, and its available to these customers often with a ~15 minute delay. All of that is bucket 1.

Then go to my Schwab, Fidelity, Bloomberg, ect to buy or sell the stock. The info I see there is bucket 2.

Then I want to buy it and perhaps on the other side of the trade is Jane Street or some other trading house (JP Morgan, Citi, Virtu) who needs the data at lightening speed in real time. They’re in bucket 3.

And finally, perhaps that company is in violation of reporting regulations. That info is also reported and owned by OTCM, and would be consumed by lawfirms, attorneys, and regulators. And thats bucket 4.

This is extremely high-margin revenue because OTCM has that data already (and they’re profiting on its collection). All they have to do is re-sell it and presto, “free money.” This is the largest portion of their revenue at ~40% of revenue.

Thing 3: Corporate Services

As you might imagine, something is missing from the equation and thats the companies listed on OTCM in the first place. This ain’t free! OTCM (which is not an exchange) offers their corporate customers (the small banks, miners, foreign companies, ect) access to public markets. In exchange, they collect a one time “signing bonus” as well as an annual “subscription.”

Your tiny company that you want to list on this “platform” can choose from 4 different tiers. They vary in their compliance needs as well as their costs. The more “legit” tiers of course give one more liquidity, but also come with a higher price tag and compliance needs (for example, you would have to furnish audited quarterly earnings on the high tier (OTC-QX), but don’t really have to report anything on the lowest tier - pink).

The pink tier is also divided into 3 categories, one of which is called the “grey market” or “expert market” where you’re not only dumpster-diving, but you’re doing so in the dumpster of a broken glass factory.

Some of the new developments at OTCM itself has been the advent of “OTCID” which is a new tier meant to replace the highest tier of the pink market. More on that later.

Along with the listing fee and subscription, corporate services includes other up-sell’s for clients including level 2 data, regulatory compliance tools, “OTC Disclosure & News Service,” and even virtual investor conference tools.

Ok, so those are the 3 things OTCM does. Notice how they all flow into one another beautifully? More companies list → the more brokers trade → the more data gets licensed. Ultimately, the success of one segment feeds on the other. And THIS, I absolutely love. Its all capital light and the moat may look shallow, but its DEEP. Why would any companies list on an exchange no one trades on? And why would brokers sign up to trade on a platform with no companies? OTCM has the market cornered, and even better they don’t have to engage in anti-competitive practices to hold their position. Moreover, they’re always in good graces with regulators since their platform makes regulation easy.

Part 3: Financials

Below is an interactive (yeah thats right) chart of OTCM’s revenue by segment over the last 10 years. As you can see, top line has grown somewhat steadily with the exception a big jump back in 2021. This is thanks to increased market activity overall. While corporate services did increase noticeably during this period, OTC-Link revenue practically doubled thanks to a ton of trading back in the meme-stock era.

Next we can see net-income rising as well with a similar pull-forward situation going on in 2021. Net-income has declined since then a bit…and more on that later.

Next up lets take a look at operating cash flow - notice that operating cash flow is consistently higher than net-income

Next is margins:

So, lets see where the operating expenses are living. By far the largest expense for this company is human capital. Salary, bonus, and stock-based compensation expenses alone were over $44 million in 2024 (about 40% of gross revenues that year), by far the largest expense category. This reflects the nature of OTCM’s business as a financial technology and market services firm – it relies on skilled employees (technology developers, market operations, regulatory compliance staff, etc) to drive its operations and growth. Management has noted the need to attract and retain talent with competitive pay and benefits, especially to develop new services and meet regulatory obligations.

The CEO (who owns a majority stake in the company by the way), was paid $733,500 in 2024 - included salary and stock.

Return on Equity: Considering this company has $0 in long term debt, i’d say this is a fantastic ROE. They hold roughly the same amount of cash as they have in “deferred revenue” liabilities, and so there isn’t any financial engineering here from where i’m sitting. This is clearly an extremely capital light business being managed as a lean, mean, cash machine.

Cap-ex is very low for this company considering they generate so much net-income (2024 net-income was $27.3m vs only $1.3m in Capex. In 2021 the Capex jumped to 5 million due to “one-time projects” in 2019. Roughly $2.9 million was spent on leasehold improvements and IT build-out for a new corporate headquarters, and another $2.0 million went into significant upgrades of the primary and secondary data centers. Totally fine by me.

Shares Outstanding: Just a note on the share count. Stock based comp is used at this company, but they engage in buybacks to offset that. Cash is returned to shareholders in the form of dividends (seen in the following chart relative to cash-flow).

Capital returns in the form of Dividends relative to operating Cash-flow. Suffice it to say they’re paying out a substantial amount of dividends each year. A note on dividends though, they pay a regular dividend as well as a “special” dividend at year end. The total yield is usually somewhere around 4-5%, although it will show up differently on Seeking Alpha since most platforms only track the regular quarterly dividend.

Assets: Nothing much to note here besides a very healthy amount of cash always sitting on the balance sheet. This dry powder helps management avoid using debt down the road if/when they make strategic acquisitions and upgrades.

The leap you’ll notice in “goodwill” happened in 2022, when goodwill rose to $3.98 million. Almost the entire $3.73 million increase came from the May 2 2022 purchase of Blue Sky Data Corp, a provider of state Blue-Sky compliance data. Overall good-will is well within a reasonable range - OTCM is not a serial acquirer.

Now a look at liabilities. You’ll notice that “deferred revenue” is the largest of all the liabilities on the balance sheet. This is much more of a feature than a bug. OTCM’s clients often pay in advance for their subscriptions, and that “service” they’ve paid for has yet to be provided - hence it being constituted as a liability. Considering that most of their cash is spent on the “compensation” line item in “operating expenses,” I don’t see this as an issue whatsoever - if anything its good because they get their cash up-front.

Moreover, The next large item, “operating lease liability,” on OTCM’s balance sheet represents the present value of future rent payments for its office leases – principally its New York headquarters lease extending through 2031 – recorded under new lease accounting rules effective 2019. No big deal.

In summary, this is an awesome financial picture. No red-flags that I can see and incredible financial figured. Maybe i’d prefer buybacks over dividends, but all in I can’t find anything to complain about.

And valuation is totally within reason: (low to mid 20s TTM PE).

FCF Yield ~4.5%

I mean hey, I own it. But why didn’t I buy more?

Part 4: Organic Growth

So far, OTCM has grown their business at a solid clip considering how little money they’ve spent doing so - top line grew 10.3% CAGR from 2010 → 2024. EPS grew even faster at 16%.

The question I have to ask myself is where will the future growth come from. It seems to me this isn’t as clear and obvious with OTCM as it can be with other businesses.

For example, TSMC can grow earnings because the world always seems to need newer and better chips, and more of them at that. More devices have cpu’s and gpu’s than ever before, and TSMC can manufacture those better than everyone else. Plus data center growth and AI doesn’t appear to be slowing down, and TSMC is a critical part of that development. This is a clear growth case that I think anyone could understand.

OTCM’s is a bit more murky, so lets get into it.

Growth Path 1: More volume over more time - 24 hour trading (ATS)

The demand to buy and sell securities doesn’t dissipate when the U.S markets close - particularly in regions other than the U.S East Coast (West Coast, Europe, and Asia.) To meet this need, OTC Markets have invested in digital infrastructure that will enable them to offer over night trading. This not only means better service for customers, but the move should also increase overall trading volume. More volume = more fees, and we already saw in 2021 what more trading volume can accomplish. Don’t forget, a boost to one segment of OTCM’s business almost mechanically becomes a boon to the rest.

Growth Path 2: Introducing OTCID (Corporate Services)

I mentioned the four “tiers” earlier:

I also explained that the Pink tier has “sub tiers” within it - including a “grey market.” OTCID is a brand brew development and is meant for companies currently in the Pink-tier who don’t yet qualify for OTCQX/OTCQB, but do meet some reasonable SEC standards. This would exclude shell companies and those who haven’t reported anything to the SEC - the glass in the dumpster. While many companies on the Pink-sheets may just remain there, a good portion will graduate up to OTCID. Still other companies who are not currently listed may be attracted to this new tier.

Before, OTCM offered “First Class,” “Business Class,” and “In the belly of the plane with the luggage and the dogs,” and OTCID is basically just coach. Not only will plenty of passengers happily move up to coach, but its likely more folks will fly the airline in the first place - now that there is a proper place for them on the plane.

This new tier will cost $7,500/year which is ~$2,500 more per year than the Pink Tier - still far less than the ~$16-26 k it costs to sit on OTCQB/QX, and a tiny fraction of a national-exchange tab that can run into six figures for fees and ongoing compliance.

Growth Path 3: Compliance Data (Market Data Licensing)

Imagine OTC Markets owns a library of information that brokers and fintech apps need every single day to stay out of trouble with regulators - after all, keeping track of the different laws in 50 states is not easy. In the last few years OTC has been buying new shelves of books for that library and bundling everything into a single subscription it can charge more for.

Compliance data is “must-have” rather than “nice-to-have,” so OTC can charge a premium. Most of the cost of creating the dataset is fixed, so each extra subscriber is almost pure profit. Its also a different sort of “budget” line item for the customers (legal/risk vs trading desk), so those its safe to assume those folks will fork up the cash.

OTC’s recent data buys (Blue Sky, EDGAR Online) plus home-grown analytics (Canari, 15c2-11 flags) turn the company from a simple quote vendor into a full-service compliance backbone.

Growth Summary: More Lanes More Gains

The beauty of this business is the flywheel effect. As one segment grows, so do the others. Each improvement to one aspect of their business deepens their already deep moat, and also drives business to the other segments. By improving and growing each of the three spokes on the flywheel, OTCM is creating momentum which - if all goes well - will turn into cash flow inertia (a term I just made up).

What do I mean? Well, with the advent of OTCID for example, they are attracting more companies to list on their…"platform.” This, in turn, increases the amount of companies on the platform, and therefore the amount of trading volume (ATS). Moreover, it improves and widens the market-data licensing portion - as more trading = more data. That growth is only multiplied by the move into the compliance data market. And all of this equals a better platform with more activity - attracting still more companies to list their shares. The addition of the overnight trading appeals to foreign companies, and this in-tern adds to the compliance needs of the brokers. Every good thing OTCM does becomes 3 good things later. And they’re accomplishing all of this while returning a huge chunk of their cash each year to shareholders.

Part 5: Down to Earth

I probably should have taken a bigger bite out of this company when it was selling at 47/share (today it sells for 60/share). But the reason I didn’t had to do with the simple fact that it was hard for me to wrap my head around the actual ability they have to grow organically with any notable speed. They can only do so much price raising before their moat is gone. Moreover, plenty of companies don’t want to be public…ever. There isn’t a giant crowd outside OTCM’s door demanding access. Instead, OTCM’s growth strategy is more like field of dreams: if we build it, they’ll come.

Now, that’s pretty much worked so far I should admit. The giant pull forward in 2021 - and subsequent hangover - makes OTCM look like its shrinking in recent years, when actually its core business is steadily growing - albeit in lumps. They can raise prices, but not much faster than NYSE or NASDAQ does (~3%/year for the last 10 years).

Another issue is the churn created by companies “graduating” to NYSE or NASDAQ. It almost reminds me of the slogan for “Hinge” you know?

“The app that was made to be deleted.”

Of course, many companies listen on the OTC’s will never scale to the size necessary to justify NYSE or NASDAQ listing, but we still do loose some folks along the way. OTCM claims this as a victory, proof that this bridge “platform” serves the companies who chose to list on it. And thats true to some extent, but it does sort of bug me.

Perhaps we can take a look at some of these KPI’s over the past decade or so.

First up, Dollar Volume/tier. Here we are looking at the ATS (trading) side of the business. Dollar Volume is a decent indicator of activity on the markets - and therefore trading-fee revenue. You’l notice the “Pink” tier is by far the most active and largest “tier” - hence the addition of OTCID this year (the next annual reports will likely all have an “OTCID” column).

Next, we can look at the overall number of securities quoted on each tier. This is an indicator showing a sort of “mid section” between ATS and “corporate services” side of the business - once again “Pink Tier” is the largest.

Since one corporate client can list multiple securities, its also probably good to take a peak at individual corporate clients on each tier. This will give you an idea of the actual growth in “corporate services.”

As I mentioned earlier, there are some clients who “move on” to the large exchanges each year. The below chart will give you a picture of the base-line attrition/churn for the corporate services segment:

And finally we can look at the market-data licensing side of the business. Notice the very small, but growing “Market data compliance file users” portion of the business. You’ll also see that “Non-Pro-Users” fell sharply after the retail frenzy of 2020/2021 died off, but the professional users glided on by:

So look, we can see this business is growing. Moreover, i’m quite bullish on the introduction of OTCID. I think it will not only drive new revenue straight to the bottom line, but I also think it will generate more activity due to the sudden “viability” of securities that used to be scattered among junk “shell corporations.” This would naturally increase the amount of trading and likely also increase the market data-licensing side of the business. I could also imagine it will grow that tiny “compliance” portion of “market data licensing.”

Part 6: Conclusion: What I’m doing

I’m not gonna lie, I regret not purchasing more of this when I had the chance. What stopped me was the combination of not fully understanding the growth story going forward, and management’s preference for dividends over buybacks. In my mind this company was/is cheap, and so I honestly believe buybacks would be the way to go. I’ll also note again there is some key-man risk here? The founder and CEO is also by far the largest shareholder and essentially controls the company. The good news is he’s singing all my favorite songs. He talks about “disciplined capital allocation” and not wasting shareholder cash to try and impress on the top line. Ultimately, it seems as though management understands that this business is lumpy, and they’re ok with that (as am I).

Its not that much more expensive that when I bought it? But I find myself hesitating to sell anything else in order to buy more of this. At $60/share its close to its all-time highs, and some of my other ideas (Pool Corp, EXP, AMR, HCC) are still just more attractive (to me) at these prices. Plus I like everything I own!

Still, this business is awesome. The positioning is amazing - basically no real competition, and the economics are sooo nice. Its not an exchange, but its definitely got every quality one loves in the exchange business. Its a royalty on public markets and trading for a chill enough price. Capital returns to shareholders are the norm, and the balance sheet is clean as a damn operating room. So much to love, and i’ll be keeping my eye on any price movement to the downside here. If it drops, i’ll likely double my current allocation - depending on if I can find something to sell.

I’ll be watching migration from “Pink” to OTCID closely as this is likely the most important indicator of how they’ll do over the next 3 years.

Its not an exchange…its a cash machine

Talk to ya later

-MoS

Disclaimer: Not investment advice. This publication is for education and entertainment only. Nothing here is an offer, solicitation, or recommendation to buy or sell any security. I may own (or short) securities mentioned and may change positions at any time without notice. Investing involves risk, including loss of principal. Do your own research and consider speaking with a licensed adviser who knows your situation.