OTC Markets Group, the self-proclaimed "investor's marketplace," released its Q1 2024 earnings transcript, painting a picture of international expansion and innovative initiatives. But beneath the optimistic pronouncements, a careful reading reveals a potentially alarming trend: the company's increasing reliance on higher-priced securities to mask a decline in actual trading activity. Could this strategy be setting the stage for a future revenue shock, especially if the current volatile market environment takes a turn for the worse?

On the surface, OTC Markets Group seems to be thriving. The company boasts a robust international trading volume, with non-US companies dominating the dollar volume across all its markets. The allure of trading global companies in US market hours is undeniably attractive, and OTCQX and OTCQB markets are positioning themselves as the ideal conduit for international companies seeking US investor engagement. This global focus, coupled with the introduction of new features like closing cross functionality and ambitious data integration projects, certainly paints a rosy picture.

However, a closer examination of the transcript, particularly the sections concerning OTC Link revenue and trading volume, raises a red flag. While the notional dollar volume traded on the company's ATSs increased by a significant 21% year-over-year, the number of shares executed and the number of trades actually declined. This discrepancy between dollar volume and share volume reveals a crucial detail: OTC Markets Group is becoming increasingly dependent on the trading of higher-priced securities to maintain its revenue levels.

"Antonia Georgieva, the company's CFO, acknowledged this shift in the earnings call, stating, "In this particular quarter, there was a shift towards higher-priced securities, which drove the overall dollar value of dollar volume traded. But at the same time, the number of shares, which is the driver of our revenue, declined." This dependence on higher-priced securities is a double-edged sword. While it currently allows OTC Markets Group to present a positive revenue picture, it exposes the company to potential vulnerability if trading in these high-priced securities slows down, especially in a volatile market environment."

The decline in the number of shares traded is especially concerning when juxtaposed against the company's efforts to increase the number of securities on its markets. Cromwell Coulson, the company's CEO, emphasized this priority in the transcript, stating, "Our near-term opportunity is greater global trading, increasing the breadth and depth of ADRs in foreign ordinary shares traded in US dollars by US broker-dealers, to grow the size of our markets by adding securities, new asset classes, and trading functionality for our broker-dealer subscribers."

While this ambition is commendable, it begs the question: will adding more securities, particularly lower-priced securities, exacerbate the decline in shares traded and put further pressure on revenue per share? The company's strategy seems to be focused on attracting more companies, but without a corresponding increase in trading activity, this growth could become unsustainable, leading to a potential revenue shock in the future.

OTC Link Subscriber Growth

The following chart shows the number of unique broker-dealer subscribers across OTC Markets Group's three ATSs. While the company saw growth in the first quarter of 2024, it's essential to monitor whether this trend continues, especially given the decline in trading activity.

The situation is further complicated by the ongoing integration of Edgar Online, a significant acquisition that promises to revolutionize OTC Markets Group's data capabilities. While the long-term potential of this integration is undeniable, the process has proven to be complex and costly, contributing to the company's increased expenses in 2023. In the earnings call, Cromwell Coulson candidly admitted, "Moving Edgar Online technology out of their data center to the cloud, addressing operational inefficiencies and pain points has been a long process."

The integration is a multiyear project, and until it is completed and the expected synergies realized, it will continue to weigh on the company's expenses and potentially impact profitability. This prolonged integration process adds another layer of uncertainty to the company's future performance, making it difficult to predict when, or if, the anticipated benefits will materialize.

Adding to the intrigue, OTC Markets Group faces another challenge: a regulatory inquiry from the SEC regarding certain OTC Link policies and procedures related to suspicious activity reports. While the company has taken an accrual and expects to reach a settlement, the situation underscores the increasing regulatory scrutiny of alternative trading systems. Navigating this complex regulatory landscape will require significant investment in compliance and supervision, adding pressure to the company's cost structure.

"Fun Fact: OTC Markets Group operates the largest electronic interdealer quotation system in the United States, connecting over 10,000 subscribing broker-dealers across its three ATSs. This vast network plays a vital role in providing liquidity and transparency for thousands of securities."

Despite the company's emphasis on international expansion and its commitment to providing superior shareholder returns through dividends and buybacks, the reliance on higher-priced securities, coupled with the uncertainties surrounding the Edgar Online integration and regulatory inquiries, raises concerns about the long-term sustainability of OTC Markets Group's revenue growth. Investors should carefully monitor these developments and assess whether the company's strategic initiatives are effectively addressing these potential vulnerabilities. The future of this "investor's marketplace" may hinge on how successfully it navigates these challenges and translates its ambitious vision into tangible, sustainable results.