Hi @sns
Yes, you can use OTP method for external user. According to this article from Microsoft: “Email OTP enables you to collaborate with anyone, no matter where they are in their cloud journey. If your partner organization is not yet in the cloud or in a hybrid environment, on-premises guests can simply sign in with email OTP instead of having to use cloud sync, federation, or another solution.”
Have you shared site with guest users? Per my research guest accounts are created when someone shares a document, folder, or site with an external person.
Settings > Site permissions > Invite people > Share site only
For Reference:
https://techcommunity.microsoft.com/t5/azure-active-directory-identity/azure-ad-makes-sharing-and-collaboration-seamless-for-any-user/ba-p/325949
https://www.petri.com/sharepoint-onedrive-azure-b2b-collaboration
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