Knight Capital units could fetch $1.4 billion, analyst says

By Bloomberg News
on November 27, 2012 at 9:40 AM, updated November 27, 2012 at 10:02 AM

Jersey City's Knight Capital is expecting a buyout offer this week following a massive trading glitch that took place in August. Jin Lee/Bloomberg

Knight Capital Group Inc., awaiting acquisition proposals as early as this week, may command as much as $1.4 billion based on the value of its biggest businesses, according to Keefe Bruyette & Woods Inc.

Knight’s market-making and institutional sales units are worth $1.71 to $2.49 a share, and its electronic execution operations 89 cents to $1.25 a share, based on a sum-of-the- parts valuation by KBW analyst Niamh Alexander. That’s equal to $950 million to $1.37 billion for a buyer, according to data compiled by Bloomberg that assumes 365.6 million Knight shares outstanding after the conversion of preferred stock.

Getco LLC in Chicago and New York-based Virtu Financial LLC are likely bidders for Knight, which dodged bankruptcy in August after losing $457 million in a trading error, a person with direct knowledge of the matter said Nov. 25. The company, founded in 1995, was bailed out by six financial firms including Getco, which bought a combined $400 million in convertible securities and owned more than 70 percent of the company.

A sale of the market-making division “could make sense strategically if the unit is for sale,” Alexander wrote in a report dated Nov. 25. The analyst upgraded the stock to market perform, the equivalent of a hold, from underperform with a price estimate of $2.60. “We think it’s possible that various suitors are still bargain hunting or looking to do a deal with KCG,” she wrote, referring to the company by its ticker symbol.

Stock Gains

Knight spokeswoman Kara Fitzsimmons and Sophie Sohn, a spokeswoman for Getco, declined to comment. Douglas Cifu, president and chief operating officer of Virtu, didn’t return calls seeking comment.

Knight shares gained 4.6 percent to $2.95 at 9:52 a.m. in New York today, adding to a 13 percent advance yesterday. It closed at $10.33 the day before the trading error. While the value of Knight’s shares trading publicly is about $500 million, its equity is worth roughly twice that when convertible securities granted to its rescuers in August are included.

The company is probably worth $3.09 a share, or about $1.1 billion, based on $750 million for the market-making business and $350 million for the electronic execution unit, Christopher Allen, an analyst at Evercore Partners Inc. in New York, wrote in a Nov. 25 note. He raised his price forecast for the stock to $3.

Weekend Negotiations

Jersey City, New Jersey-based Knight expects offers this week with negotiations for an acquisition occurring as early as next weekend, according to the person with knowledge of the matter, who asked not to be named because the discussions are private. The Wall Street Journal reported Nov. 23 that Knight expected offers for its market-making unit.

It will be up to Knight’s board to decide how to structure a deal and transactions could be anything from separate sales, an acquisition or a merger in which an acquirer gains a public listing, Allen said in a phone interview.

“If those players wanted to go public, that would be an interesting way to go about it,” he said about Getco or Virtu. Neither company is likely to be interested in Knight’s institutional equities and fixed-income trading businesses handled by humans, he said.

Getco, Virtu and Knight are designated market makers on the New York Stock Exchange or NYSE MKT. After Barclays Plc, Getco is the largest by the number of companies it represents on the Big Board, according to NYSE Euronext. Knight is the fourth biggest. Virtu has the most companies on NYSE MKT, formerly known as the American Stock Exchange, and a few NYSE corporations. Knight is the second-largest designated market maker on the MKT exchange.

Market Making

In the first half of this year, Knight’s market-making unit posted pretax earnings of $51.1 million, or 86 percent of the company’s total, according to a statement. Institutional sales and trading generated $7.2 million in the first six months of this year. Electronic execution services had pretax earnings of $23.6 million while the company’s corporate division had a loss of $22.5 million before taxes.

Knight spent the last decade expanding from a market maker that mainly handled orders from individuals sent by brokers to a financial services company with institutional clients, electronic trading services, and businesses in fixed income and currencies. The company provides research and asset management and got into the reverse mortgage business in 2010.

It acquired Hotspot FX, the foreign-exchange trading platform, in 2006, and could sell it to an exchange, Allen said. It also owns 19.9 percent of Direct Edge Holdings LLC, which operates two U.S. equities exchanges.

Knight’s future value “would depend on what the private businesses look like, what actions they’d take to improve profitability in the other Knight businesses and what would be their capital-return plans going forward,” Allen said.