Does Tom Joyce Make Knight Capital a Buy?

Knight Capital  (NYSE: KCG  ) finished the third quarter in the red to the tune of $390 million. That's awful, but it should be little surprise to investors.

The loss was driven by the epic meltdown that Knight experienced back in August, when its trading software went haywire, started firing off an untold number of unwanted trades, and saddled the company with huge stock positions that led to massive trading losses. Pre-tax, Knight took a $461 million loss tied directly to the technology issue. In addition, the accounting treatment of the rescue investment in Knight led to a $3.08-per-share non-cash hit to the bottom line.

The man at the top
In the wake of Knight's knightmarish (pun alert!) trading issue, many analysts and pundits credited the company's CEO, Tom Joyce, with saving the company. Not only did Joyce's long career in financial services give him a fat list of names to tap when Knight needed money, but the fact that he's generally viewed as a trustworthy, stand-up guy made investors more likely to pony up capital to save the staggering trading house.

Though perhaps subtle, I read Knight's Q3 report as an underscore of Joyce's style. It's clear, it's straightforward, and it doesn't try to weasel its way around the fact that the company screwed up in a big way. As we look ahead to the coming quarters, I have little doubt that the faith that Knight's customers have in Joyce will lead to a rebound in activity after a post-chaos lull.

However ...
Among everything else Warren Buffett has said, he's noted something to the tune of this: "When a top-notch manager meets a lousy business, it's usually the business that wins."

While I -- and it seems many others -- have a lot of respect for Knight's Joyce, I can't help wondering whether he's that good manager slamming head-on into a cruddy business. Market-making drives Knight's business, and it just ain't what it used to be. And while the market-making business should easily get back to core profitability next quarter, it's notable that Knight's market-making and institutional sales and trading arms took non-cash writedowns during the quarter. Investors often overlook writedowns like these, but because they are related to management's internal valuations, they can be a sign that the outlook isn't as bright as previously thought.

Investment bank Jefferies  (NYSE: JEF  ) , which led the post-meltdown investment round in Knight, along with finance heavyweights Blackstone  (NYSE: BX  ) and TD AMERITRADE (NYSE: AMTD  ) -- the latter of which is also a major Knight customer -- seem to have faith that this business is a worthwhile investment, but, then again, they got a pretty sweet deal. For the rest of us, it's tempting to want to back a leader like Joyce, but as a long term investment, I'm not crazy about the business here.

Much larger, but troubled in its own way, Bank of America is one of the most talked-about companies in the financial industry. Is B of A a better buy than Knight? To get the lowdown, check out our in-depth company report on Bank of America. The report details Bank of America's prospects, including three reasons to buy and three reasons to sell. Just click here to get access.

Fool contributor Matt Koppenheffer owns shares of Bank of America and Blackstone Group. The Motley Fool owns shares of Bank of America. Motley Fool newsletter services recommend TD AMERITRADE. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 18, 2012, at 7:16 AM, NotTheDroid wrote:

    It started out as a well intentioned article, and then decided to use a few sensationilizing words.

    DId not sync the past with the future. For example, used the past short term loss of institutions, brokerages, for that week... to point to the future. While also using some of the forward looking looking statements to support other thesis and leaving out the forward statement that those customers have returned, revenue from them was up in Sept compared to Oct, and thus, the final thesis failed.

    Overall, one of the better Motley Fool articles I've read in the past 5 years, but I still long for the old days, when there was less sensationalizing and cherry picking of information.

  • Report this Comment On October 18, 2012, at 7:17 AM, NotTheDroid wrote:

    Ugh, correction... to above. Revenue was up in Sept compared to AUGUST.

    Doing too many things at once... and trying to drink my coffee. lol

  • Report this Comment On October 18, 2012, at 10:06 AM, TMFKopp wrote:

    @NotTheDroid

    This isn't just an issue of MM customers backing away in August due to the trading meltdown. This is a much larger issue of the MM and institutional sales businesses not being what they used to be on a big-picture, long-term basis.

    Even shorter term, Knight will be challenged as long as we continue in this lower-volatility environment.

    Matt

  • Report this Comment On October 18, 2012, at 3:33 PM, cbglobal wrote:

    You could have said the same thing about Solomon Brothers in the 1970s. Not only did Buffett buy in; he also became CEO.

    So maybe you are 100% wrong when you quote Buffett.

  • Report this Comment On October 19, 2012, at 3:05 PM, TMFKopp wrote:

    @cbglobal

    Solomon Brothers was a poorly run investment bank. You're talking apples and oranges here.

    Matt

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