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Will Knight Capital Get Bought Out?

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We're not even six months out from the trading disaster at Knight Capital  (NYSE: KCG  ) and the company may be preparing for its big move: selling itself. Or, at least, a big chunk of itself.

According to The Wall Street Journal, the company may be getting bids from competitors Getco and Virtu Financial this week for its market-making unit. That's the same unit that cost the trader more than $400 million and nearly snuffed it out of existence. However, it's also the unit that accounts for most of Knight's profits and makes the company an attractive investment at all.

In 2011, Knight's market-making business accounted for $705 million of the company's $1.4 billion in total revenue. Meanwhile, the segment delivered $256 million in pre-tax profit versus $187 million for the entire company. Knight's electronic execution services business contributed roughly $50 million in pre-tax profit, while the institutional sales and trading and corporate divisions lost $44 million and $74 million, respectively.

Those results speak to the quality of Knight's market-making unit. With deep relationships with major retail trading houses like TD AMERITRADE (NYSE: AMTD  ) , E*TRADE (Nasdaq: ETFC  ) , and Vanguard, the business is a leader in the industry. To be sure, it's also a business with challenges ahead -- with the NYSE Euronext's (NYSE: NYX  ) Retail Liquidity Program as one notable sign of the changing landscape. But those challenges may only make a tie-up between Knight's market-making group and a competitor like Getco all the more enticing.

If you're an investor though, it's a bit of a complicated situation. The upside to selling the market-making unit would be the short-term pop as the valuation for the business gets factored into the stock. And, in all likelihood, if the company is considering selling its crown jewel, the rest of the company may be -- or, at least, may soon be -- on the market as well, and that sale could also provide a pop.

But remember that the lion's share of the company is now owned by the consortium -- Jefferies  (NYSE: JEF  ) , Blackstone  (NYSE: BX  ) , Getco (yes, the same Getco), et al. -- that bailed out Knight after its trading disaster. With their shares convertible at $1.50, they wouldn't need to sell the company for any more than its current price to see an impressive return on their investment. 

Looking out longer term, I'm not crazy about about Knight's business, even if I do think highly of the company's CEO. That said, my fellow Fool Tyler Crowe argued that Knight's current valuation suggests the stock should be headed higher. A sale, then, could be the right solution for investors -- a way for the stock to be revalued at a more reasonable price without investors having to wade through the challenges headed Knight's way. This may seem far from ideal to investors that owned pre-meltdown shares at $10-plus, but when a $1 billion company loses $400 million or so and has to take a highly dilutive bailout, a hefty loss will usually be in the cards.

A better long-term bet?
Goldman Sachs 
(NYSE: GS  ) may not be the epitome of a safe, transparent financial company to invest in, but with its stock trading well below historic norms, could it be a better bet than Knight in the years ahead? To help figure out whether Goldman Sachs is a buy today, I invite you to read our premium research report on the company today. Click here now for instant access.

Read/Post Comments (3) | Recommend This Article (3)

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 November 26, 2012, at 1:21 PM, gallery79 wrote:

    Any advice on what to do if I own this stock? I bought it post-meltdown, hoping for easy money on a recovery. I bought at $3.10, and it's almost back up to that. Should I sell now and reduces losses, or is there a good chance of it going up much more? Generally, what happens to stock prices of a company when it gets bought?

  • Report this Comment On November 26, 2012, at 1:48 PM, TMFKopp wrote:


    *If* there's a buyout, the hope would be that the buyer would have to pay a premium over today's prices. So that could work out in your favor. As I noted in the article, the bailout group came in at such a favorable price that they don't have to push for a particularly high price to end up with a great return on their investment, but that's not to say that they won't still try to get as much from a buyer as they can.

    The risk that you run is that what can happen in these situations is that excitement builds over a potential buyout and if it doesn't happen, the stock can fall back below what it was fetching prior to the buyout talk. For that reason, it's helpful to anchor around something to help guide you on buy/sell decisions. In this case, I don't think using tangible book value is a bad idea -- that's what Tyler Crowe used in his article (

    Everyone's situation and risk tolerance is different, but if it were me, I'd probably try to wait on a price that was around tangible book value per share (with the bailout shares are factored in of course) or a slight premium to that.

    I'd encourage you to go back and take a look at Tyler's article for more information on looking at this from a tangible-book-value perspective.

    Hope this helps!


  • Report this Comment On November 26, 2012, at 2:13 PM, gallery79 wrote:

    Great. Thank you for the advice. This is the first time I've owned stock of a company (potentially) being bought out. Much appreciated.

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