What to Do About the Knight Capital Buyout Battle

It's looking more and more likely that Knight Capital  (NYSE: KCG  ) is going to have a new owner, and it's going to get that new owner in relatively short order. As privately-held Getco and Virtu Financial battle over the opportunity to take over Knight, investors are caught in the middle, trying to figure out whether to buy, sell, or sit tight. 

What's the right move?

A look at the deals
The reason the decision for investors is particularly difficult here is that these aren't two offers that can easily be stacked against each other. If there's a takeover battle, and one company offers $10-per share in cash and another offers $11 in cash, it's easy to tell which is the better deal for shareholders.

In this case, Virtu has reportedly offered to buy Knight for $3-per share in cash. This is an easy deal for investors to understand -- they get $3, Virtu gets the company, and that's that.

Meanwhile, Getco has offered a deal valued at $3.50 per share. At first glance, that may seem like the obvious choice for shareholders. However, the Getco deal is only partially in cash. The rest of the deal value comes from the fact that Getco would execute a reverse merger with Knight -- which would make the combined company a publicly-held company -- and current shareholders would get a stake in the new company. 

To facilitate the deals, Virtu is reportedly getting financing from Credit Suisse  (NYSE: CS  ) , Barclays  (NYSE: BCS  ) , and Citigroup  (NYSE: C  ) , while Jefferies  (NYSE: JEF  ) is supplying Getco with financial backing. Both Jefferies and Getco own a stake in Knight following its epic August trading meltdown.

Which to root for?
Obviously, the deal to root for is one that you think will give you the most value for the Knight shares that you currently own. Virtu's offer makes that value very clear. The value of Getco's, meanwhile, depends a lot on how you view the future of a combined Getco/Knight.

As it currently stands, I think that the Getco offer may be the preferable one. If Knight's going to get bought out for cash, I think it'd be reasonable for the acquirer to pay tangible book value -- which, at the end of the third quarter, was $3.26. Virtu's offer undershoots that; while the Getco offer has more risk to it because it's partly in shares of the new company, it looks preferable for now.

That said, I don't think the volleys are over and done with and, before it's all said and done, I wouldn't be surprised if we see Virtu's cash offer come up. At the point that that crosses tangible book value, that offer becomes a lot more interesting.

Pulling the strings
We do need to bear in mind here that the parties that have the biggest say in this process are not the investors that backed the company prior to the trading disaster. Thanks to the big bailout in August, the new owners -- which include Getco, Jefferies, Blackstone  (NYSE: BX  ) , and TD Ameritrade  (NYSE: AMTD  ) -- will have key votes in this buyout.

We have a pretty good idea, at this point, which way Getco and Jefferies are likely to lean, but it's questionable whether the others involved would want to hang on with an investment in the new company, or just get cash and take their gains. My bet is that they'd be amenable to continued ownership -- in the case of Blackstone, at least, there had been rumors previously that it was interested in buying Knight -- and that works in Getco's favor.

With all of this in mind, I'm inclined to think that Getco has an edge in the bidding process. But if Virtu gets more aggressive with its offer, it could easily pull off an upset.

Your three choices

  • Buy: I'm not keen on speculating on takeovers, so investors should only really be buying here if they think Getco's bid will get the nod, and they like the long-term prospects of the combined Getco/Knight.
  • Sell: If you're iffy on owning Knight in the first place and have been looking for an out, this might be it. At the time of this writing, the $3.36 that the stock is trading at gives investors a slight premium over tangible book. Selling would also be the play if you think Virtu will somehow pull off the deal with its current $3 offer.
  • Hold: The more this process unfolds, the more confident I've become that somebody is about to buy Knight. I also think it's reasonable to think that that somebody is going to pay at least tangible book. For that reason, I think most current shareholders may be best off simply sitting tight for now and letting the process play out.

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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 29, 2012, at 9:36 PM, mashiach wrote:

    Fool LOSER.... Both offers should be rejected...why should the stock holder take such low offers...NICE TRY (Trying to help the Big Boys )

  • Report this Comment On December 04, 2012, at 1:27 AM, Lordrobot wrote:

    Neither of these deals are close to the value of Knight. Tangible book is the not the end point but the starting point. Knight can go on by itself. It is larger that either of its suitors and it has corrected its software issue. There is no reason that over time they could not buy back shares and reduce the float.

    A good deal here for Getco would be to push the targets to $5 a share and structure the final stock value at $5 a share with a cash payout of $4. This would accomplish a few goals which would be to increase share participation and to offer .75 cents a share for good will. That is dirt cheap.

    But by keeping the new offering at $5 or over, this would encourage institutional investment. With Knight #1 and GETCO #2, in this market making space it is a very powerful operation with a great forward upside.

    The Grasso deal is dirty. They have already tried to tempt Joyce with an illegal offer as CEO of the new company with the board members coming along for a new IPO. That just fails the stink test and it would create a raft of lawsuits including once from me.

    The Grasso offer will rise to $4 and Getco should follow suit as I have suggested above for the best offer.

    Joyce has to realize that he was part of the Knight trading problem. He is not to be rewarded for killing the company or for making a convertible deal that was way too generous.

    There are other options here as well. There may be other suitors. I would like to see Goldman go after both Knight and Getco with a stock offer no cash at say $10 convertible to Goldman shares. Goldman would take the carryover loss which wasn't even addressed in this naive article and would have a $400 million tax deduction.

    Its a perfect property for Goldman and in the back rooms somewhere they have to be thinking about it.

    Citi could have done a deal but they are fools, TD Ameritrade is timid. JPM should be in there and Jefferies with LUK should make a move on their own.

    Knight is a great company. To start a Knight with all the regulatory and technology involved would be impossible. So to value this company at book shows a real level of mindless ignorance to both M&A, Federal TAX, as well as the dark pool industry. Computer trading is not coming to an end, it is exploding across the globe and Knight and GETCO are at the leading cusp. This is a very valuable operation. The fast deal is intended to steal the company. This is why Goldman and JPM ought to wake up and see the glitter.

    Shareholders should sit pat and even increase their holdings because the present offers will go higher. The Cash deal has no appeal to Knight shares. Knight shares are in here because the future of high frequency trading is huge and it is consolidated in a Knight GETCO merger to a level that is incredible. Knight Getco is an exciting deal but its not quite sweet enough to fly. Not yet. But as I said, if JPM or Goldman wake up from their holiday bonuses, they may realize that this may be their golden moment to snatch both Knight and Getco at the Christmas sale of the century!

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