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.
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 (UNKNOWN:JEF.DL), which led the post-meltdown investment round in Knight, along with finance heavyweights Blackstone (NYSE:BX) and TD AMERITRADE (NASDAQ: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.
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.