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 (AMTD), E*TRADE (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 (NYX.DL) 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 (JEF), Blackstone (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.
