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 (NASDAQ: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.