Knight Capital Group Conquered By Getco But Questions Linger

Knight Capital Group Conquered By Getco But Questions Linger
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Knight Capital Group Conquered By Getco But Questions Linger

Knight Capital Group Inc. (NYSE:KCG) has agreed to be acquired by Getco following a highly-publicized bidding war between high frequency trading firms Getco LLC and Virtu LLC. The Wall Street Journal is reporting that Getco will pay $3.75 per share in cash for around two-thirds of the outstanding shares of Knight not currently owned by Getco, with the remaining Knight Capital Group Inc. (NYSE:KCG) shares converted into equity in a combined publicly-traded Knight/Getco entity.

According to the initial offer terms, Getco would receive 242 million newly issued shares in the combined entity, as well as receive a series of warrants at escalating prices and tenures. Investors expect final deal terms to be released sometime this morning, and are hopeful that Getco will publish its financial statements as well.

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A fair valuation for Knight, probably

There is a widespread belief that Knight Capital Group’s intermediate-term earnings power was significantly harmed due to share dilution related to its August 1 trading error as well as depressed industry-wide trading volumes. As a result, it is not a strech to say that an acquisition price of $3.75 per share greatly surpasses what Knight Capital Group would likely have garnered over the next year as a stand-alone entity as well as its tangible book value per share of $3.26.

That said, a key component to the deal is equity in a combined Knight Capital Group Inc. (NYSE:KCG)/Getco entity, and no one can reasonably estimate a valuation on that entity as investors have yet seen Getco’s financial statements.

Subsidiary sales likely

Some believe that Getco will look to sell several of Knight Capital Group’s businesses in the near term, including its BondPoint and HotspotFX trading platforms.  Earlier this week, analysts from Wells Fargo noted that  NASDAQ OMX Group, Inc. (NASDAQ:NDAQ) had expressed interested in acquiring Hotspot FX from KCG. Hotspot is the company’s electronic foreign exchange trading platform. KCG does not disclose specific financials for Hotspot. However, it is a part of the company’s EES segment which reported LTM EBT of roughly $40MM. Assuming Hotspot accounts for 25% of segment EBT ($10MM), Wells Fargo analysts think it could be worth $7090MM to a potential buyer at a 79x EBT multiple (1214x EAT).

There could be multiple bids for the two electronic trading businesses, and some analysts have pegged the estimated potential valuations of around $250 million for both platforms. Getco could explore a sale of Knight’s Urban Financial reverse mortgage business, although many are skeptical as to whether a buyer exists for that business.

Cost reductions also likely

Although Knight operated a reasonably lean operation, a combined Knight/Getco would likely have significant redundancies of trading technology, communications, and occupancy expenses, as well as potential back-office personnel synergy opportunities. Knight Chairman and CEO Tom Joyce has been offered the role of non-executive chairman of the combined entity.

Disclosure: No position

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