Saturday, August 4, 2012

Knight equity is an interesting market situation

Read, understand and consent to the blog's DISCLAIMER here before proceeding to read the article

While the investment is very risky, consider the following points:
1. They have identified the root cause that caused the one-time loss. CEO said "we put in a new bit of software the night before because we were getting ready to trade the NYSE's [Retail Liquidity] program," and that a "major bug" in the software "sent into the market a ton of orders, all erroneous"
2. They have identified $loss
3. They have convinced some of their clients  like TD ameritrade to come back. It appears this happened late friday. So as of friday, their market making volume was 2% vs their normal 20% in NYSE stocks. Of course not all clients are back.
4. Consider the fact that they have 17 years of almost glitch-free support to their clients. That IMO makes a strong case of goodwill for their remaining clients to get back. CEO appears to be a great crisis manager
5. $10 was market cap before err, $4.9(one time-time loss) . +v pre-tax earnings of >$2 per year
    Cash = $4. Net of one-time loss , Tangible book value = $7 
   One would think $2 capital injection should suffice to bring confidence
6. The future key here is what testing conditions/controls will they put that will 100% eliminate glitch causing an error of such magnitude. This is of course to bring confidence in all clients/counter-parties to come back and use Knight. I think they will likely assure all clients that until such a thing is done, no new s/w will be added to the current environment.
7. Will they cure this situation without significant hit to equity ?
     Likely IMHO. Commonsense would say
     1. Knight would  be prepared for crisis. Actions of CEO hiring Goldman and getting this in control in 2 days. Look in this video how cool this ceo is(or wants to portray) in the middle of this
     2. So their crisis management would be prepared how to get capital
     3 Knight should understand capital markets and auctions all too well . They are in the business of market-making. While time is exactly not on their side(esp for confidence building), they should know how to get buyers in a table and start competitive bidding for getting capital.
     4. Co-founder says no white knight needed - 
8. KCG traded 121m shares or ~1.3 times it's outstanding shares and went up 56% on friday.
9. Major Direct Holders (Forms 3 & 4)
JOYCE THOMAS M (CEO)467,788Jan 30, 2012
SOHOS GEORGE541,281Jan 30, 2012
SADOFF STEVEN J372,895Jan 30, 2012
BISGAY STEVEN139,177Jan 30, 2012
MAZZELLA JOSEPH102,872Jan 30, 2012
Co-founder came on cnbc and said he is buying shares and has significant 6-figure in number of shares. He also appreciated the current ceo's crisis management.

10. Converts traded up from 40 cents to 70 cents. Apparently there is language in the converts that they are protected and would be paid at par value in case of an acquisition.

Key Risks:
1. If they can't convince all their clients to come back (low probability considering their 17 year track record and considering they have identified the root cause)
2. Future liabilities like regulatory fines, costs for additional controls, if any, unknown
3. The future risk is what testing conditions and controls will they put that will 100% eliminate glitch causing an error of such $ magnitude. If they cannot do this, then they are always open to the risk of 2 hours of error eroding their business completely.

Knights June IR presentation-

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