Knight Capital Sale Only a Matter of Time

Under normal circumstances, tonight’s annual Christmas Party for the employees of Knight Capital (NYSE:KCG) would be a joyous event; executives indulging in good food and stiff drinks at the elegant Lighthouse at Chelsea Piers in Manhattan while overlooking the Hudson River isn’t a bad way to end the year.

But these aren’t normal times for the 1,400 or so employees of Knight; a trading error in the summer nearly destroyed the firm. A last-minute rescue by a coterie of investors saved Knight from extinction but at a huge price: The bailout -- which raised capital through the issuance of convertible stock to a new batch of shareholders -- badly diluted existing ones.

Shares sank to around $2.50 from around $10 before the trouble started. They have popped back up to around $3.30 but only after two firms made bids to buy Knight, all but guaranteeing this holiday party will be the last one for the firm, at least as an independent company.

People who follow Knight say the deal could be consummated as early as this Monday, but talk to executives at the firm and they will tell you that they still believe the firm’s chief executive, Tom Joyce, will hold out for more money, and rebuff the bids offered by two outfits that specialized in so-called high-frequency trading: Getco LLC., and Virtu Financial.

Virtu has made an all cash bid of between $3 and $3.20 a share for Knight, and according to people close to the firm and it has assembled strong financial players to back its offer. Virtu executives say private equity powerhouse Cerberus has agreed to contribute at least $200 million to the deal.

Getco’s bid is more complex for investors to digest; it is offering a combination of cash and stock it says is worth $3.50 a share. But what gives this bid strength is that both Getco and its adviser, Jefferies Group (NYSE:JEF), control close to 40% of Knight’s stock since both were part of the team of investors that bailed out Knight after that now infamous trade landed the firm perilously close to insolvency.

“Tommy is telling people he can walk away from this deal,” said one Knight employee who spoke on the condition of anonymity. “First we’re making money and we were making a lot of money before the trading screw up. That’s why he’s telling people maybe the firm is worth $4 or $5 a share. He’s also saying that this isn’t all about the stock price; he’s thinking about the employees as well.”

But analysts who cover the company, as well as major investors who were part of the bailout team, say a sale is coming, the only question is when -- and employees can expect significant layoffs. They say most of the firm’s new investors have board seats and want a deal so they can cash in on their investment.

The price, they say, isn’t likely change much since no other public bidders have emerged, though it might not matter; the new investors hold the preferred shares that convert to common stock at $1.50 a share so either of the current bids is likely to result in a huge payday.

Employees of Knight will not be faring as well. Both Virtu and Getco are likely to shut down businesses or sell some off (the firm’s foreign exchange ECN HotSpot FX is being eyed by the Nasdaq Stock Market), resulting in significant layoffs once the merger is complete. Both companies are really only interested in Knight’s flagship business of market making, or matching buyers and sellers of stock trades supplied to it by retail brokerages.

As for Joyce, under the Getco bid he is out of a job. Virtu has said it will make him CEO of the new Knight unit of Virtu, but people close to the deal say they are likely to push him out after a period of transition.

So when is a deal coming? Knight officials didn’t return telephone calls for comment, and some speculate that the due diligence could take the rest of the year. Meanwhile, another potential suitor might come along; TD Ameritrade, also part of the bailout group, expressed some interest in placing a bid early on. If Joyce did walk away from the current offers, shares of Knight would drop back to $2.50, almost guaranteeing shareholder lawsuits.

In other words, the only question is when Knight ceases to remain independent. What a way to celebrate Christmas.