Knight Capital Group Sale Rumors: What is the Company Worth?

After rumors started this past weekend of a potential sale, shares of Knight Capital Group Inc. (NYSE:KCG) are actively trading on Monday.

As of 3:00 p.m. ET, the stock is up 18.07 percent, trading at $2.94.

On Saturday, the Wall Street Journal reported that the firm was holding talks to potentially sell its large and profitable market-making operation.

From 2009 to 2011, the unit had pretax profits of $663.8 million, but in 2012′s first nine months, it incurred a $400.9 million loss due to a software glitch that resulted in erroneous trades back on Aug. 1.

Two rivals, Getco LLC and Virtu Financial LLC, have supposedly approached the firm about a possible sale and they are expected to submit proposals this week.

Early on Monday, CNBC reported Knight Capital Group Inc. (NYSE:KCG) is receiving offers from the two firms, as well as other ones to maybe purchase the entire company. Terms have not been disclosed, but a $600 to $700 million purchase prices is possible.

According to FactSet, Knight has a current market cap of $431 million.

In addition to all of the media reports, research firms put together Knight Capital Group Inc. (NYSE:KCG) reports on Monday and we’re looking at two: Evercore Partners Inc. (NYSE:EVR) and Wells Fargo & Company (NYSE:WFC).

Highlights from Evercore Partners Inc. (NYSE:EVR) report, Sale Imminent?, includes a discussion on price targets and earnings forecast changes.

Increased Price Target

• We are raising our price target for Knight Capital Group Inc. (NYSE:KCG) to $3 from $2.10, reflecting our SOTP implied valuation. This represents an approximate 17% premium to our raised 2013 tangible book estimate ($2.55, up thanks to a $174m tax benefit KCG is expected to receive in 1H13). KCG is currently trading at 12x our 2013 estimate and 0.76x TBK ($3.26).
• Our $3.00 price target represents a 14x multiple of our 2013 EPS estimate and 1.2x our 2013 estimate of TBV ($2.55).

Sum of the parts analysis

• The environment and Knight Capital Group Inc. (NYSE:KCG)’s missteps have created challenges across KCG’s segments, but the firm still has valuable marketmaking and electronic execution businesses. Based on a sum of the parts analysis, we estimate a fully-diluted value of $3.09/share.
• We reach this valuation by applying a 9x multiple on the market making business (on estimated 2013 earnings of $84m) and a 12x multiple on the electronic execution business (on estimated 2013 earnings of $29m).
• The institutional sales and trading business has been breakeven at best. We suspect that in any transaction this business would be largely shut down. Therefore we are not assigning any value in our sum of the parts analysis.

Fourth quarter outlook

• October volumes ($20.0b) were higher than expected on improved market share (9.8% up from 9.1% in prior month), and November industry activity is currently tracking at a 7% sequential increase.
• Our 4Q estimate for KCG’s avg. daily dollar volume traded stands at $19.6 billion, which represents a 15% decline YOY and a 17% sequential rise. In terms of the capture rate, we are forecasting a 4Q capture rate of 1.04bps, in-line with 3Q12 levels, but if intraday volatility continues to improve through the quarter, there could be upside to our estimate.
• In 4QTD, intraday volatility has increased, averaging 1.12%, up from 3Q12 levels of 0.94%. Our 4Q EPS estimate stands at a $0.00, compared to consensus estimates of $0.03.

In the Wells Fargo & Company (NYSE:WFC)’s report, KCG: Reportedly In Discussions To Sell Market Maker, it highlights the SEC investigation, earnings estimates and book value.

• A Knight Capital Group Inc. (NYSE:KCG) market maker sale could be complicated by an SEC investigation into the company’s August trading mishap. Also noteworthy, KCG’s CEO employment contract expires at year end.
• Per the Wall Street Journal story, people close to the discussions said one possibility is for the CEO to stay on as the head of the smaller entity.
• KCG’s market making business is its largest business unit accounting for 50% of revenues and nearly all of its 2011 profit.  We are estimating the market maker to earn roughly $120MM of pretax income in 2013 or $73MM after tax.
• This could be worth between $500 to 600 MM to a buyer at 78xnet income or $1.40 to $1.60 per KCG share.
• KCG’s tangible book value per share was $3.26 at September end (stock closed at $2.49/share on Friday). It could be argued the firm should be valued higher under a breakup scenario but a lot depends on the offer for the market maker.
• While our breakup value is not dissimilar to where KCG’s stock is currently trading, the WSJ story could have some positive impact on the stock today.