'Some Value' Left in Knight Capital: Analyst (Update 2)

By Philip van Doorn - 08/02/12 - 1:25 PM EDT

Tickers in this article: KCG

Updated with comments on Bloomberg TV from Knight Capital CEO Thomas Joyce, and comment from KBW analyst Niamh Alexander.

NEW YORK (TheStreet) -- While Knight Capital Group seems to be in the midst of a meltdown, Stifel Nicolaus analyst Matthew Heinz still sees "some value" left in the firm.

After falling 33% on Wednesday, after a morning trading glitch affected some 150 individual stocks, with the Securities and Exchange Commission halting trade on several and announcing an investigation, Knight Capital early on Thursday announced a $440 million pretax loss from the event.

Knight Capital's shares were down another 50% in morning trading, to $3.56.

The Jersey City, N.J., firm -- headed by executive chairman and CEO Thomas Joyce -- said that its "clients were not negatively affected by the erroneous orders, and the software issue was limited to the routing of certain listed stocks to NYSE," and that it had "traded out of its entire erroneous trade position." While the firm's broker-dealer subsidiaries began operations Thursday "in full compliance with their net capital requirements," Knight Capital was "actively pursuing its strategic and financing alternatives to strengthen its capital base."

Heinz lowered his rating for the Knight Capital Group to "Hold," from "Buy," saying that if the firm were to sell to a competitor, it would be worth "approximately $3.40" a share.

The analyst said that he continues "to see value in the firm's business lines, particularly in its electronic execution services segment where we estimate ~$60M of earnings before interest, taxes, depreciation and amortization, or EBITDA for 2012."

"Under normal circumstances," Heinz said, "we could argue for a 12x multiple on this business given its growth and margin expansion potential, but would give any purchase multiple a 25% discount." At nine times his EBITDA estimate for the electronic execution services (EES), Heinz would value this portion of Knight Capital's business at $540 million, or $5.50 a share.

Applying a 50% discount to an estimate $280 million valuation for Knight Capital's market making business, Heinz arrived at a total value of $820 million, for a takeout value of $340 million, or roughly $3.40 a share, after netting-out the $440 million trading liability and $40 million in net debt.

In an interview on Bloomberg TV, Joyce said that the trading problems on Wednesday occurred after "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, so we ended up with a large error position which we had to sort through the balance of the day."

Joyce said that Knight Capital is "very confident in the current operating environment we've reestablished."

When asked about the company's efforts to shore up its capital, Joyce said "it is hard to give anybody a timeline when you are working through it, but we are focused and doing all the work I believe need to be done as we speak. We're kind of pushing ahead and we hope to have the news and then we will share it immediately with our shareholders, our regulators and stakeholders."

KBW analyst Niamh Alexander on Thursday said that "the Board needs to sell this company ASAP in our opinion if it can't get private financing to shore up capital," adding that "there are buyers, this business has attractive assets," and that "continuing independently will be challenging without more capital."

Alexander rates Knight Capital "Market Perform," and lowered her price target for the shares to $4, or less than 50% of an estimated revised tangible book value of $8.50.

According to Alexander, potential acquirers for Knight Capital Group include Goldman Sachs , Credit Suisse , and Cantor Fitzgerald, all of which "recently expressed interest to expand into wholesaling organically." The analyst said that KBW would potentially consider JPMorgan Chase , Interactive Brokers Group , or Jefferies , to be buyers "as they would likely be interested in the trading technology and the retail wholesale network while also potentially eliminating a competitor in the trade execution institutional business."