Analysts Say Sharp Knight Discount Is Sensible

Knight Capital Group Inc shares rebounded on Tuesday after a rescue deal that undercut existing investors and left a number of open questions about the embattled firm's valuation and plans.

Knight shares were initially down in premarket trading before rising 3.6 percent to $3.18. One week ago, before a devastating trading loss caused by a software glitch, the stock traded above $10.

On Monday, Knight kept its doors open because of a $400 million rescue from a consortium of investors, who will now own 73 percent of the equities market maker.

While the deal comes at a steep cost for existing investors by diluting their stakes, it was a home run for the consortium. Those investors can convert their preferred stock to common at $1.50 per share, half of where Knight is trading now.

Jefferies Group Inc led the investment, which included Blackstone Group LP, rival market maker Getco and financial services companies TD Ameritrade Holding Corp , Stifel Nicolaus and Stephens. Blackstone, Getco parent General Atlantic and Jefferies will get board seats.

For other investors, though, the question is how much Knight is actually worth, given its current circumstances. KBW analyst Niamh Alexander assigned a new price target that is 75 percent of tangible book value; before the loss, Knight traded at 90 percent of book.

"We use a higher discount to (book) than historically to reflect the higher risk profile of the earnings after now two consecutive months of outsized trading losses, and as well as the liquidity and dilution and risk of shareholder lawsuits," Alexander said in a note on Tuesday.

Alexander's analysis matches that of Barclays Capital analyst Roger Freeman, who in a note on Monday also suggested that a valuation around 75 percent of tangible book value was reasonable in light of Knight's situation.

Knight Chief Executive Officer Thomas "TJ" Joyce said on Monday that the firm would look at its business units over the next few months and decide whether all of the parts should remain in place.

JPMorgan analysts have suggested that investors will look at Knight only as the sum of its parts, in expectation of an eventual breakup. Among the most attractive assets are foreign exchange platform Hotspot FX and Urban Financial, the second-largest reverse mortgage lender in the United States.

Knight has been the largest U.S. provider of retail market-making in New York Stock Exchange and Nasdaq-listed stocks, buying and selling shares for clients. As a market maker, it also provides liquidity to equity markets by stepping in to buy and sell stocks, using its own capital to ensure orderly activity.

Knight's problems started last Wednesday, when a software glitch flooded the NYSE with unintended orders for dozens of stocks. That boosted some shares by more than 100 percent and left the company holding the shares, causing the trading loss.

In subsequent days, customers deserted Knight, causing volumes to plunge, and securities regulators stepped in to probe whether any market rules had been broken.

(Reporting by Ben Berkowitz in Boston; Editing by Lisa Von Ahn)