Quick Thoughts On The GETCO – Knight Capital Group Story

The headline today is “GETCO offers to buy $KCG for $3.50 per share.”   There’s one major problem with this headline: it’s not accurate.

The first thing you need to do if you want to talk about this situation is read the proposal that GETCO made to Knight.

Remember a few months ago when I wrote a post about the Sprint ($S: long) merger with Softbank?   This proposal is similar in some ways.  Let’s go to the details, emphasis mine:

“The Merger would be accomplished through a two-step process that is designed to provide maximum flexibility for your shareholders. The first step would be a Knight holding company reorganization / GETCO merger with GETCO shareholders receiving approximately 242 million newly issued shares of Knight and warrants to purchase Knight common stock as follows: 23 million ($4 strike price, 4 year expiration), 23 million ($4.50 strike price, 5 year expiration), and 23 million ($5 strike price, 6 year expiration). Based on September 30, 2012 financials, Knight’s tangible book value would accrete to $3.50 per share pro-forma for the Merger. As a result of this first step, the 57 million shares of Knight currently owned by GETCO would be retired.

The second step would be an issuer tender offer for up to 154 million shares of Knight (representing 50% of the outstanding shares of Knight not currently owned by GETCO) at a cash price of $3.50 per share (total consideration of approximately $539 million). The tender offer would launch before the closing of the Merger and would be contingent upon, and close immediately after, the Merger closing. GETCO and its former owners would not participate in the tender offer.

The optionality embedded in the tender structure means that to the extent some Knight shareholders decide to keep more than 50% of their shares, those Knight shareholders that have a higher preference for cash would be able to tender more than 50% of their shares. As such, we believe this two-step structure is an efficient and highly executable way to accomplish the financial goals of our proposal, but we would be open to discussing other transaction structures that achieve the same outcome.

After completion of the Merger, assuming full participation in the tender offer, no shareholder would individually own more than 20% of the combined company and most large shareholders would be under 10% ownership”

Now, when I look at the recently filed KCG 10q, I come up with a current fully diluted share count of about 365MM.  If anyone disagrees with my numbers, please do let me know.

So: start with 365MM shares of KCG fully diluted, currently (that assumes the conversion of the Preferred into Class A common).

add:  242MM new shares that GETCO will receive, and subtract the 57MM shares currently owned by GETCO which would be retired* then:

subtract: 154MM shares that GETCO will tender for at $3.50 each and we’re left with:

396MM shares outstanding in the new GETCO/Knight.  I completely ignored the warrants described above, which would be further dilutive, because I have no idea how to value GETCO anyway.

What’s my point here?

Well, my point is that this isn’t a $3.50 cash buyout for $KCG shares.  It’s a merger PROPOSAL, and it involves a tender for half of the outstanding fully diluted shares that GETCO doesn’t already own.   There will be a “back end” company that trades: the combined GETCO/Knight.  What is that puppy worth?  That’s the billion dollar question.  I have no friggin’ idea.

Of course, this is just a proposal from GETCO, and they are not the only suitor looking at Knight.

disclosure:  at the time I am hitting “publish” on this post, I have NO POSITIONS in $KCG

 

EDIT:  Here is a much better post than mine, with the math I didn’t do

 

GETCO – Knight Proposal

Knight 10-q

-KD

*thanks to an anonymous email for correcting this

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