* Investors get 70 percent-plus in company
* Analyst says company likely to be broken up
* CEO: Too soon to say if firm will shrink
* Shares tumble 24 percent
NEW YORK, Aug 6 (Reuters) - A group of investors rescued
Knight Capital Group Inc in a $400 million deal that
keeps the embattled leader in U.S. equities market-making in
business, but comes at a huge cost to existing shareholders.
Chief Executive Tom "TJ" Joyce told Reuters the new
investors support him and his management team, but it was too
early to tell whether the firm would shrink or keep the same
strategy it had before last week's losses.
There were immediate signs the Jefferies Group -led
rescue gave Knight back some of the market confidence it had
lost, as two large brokerages resumed routing orders through the
company and new data showed volumes picking up from last week.
Blackstone Group LP, rival market maker Getco and
financial services companies TD Ameritrade Holding Corp
, Stifel Nicolaus, Jefferies and Stephens Inc
purchased preferred shares for what works out to be a 73 percent
stake in the company, Knight said.
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 shares closed down 24.2 percent at $3.07. Those who
held Knight shares before Monday will feel the pain of the
company's rescue the most acutely. The massive dilution that
accompanies the deal means their stakes are worth just a
fraction of what they were days ago.
Roger Freeman, analyst at Barclays, said the dilution due to
the new investment would imply Knight's value is about $1 a
share. He has a $3 price target on the stock, but said it was
too early to estimate how earnings would be affected in 2013.
Yet Knight co-founder Kenneth Pasternak told Reuters he had
no regrets about accumulating hundreds of thousands of shares in
the company since last week's disaster emerged, despite having
lost money as a result of Knight's rescue. He retired from
Knight in 2002.
BREAKUP COMING?
The rescuing companies will buy preferred stock convertible
at $1.50 each with a 2 percent dividend to save Knight, which
was left reeling last week by a software glitch that caused
errant trading in dozens of stocks. Knight lost money by
selling shares it had inadvertently bought during the day.
The preferred shares are convertible into about 267 million
common shares, Knight said in a U.S. Securities and Exchange
Commission filing.
Jefferies CEO Richard Handler and executive committee
chairman Brian Friedman reached out to Knight on Wednesday, the
day of the trading snafu, to offer their services, one source
directly familiar with the matter said. The person was not
authorized to discuss the issue publicly.
Sandler O'Neill had been tapped by Knight to advise on a
deal. But by Friday Jefferies was circulating a term sheet to
potential investors based on the same deal format that was later
announced on Monday, sources said. Jefferies backed the deal by
making a principal investment itself.
Unlike many private equity firms that snubbed an approach by
Knight, Blackstone took an active interest as it was exploring a
buyout of the firm. But Blackstone was told to either join the
investor group or walk away, according to one of the sources.
"As a financial investment, Knight is a very valuable firm,
but it needed liquidity and if it didn't have liquidity, a lot
of that value was going to go away," Getco CEO Daniel Coleman
told Reuters in an interview. "So we thought it was a pretty
good bet that by providing liquidity we could preserve that
value and perhaps increase it."
Getco, nominally a Knight rival, gets a strategic advantage
via the deal as well -- an inside peek at a bigger rival that
has some lines of business Getco does not.
Stephens Inc Chief Operating Officer Curt Bradbury, in an
interview, said he was long-time friends with Joyce and that his
firm approached Knight in that vein on Friday. He said that
while there may have been some negotiations by others on terms,
Stephens was fine with the term sheet as it was presented.
As part of the deal, the investor group will take three
board seats. In a regulatory filing, Knight said Blackstone and
Getco parent General Atlantic would each fill one seat, while
the board will propose a third member acceptable to Jefferies.
Each retains those rights as long as they hold at least 25
percent of the preferred shares they purchased in the deal.
JP Morgan analyst Kenneth Worthington, in a client note
after the initial reports of the rescue on Sunday night, said
the deal presaged Knight's eventual breakup.
Worthington cited two Knight businesses, the reverse
mortgage lender Urban Financial and foreign exchange platform
Hotspot FX, as assets that could draw interest, but Joyce said
it was too soon to say what would happen to the firm's assets.
"Right now we kind of like our footprint and we will
continue to execute on the strategy we had before the error took
place, but as we kind of get back to business and do our annual
budgeting and strategic reviews at the end of the year, that
will be something that we will have to address," he said.
FUTURE STILL UNCERTAIN
Vanguard Group, one customer that pulled orders from Knight
last week, said Monday it was again routing there, as did
E*Trade Financial Corp.
But even if Knight has been saved for now, the company could
face litigation from shareholders.
The potential liability could increase if it were found that
Knight violated market rules. The SEC, the top U.S. securities
regulator, said on Friday that government lawyers were trying to
determine whether Knight violated a new rule designed to protect
the markets from rogue algorithmic computer trading programs.
According to those people familiar with the matter, U.S.
Securities and Exchange Commission Chairman Mary Schapiro spoke
with Joyce last Wednesday afternoon from her vacation spot in
Maine. Joyce brought up rules on erroneous trades during the
call and expressed hope for some flexibility. But Schapiro did
not convey a view on it during the call, the sources said.
Knight's problems started early 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.
DAMAGE SWIFT
The damage to Knight was swift. Whereas Knight once
accounted for 20 percent of the market-making activity in shares
of Apple Inc, by midday Friday it was the market maker
for 2 percent of the volume, according to Thomson Reuters AutEx.
But on Monday, AutEx data showed, that volume was back up to
19.4 percent, and it was on the rise for other stocks as well.
Barclays Capital's Freeman, in a note Monday, said he
assumed that Knight's overall volumes in 2013 would be about 15
percent below where they were in the second quarter of 2012.
Sandler O'Neill + Partners and Wachtell, Lipton, Rosen &
Katz advised Knight Capital on the bailout. Barclays Plc
advised TD Ameritrade on its investment.