Software Glitch Pushes Knight Capital Towards Bankruptcy

| About: KCG Holdings, (KCG)

Knight Capital Group (KCG) is one of the market marker companies on the New York Stock Exchange (NYSE), responsible for maintaining a fair and orderly market. The company provides access to capital markets to a diverse client base. For the purpose of operations, the company is organized into four segments; Market Making, Institutional Sales and Trading, Electronic Execution Services, and Corporate and Other. The company's Market Making segment, which accounts for around 50% of total revenues, makes markets in listed domestic options and global equities, and executes trades by offering to buy or sell securities to clients. Sophisticated and reliable technology that allows clients to interact with the market is utilized by the company in this regard.

Software Glitch

The company, on August 1, 2012, was forced to tell brokerages to redirect their trading orders to other trading companies, as it faced a technological glitch in its Market Making segment, which resulted in routing of shares and a loss of $440 million. The glitch left some stocks soaring, while others dipped. Soon after the news, Knight Capital's shares plunged 33%. The stock, with a short ratio of 6.4 days, has lost 75% of its value in two days. The Securities and Exchange Commission (SEC) is also monitoring the situation and will determine whether new steps are required to safeguard the markets.

Looking at the situation, many of the biggest customers, including TD Ameritrade (AMTD), Vanguard and Fidelity Investments, and Citigroup (C) were forced to stop working with the company, and are not resuming their trades with KCG. If the situation worsens, Knight Capital could collapse, resulting in losses for its clients and creditors. The management, in order to ensure the survival of the company, is seeking new funding.

Experts are pointing fingers at the complex structure that is in place. The capital markets have already seen technology glitches, like The Flash Crash of May 2010, and the Facebook (FB) IPO debacle. Experts believe such an event could happen in the top exchanges in Europe as well.

Financial Position



Fiscal Period

Sep-10 QTR

Dec-10 QTR

Mar-11 QTR

Jun-11 QTR

Sep-11 QTR

Dec-11 QTR

Mar-12 QTR

Jun-12 QTR

Revenues ($mn)


















EPS ($/ Share)


















The table above demonstrates how the company's top and bottom line have been witnessed negative growth over the past few quarters, reflecting the financial difficulty that Knight Capital was already dealing with. When compared sequentially, EPS plunged by 89% and 14% for the quarter ended June 2012 and March 2012, respectively.

In conclusion, Knight Capital on average makes $24 million in quarterly earnings, and is now widely expected to go bankrupt after the $440 million trading loss. Furthermore, the company, which was already facing financial difficulties, is expected to be sued by many of its retail and institutional investors for negligence. This combined with a sluggish U.S. economy in general and weak equity volumes in particular, going forward, make us believe that the outlook for Knight Capital is bleak. Therefore, we recommend investors to stay away from the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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