At $3.07 a share after its 24% drop yesterday, Knight Capital Group (NYSE:KCG) looks to be priced exactly right. That's because, although it secured funding to stay afloat, it did so at great cost to legacy shareholders while admittedly saving what they had left. So I find it ironic that some believe that KCG is worthy of a higher value now. To me, that is amusingly anomalous to the mathematic malfunction that nearly erased the company.
Knight Capital Group secured a lifeline of $400 million in equity financing from a consortium of investors, including Jefferies (JEF), Blackstone (NYSE:BX), GETCO LLC, Stephens, Stifel Financial (NYSE:SF) and TD Ameritrade (NASDAQ:AMTD). In doing so, the company stayed afloat, yes, but it gave up 70% of equity -- the equity of legacy shareholders.
Some are talking today about the franchise value of Knight, the potential gain for the new shareholders, and the ongoing opportunity for all parties moving forward. While it's true the company avoided bankruptcy, the odds of it rising from here back to $10, representing a 233% gain, are equal to the odds that it had in July -- before the algorithm disaster -- to rise from its price of $10 at the time to $33. In other words, the only thing that was saved was the $3 per share investors have left, and the jobs of the executives and the employees of Knight. The potential of the company is probably unchanged, despite whatever creative capital minds might construct to sooth the wound. What was lost -- and it was lost -- was $7 per share, or 70% of capital for each legacy Knight shareholder who, not long ago, saw quotes of $10 a share for their stock.
The stock is priced right according to the efficient market (efficient in theory), but I would say from here there is more likelihood of downside, given the potential for shareholder lawsuits and regulatory penalties. Given the broad reaching impact of mankind's colossal failures in finance -- more recently made famous by algorithmic trading, the mortgage security malfunction at the hands of Wall Street, and the rating agencies Standard & Poor's of McGraw-Hill (MHP) and Moody's (NYSE:MCO) -- these latest algorithmic errors are likely to bring down Capitol Hill's hammer once again. So I would avoid investing in Knight rather than imagine value where it is not.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.