I give you a tiny puzzle. Getco offered to buy Knight Capital a month ago for $3.50 a share, in the form of a cash-stock-election structure complicated by the fact that Getco is not (yet) a public company and so the value of your stock election is a bit of a mystery. Today the Knight board accepted Getco’s revised offer, which is similar but provides $3.75 per share, so I guess the mystery has been cleared up to its satisfaction; there will eventually be a merger proxy/prospectus so soon it will be cleared up to everyone’s satisfaction or possibly dissatisfaction.

The puzzle: if Getco is increasing the cash paid for Knight shares by 25 cents, or 7.1%, then it should also increase the value of the share election by 7.1%, to keep things in balance. And in fact it seems to have done so: while the original offer said that the tangible book value per share of newco would be $3.50, the revised one says:

Under the agreement, existing Knight shareholders (other than GETCO) will have the right to elect to receive $3.75 per share in cash or one share of common stock of the new holding company. The cash consideration will be subject to pro-ration if the holders elect to receive more than $720 million in cash in the aggregate. … GETCO members will receive 233 million shares of the new holding company and the 57 million shares of Knight currently owned by GETCO will be retired. GETCO members will receive warrants in the new holding company as follows: 25 million warrants with a $4.00 exercise price and a four-year term; 25 million warrants at a $4.50 exercise price and a five-year term; and 25 million warrants at a $5.00 exercise price and a six-year term. Based on the tangible net worth of GETCO and Knight as of September 30, 2012, pro forma tangible book value of the combined company would be approximately $3.75 per share.

Hmm, so, how did the tangible book value of the combined company get to be 7% bigger than it was a month ago? Well, Getco is taking fewer shares (but more warrants) in newco; 233mm instead of the 242mm in its original offer. That’s about 4% fewer shares, which shouldn’t really make the per-share value 7% bigger, should it?

Anyway my silly math is here and it suggests that Getco’s implied tangible book value – implied by the deal I mean – was $735mm a month ago and is $839mm today. Where’d the extra $104mm come from? Well $55mm of it seems to have come – the mechanics are a little vague – from General Atlantic, which is investing another $55mm in Getco as part of the deal. The rest of it … I am puzzled. Any ideas?

A spreadsheet [Google Docs]
Knight Capital 8-K [EDGAR]
Knight Capital and Getco to Merge [DealBook]
Earlier: Knight Rides Again, Maybe

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Comments (7)

  1. Posted by Bob | December 20, 2012 at 10:53 AM

    Another dead-on-arrival post. Well done!

  2. Posted by Guest | December 20, 2012 at 10:54 AM

    You're definitely a cornball brother.

  3. Posted by Anonymous Trader | December 20, 2012 at 11:56 AM

    While not entirely on-topic, I'd like to point a few things out about this deal. First off, this merger strongly suggests to me that things aren't going especially well at GETCO, and they're trying to sell their business at an inflated value to the public at large. So, good for them, bad for KCG sharesholders / anyone else into this deal. Why? When you look at the pantheon of successful, highly profitable HFT firms (e.g. SIG, Jane Street, Citadel) you'll notice that most of these guys have no interest in being public. They make tons of money and the owner/partners don't want to be public. GETCO is weird in that they have some private equity ownership (e.g. Atlantic) which none of the other guys have. Word on the street is that GETCO is getting pretty badly squeezed by the (a) drop in equity volume over the last four years running, (b) proliferation of other small HFT competitors, and (c) huge legacy infrastructure costs they're wearing (e.g. fancy expensive spread networks lines).

    The other thing is: let's say that this public move basically lets the main people at GETCO cash out the half of their business that they didn't sell to Atlantic. The value of any trading firm is basically in the people running it (in part) and the infrastructure (in part). This isn't a machine like KO or PG where the CEO doesn't have all that much of a role in determining the success of the venture. This is a lot more like a law firm or small consultancy where the right 10 people make or break the firm. I would be very very ware of buying into a deal like this.

  4. Posted by guest | December 20, 2012 at 12:53 PM

    The silly math seems to be hard to get to, with proxy server refusing connections. So I reserve my comments.

  5. Posted by Anihilist | December 20, 2012 at 1:30 PM

    Reserve an ESL class while you're at it

  6. Posted by Guest | January 1, 2013 at 9:12 AM

    Probably they were planning a dividend/distribution before the deal. In raising the price I guess they had to skip it, hence the increase. If GA added $55 million then they were looking at ~$45 million for a distribution they had to forgo.

  7. Posted by timmy | July 11, 2013 at 12:48 PM

    Heard there is a book coming about knight trading’s blunder last year, something like knightmare on wall street