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Knight Said to Draw Interest From KKR, TPG, Silver Lake

KKR & Co., TPG Capital and Silver Lake are among the buyout firms that have initial interest in making an investment in Knight Capital Group Inc., according to two people with knowledge of the matter.

The firms are taking a preliminary look at Knight and chances of a deal are small since Knight’s future is uncertain, said one of the people, who asked not to be named because the process is private. Knight, seeking a deal to survive a $440 million trading loss, has already opened its books to suitors, said two people with knowledge of the matter.

“Part of what private equity does is provide liquidity,” said Steven Kaplan, a professor at the University of Chicago Booth School of Business. “It’s not a typical deal, and a quick rescue is hard to structure.”

Citadel LLC, a Chicago-based hedge fund that also has a market-making unit, has expressed interest in Knight, said a person with knowledge of the matter. Bank of America Corp. also was among several potential partners in talks with Knight yesterday, said another person. Knight is working with Sandler O’Neill & Partners LP as an adviser on the rescue talks, according to another.

Two Sigma

Two Sigma Securities LLC, a market maker and broker that competes with Knight and Citadel, is interested in acquiring all or portions of Knight’s business, according to a person with knowledge of the matter who declined to be identified because the information isn’t public. The New York-based firm, a U.S. equities wholesaler that executes orders for retail brokers, is affiliated with Two Sigma Investments LLC, a diversified investment adviser with about $10 billion in assets.

Silver Lake, the largest technology-focused private-equity manager, already backs Virtu Financial LLC, another market maker. Representatives at Silver Lake, TPG, KKR, Citadel and Two Sigma declined to comment. John Yiannacopoulos, a Bank of America spokesman, declined to comment. Kara Fitzsimmons, a spokeswoman for Knight, didn’t return phone calls and e-mails requesting comment.

Knight told brokers it obtained short-term financing to fund market making, giving the Jersey City, New Jersey-based firm money for today, said a person with knowledge of the matter. The stock climbed 57 percent to close at $4.05 in New York, trimming its weekly decline to 61 percent.

Market Maker

Knight, one of the biggest U.S. market makers, is exploring strategic and financial alternatives after a software malfunction cost the company almost four times what it earned last year. The firm’s shares lost 75 percent in two days after its computers flooded the market with unintended trades, sending dozens of stocks into spasms.

Knight fought to preserve its business amid concern about its solvency. Analysts at CLSA Credit Agricole Securities said bankruptcy was a possibility if it failed to get financing. The trading fault, which caused stocks to swing as much as 151 percent, left the firm with a “large error position,” Knight Chief Executive Officer Thomas Joyce told Bloomberg Television’s “Market Makers” program with Erik Schatzker and Stephanie Ruhle yesterday.

While the company’s balance sheet was “severely impacted,” its broker/dealer subsidiaries are in compliance with capital requirements, according to a statement.

‘Capable People’

“We’re talking to a lot of capable people, people who are in touch with situations like this,” Joyce said. “This was an anomaly, not one we’re proud of.”

Citadel’s electronic-trading and market-making business is a unit of Citadel Securities which says it executes about 10 percent of U.S. equity volume, according to its website, a similar amount to Knight.

“The businesses they are in are attractive to other players,” Justin Schack, managing director for market-structure analysis at Rosenblatt Securities Inc., said in a phone interview. “The likely candidates include banks that have an equity capital markets business and firms that want to get into market making.”

Knight had $365 million of cash as of the end of June, with about $70 million in its revolving credit line, Robert Rutschow, a New York-based analyst with CLSA, wrote in a report. He said there’s a risk it will break loan covenants and cut his rating on the stock to sell from outperform.

Working Capital

“Without finding a buyer, it’s going to be tough to have the working capital to keep the firm afloat for much more than a week,” Matthew Heinz, a St. Louis, Missouri-based analyst at Stifel Nicolaus & Co., said in a phone interview. “You may be able to secure some emergency funding to hold them off before a buyer can come in. That’s the game plan for Knight right now.”

Knight’s $440 million loss compares with net income of $115.2 million in 2011 and is more than the company’s market value of $253 million at the close yesterday, data compiled by Bloomberg show. The company was worth as much as $4.8 billion in 2000 and valued at more than $1 billion before yesterday, according to data compiled by Bloomberg.

The programming bug swept through the market at the open of exchanges on a day when Joyce, a 57-year-old Harvard College graduate known as TJ, limped into work following knee surgery. Joyce said that while the bug sent “a ton of orders, all erroneous” into the market as the firm prepared to trade with the New York Stock Exchange’s new so-called retail liquidity program, it had “nothing to do” with the NYSE.

“Technology breaks,” Joyce told Bloomberg TV. “It ain’t good. We don’t look forward to it.” He added that the problem is mainly one for his firm, and “we did not harm individual investors, we got them out of the way.”

Exchange Shares

Knight’s market-making unit executed a daily average of $19.5 billion worth of equities in June, according to its website. The unit traded 711 million exchange-listed shares a day in June, according to data compiled by the company and Bloomberg.

The software was fixed, he said, and some clients of the market-making business were executing with the firm by the end of Aug. 1 after Knight told them initially to go elsewhere.

The NYSE reviewed trading in 140 stocks from Molycorp Inc. to AT&T Inc. as the market’s Aug. 1 open was disrupted. Trades that occurred during the height of the volatility were canceled in six securities, where prices swung at least 30 percent in the first 45 minutes. Trades in all of the other stocks were allowed to stand.

Flash Crash

The software malfunction was the latest black eye for the computer infrastructure of an equity market still haunted by the May 2010 market crash, the botched initial public offering of Facebook Inc. and failed IPO of Bats Global Markets Inc.

“It appears Knight and other firms reliant on software to execute trades do not have the testing and quality-assurance function figured out yet,” said Bruce Weber, dean of the Lerner College of Business and Economics, who co-wrote “The Equity Trader Course” with Robert Schwartz and Deutsche Boerse CEO Reto Francioni. “As we’ve seen the consequences of weak testing and bugs that slip through is enormous.”

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