The Shorting of Frauds, Overhyped and Bankrupt Stocks Journal

Quote from Daal:

Best case scenario for KCG that I can see. They raise $200M, sell some assets which raises another $50-$100M. The equity raising ends up giving 51% of the stock to the new investors. Current shareholders will own 49%. The company is worth something like $500M(But with the asset sale, it will be less, specially if its a crown jewel like their market making division).

49% of $500M = $245M of value or $2.75 per share of the current stock. Stock would be overvalued by 31% in this scenario. Everything else the stock plunges huge
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This company is worth over 1Bn in equity if the capital gets shored up. Whatever it costs to get teh capital will eat into current shareholders stake. The bet is how this will progress. Do firms play chicken and see if they can get Knight for free (bankruptcy) or does a firm just buy the equity (or some portion) to beat out the competition (if there is any).

I don't think the assets are worth much split apart or in a bankruptcy. Either you buy a running machine or you just let it be scrapped. I honestly think a trading or banking firm puts in 1Bn (500MM to current shareholders and 500MM to cover the loss). And they will have an asset that can generate 200MM / year in return (Knight earnings + synergies with current platform). A 20% ROE.

You can't get into this business any other way.... so whoever loses this will be hoping the same happens to Getco.
 
Quote from newwurldmn:

This company is worth over 1Bn in equity if the capital gets shored up. Whatever it costs to get teh capital will eat into current shareholders stake. The bet is how this will progress. Do firms play chicken and see if they can get Knight for free (bankruptcy) or does a firm just buy the equity (or some portion) to beat out the competition (if there is any).

I don't think the assets are worth much split apart or in a bankruptcy. Either you buy a running machine or you just let it be scrapped. I honestly think a trading or banking firm puts in 1Bn (500MM to current shareholders and 500MM to cover the loss). And they will have an asset that can generate 200MM / year in return (Knight earnings + synergies with current platform). A 20% ROE.

You can't get into this business any other way.... so whoever loses this will be hoping the same happens to Getco.
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Company was worth $1B before glitch, but the glitch showed that the business model has more uncertainty than thought, so it should trade at a lower multiple. To be optimistic lets call that $700M
Do you like to throw money in the garbage can?Nobody likes, in this case here taking shareholders out at a premium is unnecessary because they hold the cards. If they do a financing with of convertible bonds they essentially get to own the company without having to throw money in the garbage can by paying for the current stock

Honestly I don't think I ever saw a financial company by taken out at a premium when they are on the verge of bk. I would be happy to hear about cases like that
 
Quote from Daal:

Company was worth $1B before glitch, but the glitch showed that the business model has more uncertainty than thought, so it should trade at a lower multiple. To be optimistic lets call that $700M
Do you like to throw money in the garbage can?Nobody likes, in this case here taking shareholders out at a premium is unnecessary because they hold the cards. If they do a financing with of convertible bonds they essentially get to own the company without having to throw money in the garbage can by paying for the current stock

Honestly I don't think I ever saw a financial company by taken out at a premium when they are on the verge of bk. I would be happy to hear about cases like that
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Normally when firms go under it is because it is unclear what their asset/liability structure is. Here it's different. There is no uncertainty. You know what you are buying and it's worth. What is unclear is if the business is permanently impaired or not.

If it's not impaired, then current shareholders have leverage. There are many firms for which this has real strategic value. It was a billion dollars before but no strategic could buy it for less than 2bn. Now they can buy the whole thing for 1bn (giving current shareholders 500-600MM) and keep a running business.

If the lights go out at Knight, the value drops immensely to a new buyer as that order flow might permanantly go somewhere else.

For the record I am long august 2.5 calls and short Jan 5 calls 1up with an entry point of 50 cents.
 
Quote from newwurldmn:

Normally when firms go under it is because it is unclear what their asset/liability structure is. Here it's different. There is no uncertainty. You know what you are buying and it's worth. What is unclear is if the business is permanently impaired or not.

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-There might be enforcement action by regulatory agencies against the company
-There might be legal liabilities tied to the event
-Investors have less than 3 days to do due diligence
-There will certainly face more regulatory scrutiny going forward

There is quite a bit of uncertainty in the investment. All of that call for a conservative deal in order to take that into account

You scenario of a 30% premium to the stock is slightly above my main scenario as potential downside. I shorted more shares in the after market yesterday at $4, most that I see losing is 50 cents(they get taken at $4.5). Everything else will lead to a decline ranging from 30% to 80%

These are terrible odds to get for the bull case, specially when you combine with the actual chance they the CEO will control the pricing of the deal(Which he won't)

The reason the odds are so bad was because yesterday price rise had little do with with rational pricing, it was a short squeeze triggered a few news item during the aftermath of praetorian 'Great New Pattern' which tends to get a stock up huge for a day or 2. In the last 2 weeks that happened in EDU and UBNT, stock usually loses strength afterwards and just drifts down to a more rational price dictated by both bulls and bears as opposed to just the bulls(as the bears usually have already sold at the bottom of the praetorian pattern)
 
Quote from Daal:

-There might be enforcement action by regulatory agencies against the company
-There might be legal liabilities tied to the event
-Investors have less than 3 days to do due diligence
-There will certainly face more regulatory scrutiny going forward

There is quite a bit of uncertainty in the investment. All of that call for a conservative deal in order to take that into account

You scenario of a 30% premium to the stock is slightly above my main scenario as potential downside. I shorted more shares in the after market yesterday at $4, most that I see losing is 50 cents(they get taken at $4.5). Everything else will lead to a decline ranging from 30% to 80%

These are terrible odds to get for the bull case, specially when you combine with the actual chance they the CEO will control the pricing of the deal(Which he won't)

The reason the odds are so bad was because yesterday price rise had little do with with rational pricing, it was a short squeeze triggered a few news item during the aftermath of praetorian 'Great New Pattern' which tends to get a stock up huge for a day or 2. In the last 2 weeks that happened in EDU and UBNT, stock usually loses strength afterwards and just drifts down to a more rational price dictated by both bulls and bears as opposed to just the bulls(as the bears usually have already sold at the bottom of the praetorian pattern)
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Their might be other liabilities but this is unlikely to be large as there wasn't any fraud. I doubt there will be any substantial fines or regulatory action because no one (especially small investors) got hurt. That's what makes this so unique. No one got hurt and it wasn't fraud.

I wouldn't be buying here at $4. And I wouldn't have been shorting at $2.5.

Difference between this and EDU and UBNT is that KCG will be resolved by Wednesday. There is little time to get impatient. Either the stock will be a 5+ or a zero.

I'm not saying that you can't be short for a trade (saying friday was an over reaction), I'm just saying that this will probably end up better than you think.

Whether you are long or short is entirely dependent on what you think the business (properly capitalized) is worth.

If you think this is still a 100MM net income business then the stock is too cheap as someone will loan money, add equity, or do something favorable. It's possible that a mezz fund will loan 400MM on a 9% rate (going rate), which drops the earnings of the company to 60MM but now you have a 600MM equity valuation (no dilution).

If you think their future ability to access orderflow is now diminished then the stock is too expensive and no one should touch it.

What's your cost basis for your short?
 
No one is arguing the company doesn't have value, they have but the factors in this situation call for a rescuers to get a good deal instead of the stock holders. In 2008 there was a financial crisis with lots of financial companies in trouble, most situations the shareholders got a bad deal compared to the rescuers. Even countrywide was acquired at a discount to where the stock closed

I can only 2 cases where shareholders got 'bailed out', C rescue and BAC rescue. But its was not a private deal that clears at a market price. It was due systemic issues that they didn't got wiped out all the other cases you had stock being issued at discounts, take unders or hybrid securities being issued diluting the stock. You never saw a company be in huge trouble then be acquired at a premium in a rushed deal with 3 days due diligence

You might argue, KCG is different, its a one time loss. I'd say when a company loses 40% of tangible equity and is on the verge of filling, its not different at all

Judging by the experiences in 2008 virtually every time there was trouble stock did not get bought at a premium. Its not a likely event this time
 
You can always get the assets in bk so in the private negotiations before bk you almost ALWAYS will make the offer lower than what you would do in the bk. If there are synergies or whatever, then you buy the parts that have synergies and don't buy the rest

Honestly, I believe you are overplaying the whole synergy think, from what I've read they have quite a few divisions that work by themselves and don't need one another
 
The answer to two questions:

1. Is this still a 100MM business?
2. Are the losses from this incident contained?

In the case of 2008 or MF global the answer to #2 was "no." Here the answer is "yes." Goldman took them out of their financial risk. If that hadn't happend then this would be more toxic.

The answer to #1 is "yes" as well. I take it you agree with me here.

And you agree that the value to the business is probably $1Bn or so. The question is who gets what? I think that this company is worth nothing if they go dark. I think that anyone who wants the business can't let it go dark.

I think the synergies are important. I used to work in Cash Equities at a bulge bracket. The access to order flow and improved execution capabilities are worth tons (especially if you get them for free). Being #1 in marketshare for a name makes it easier to get more orderflow.
Secondly, if a company wants to get into this business this is the easiest and least risky way. That's why I think there's value to the equity.

I think shareholders get $5-6.
 
They earn $100M in a good year, normalized earnings is less than that. The multiple should also be lower due to the fact that you can wipe out years worth of earnings really quickly
 
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