Knight Capital Group [NDQ:NITE]: April 20, 2009 $15.14 1:15 PM EST
52-week range: $11.03 (Oct. 10, 2008) - $19.98 (Feb. 9, 2009)
Knight Capital and its subsidiaries are the largest wholesale market makers in United States based equity securities. They execute trades for institutional clients and broker dealers. They had been involved in Hedge Fund management but that operation (51% owned Deepwater Funds) is now being treated as a discontinued operation with a pending sale agreement in place.
Knight remained solidly profitable in 2008 despite the horrendous market conditions. Earnings per share were $1.63 versus $1.23 (excluding $0.33 /share in one-time gains in Q4 2008).
Zacks now estimates $1.42 and $1.68 in EPS from continuing operations for 2009 and 2010 respectively. Thus, NITE shares now trade for a quite reasonable 11.2x this year’s and < 9.5x next year’s expectations.
The company held $440.6 million in cash at YE 2008 against only $140 million in total debt. Debt is just 14% of total capitalization. December 31, 2008 book value was $11.40 per share.
Knight’s revenues and profits are quite sensitive to overall market volume so the recent upturn in the averages bodes well for future prospects. You would expect shares of a market maker to be quite volatile yet the last few years’ range for NITE shares has been subdued compared with most other issues.
The 52-week high of $19.98 was set recently (February 9 of this year) and the low, not surprisingly, was hit as the market tanked last October 10th. NITE shares are now in the middle of their last three years’ trading range even as revenues, cash flow, book value and profits have all increased nicely.
Here are the past few years’ numbers as reported by Value Line:
Year ….. Sales …..… C/F ….. EPS ….... B/V ….. Avg. P/E
2004 ….. 5.71 ……. 0.51 …. 0.36 ….. 7.79 …… 31.3x
2005 ….. 5.57 ……. 0.51 …. 0.34 ….. 7.93 …… 26.5x
2006 ….. 9.18 ….… 1.73 …. 1.49 ….. 9.29 …… 10.5x
2007 ….. 9.89 ….… 1.59 …. 1.23 ….. 9.67 …… 12.4x
2008 …..11.16 .……1.75 …. 1.63 …..11.40 ……10.3x
How should we project the future value of Knight’s shares?
I think a look at the historical price/book value ratio gives a good answer to that. Here is a chart showing the high and low annual shares prices and their P/BV levels during each of the past five years:
Year ……Share Low …….. P/BV ……. Share High ……. P/BV
2004 …….. 8.10 …………. 1.04x ……… 17.30 ………... 2.22x
2005 …….. 7.30 …………. 0.92x ……… 11.00 ………... 1.39x
2006 …….. 9.00 …………. 0.97x ……… 20.50 ………... 2.21x
2007 ……..11.50 ………… 1.19x ……… 21.80 ………... 2.25x
2008 ……..11.00 ………… 0.97x ……… 19.80 ………... 1.74x
At today’s quote of $15.14 the P/BV is now 1.33x the $11.40 /share December 31, 2008 book value. Thus, NITE’s valuation on this metric is perhaps just a bit below its mid-point from past cycles.
With the P/E and P/BV slightly below average and its rock solid balance sheet, I see limited risk that NITE shares will go down significantly from its current price.
Value Line is using a 14 multiple for their 3 – 5 year share price projections. Even 12 times the $1.42 estimate would bring NITE back to $17.04/share.
Morningstar now carries a ‘fair value’ of $17 for NITE- independently confirming my own view.
With decent but unspectacular upside and low downside risk, I have two buy and write combination plays that offer excellent total return over the next nine and 21 month periods.
………………………....................……….….Cash Outlay ……….. Cash Inflow
Buy 1000 NITE @ $15.14 ……............. $15,140
Sell 10 Jan. $15 Calls @$2.90 ……...............…………………….. $2,900
Sell 10 Jan. $15 Puts @$2.60 ……..............……………………….$2,600
Net Cash Out-of-Pocket …...........……… $9,640
On expiration date (Jan. 15, 2010) if NITE shares remain > $15:
Your $15 calls will be exercised.
You will sell your shares for $15,000.
Your $15 puts will expire worthless (a good thing for you as a seller).
You will have no further option obligations.
You will have no shares and $15,000 cash for your $9,640 original outlay.
That’s a $5,360 best-case scenario profit or + 55.6% cash-on-cash on shares that did not need to go up at all from the trade’s inception.
This return would be achieved in just nine months.
What’s the Risk?
Break-even on this trade is calculated as follows:
On the original 1000 shares it’s the purchase price of $15.14 less the $2.90/share call premium = $12.24/share.
On the puts it’s their $15 strike price less the $2.60/share put
premium = $12.40/share.
Your break-even is the average of those figures or $12.32/share.
If NITE shares finish < $15 on January 15, 2010 you would be forced to buy an additional 1000 shares and to lay out another $15,000.
You would end up owning 2000 shares of NITE at an average net cost of $12.32/share or 18.6% below the $15.14 starting price. A drop of anything less than 18% would still leave you in profit on the trade from start to finish.
Here’s a longer-term play that looks good also:
…………………………………………....................….Cash Outlay ……….. Cash Inflow
Buy 1000 NITE @ $15.14 ……........………..…... $15,140
Sell 10 Jan. 2011 $17.50 Calls @$3.00 …........………………………….. $3,000
Sell 10 Jan.2011 $15 Puts @$3.50 ……….........…………………..……….$3,500
Net Cash Out-of-Pocket ……….........…….……..…$8,640
On expiration date (Jan. 2011) if NITE shares are > $17.50:
Your $17.50 calls will be exercised.
You will sell your shares for $17,500.
Your $15 puts will expire worthless (a good thing for you as a seller).
You will have no further option obligations.
You will have no shares and $17,500 cash for your $8,640 original outlay.
That’s an $8,860 best-case scenario profit or + 102.5% cash-on-cash on shares that only needed to rise by $2.36 or + 15.6% from the trade’s inception.
This return would be achieved in just twenty one months.
What’s the Risk?
Break-even on this trade is calculated as follows:
On the original 1000 shares it’s the purchase price of $15.14 less the $3.00/share call premium = $12.14/share.
On the puts it’s their $15 strike price less the $3.50/share put
premium = $11.50/share.
Your break-even is the average of those figures or $11.82/share.
If NITE shares finish < $15 on expiration date in January 2011 you would be forced to buy an additional 1000 shares and to lay out another $15,000 cash.
You would end up owning 2000 shares of NITE at an average net cost of $11.82/share or 22% below the $15.14 starting price. A drop of anything less than 21.9% would still leave you in profit on the trade from start to finish.
Disclosure: Author is long NITE shares and short NITE options.
52-week range: $11.03 (Oct. 10, 2008) - $19.98 (Feb. 9, 2009)
Knight Capital and its subsidiaries are the largest wholesale market makers in United States based equity securities. They execute trades for institutional clients and broker dealers. They had been involved in Hedge Fund management but that operation (51% owned Deepwater Funds) is now being treated as a discontinued operation with a pending sale agreement in place.
Knight remained solidly profitable in 2008 despite the horrendous market conditions. Earnings per share were $1.63 versus $1.23 (excluding $0.33 /share in one-time gains in Q4 2008).
Zacks now estimates $1.42 and $1.68 in EPS from continuing operations for 2009 and 2010 respectively. Thus, NITE shares now trade for a quite reasonable 11.2x this year’s and < 9.5x next year’s expectations.
The company held $440.6 million in cash at YE 2008 against only $140 million in total debt. Debt is just 14% of total capitalization. December 31, 2008 book value was $11.40 per share.
Knight’s revenues and profits are quite sensitive to overall market volume so the recent upturn in the averages bodes well for future prospects. You would expect shares of a market maker to be quite volatile yet the last few years’ range for NITE shares has been subdued compared with most other issues.
The 52-week high of $19.98 was set recently (February 9 of this year) and the low, not surprisingly, was hit as the market tanked last October 10th. NITE shares are now in the middle of their last three years’ trading range even as revenues, cash flow, book value and profits have all increased nicely.
Here are the past few years’ numbers as reported by Value Line:
Year ….. Sales …..… C/F ….. EPS ….... B/V ….. Avg. P/E
2004 ….. 5.71 ……. 0.51 …. 0.36 ….. 7.79 …… 31.3x
2005 ….. 5.57 ……. 0.51 …. 0.34 ….. 7.93 …… 26.5x
2006 ….. 9.18 ….… 1.73 …. 1.49 ….. 9.29 …… 10.5x
2007 ….. 9.89 ….… 1.59 …. 1.23 ….. 9.67 …… 12.4x
2008 …..11.16 .……1.75 …. 1.63 …..11.40 ……10.3x
How should we project the future value of Knight’s shares?
I think a look at the historical price/book value ratio gives a good answer to that. Here is a chart showing the high and low annual shares prices and their P/BV levels during each of the past five years:
Year ……Share Low …….. P/BV ……. Share High ……. P/BV
2004 …….. 8.10 …………. 1.04x ……… 17.30 ………... 2.22x
2005 …….. 7.30 …………. 0.92x ……… 11.00 ………... 1.39x
2006 …….. 9.00 …………. 0.97x ……… 20.50 ………... 2.21x
2007 ……..11.50 ………… 1.19x ……… 21.80 ………... 2.25x
2008 ……..11.00 ………… 0.97x ……… 19.80 ………... 1.74x
At today’s quote of $15.14 the P/BV is now 1.33x the $11.40 /share December 31, 2008 book value. Thus, NITE’s valuation on this metric is perhaps just a bit below its mid-point from past cycles.
With the P/E and P/BV slightly below average and its rock solid balance sheet, I see limited risk that NITE shares will go down significantly from its current price.
Value Line is using a 14 multiple for their 3 – 5 year share price projections. Even 12 times the $1.42 estimate would bring NITE back to $17.04/share.
Morningstar now carries a ‘fair value’ of $17 for NITE- independently confirming my own view.
With decent but unspectacular upside and low downside risk, I have two buy and write combination plays that offer excellent total return over the next nine and 21 month periods.
………………………....................……….….Cash Outlay ……….. Cash Inflow
Buy 1000 NITE @ $15.14 ……............. $15,140
Sell 10 Jan. $15 Calls @$2.90 ……...............…………………….. $2,900
Sell 10 Jan. $15 Puts @$2.60 ……..............……………………….$2,600
Net Cash Out-of-Pocket …...........……… $9,640
On expiration date (Jan. 15, 2010) if NITE shares remain > $15:
Your $15 calls will be exercised.
You will sell your shares for $15,000.
Your $15 puts will expire worthless (a good thing for you as a seller).
You will have no further option obligations.
You will have no shares and $15,000 cash for your $9,640 original outlay.
That’s a $5,360 best-case scenario profit or + 55.6% cash-on-cash on shares that did not need to go up at all from the trade’s inception.
This return would be achieved in just nine months.
What’s the Risk?
Break-even on this trade is calculated as follows:
On the original 1000 shares it’s the purchase price of $15.14 less the $2.90/share call premium = $12.24/share.
On the puts it’s their $15 strike price less the $2.60/share put
premium = $12.40/share.
Your break-even is the average of those figures or $12.32/share.
If NITE shares finish < $15 on January 15, 2010 you would be forced to buy an additional 1000 shares and to lay out another $15,000.
You would end up owning 2000 shares of NITE at an average net cost of $12.32/share or 18.6% below the $15.14 starting price. A drop of anything less than 18% would still leave you in profit on the trade from start to finish.
Here’s a longer-term play that looks good also:
…………………………………………....................….Cash Outlay ……….. Cash Inflow
Buy 1000 NITE @ $15.14 ……........………..…... $15,140
Sell 10 Jan. 2011 $17.50 Calls @$3.00 …........………………………….. $3,000
Sell 10 Jan.2011 $15 Puts @$3.50 ……….........…………………..……….$3,500
Net Cash Out-of-Pocket ……….........…….……..…$8,640
On expiration date (Jan. 2011) if NITE shares are > $17.50:
Your $17.50 calls will be exercised.
You will sell your shares for $17,500.
Your $15 puts will expire worthless (a good thing for you as a seller).
You will have no further option obligations.
You will have no shares and $17,500 cash for your $8,640 original outlay.
That’s an $8,860 best-case scenario profit or + 102.5% cash-on-cash on shares that only needed to rise by $2.36 or + 15.6% from the trade’s inception.
This return would be achieved in just twenty one months.
What’s the Risk?
Break-even on this trade is calculated as follows:
On the original 1000 shares it’s the purchase price of $15.14 less the $3.00/share call premium = $12.14/share.
On the puts it’s their $15 strike price less the $3.50/share put
premium = $11.50/share.
Your break-even is the average of those figures or $11.82/share.
If NITE shares finish < $15 on expiration date in January 2011 you would be forced to buy an additional 1000 shares and to lay out another $15,000 cash.
You would end up owning 2000 shares of NITE at an average net cost of $11.82/share or 22% below the $15.14 starting price. A drop of anything less than 21.9% would still leave you in profit on the trade from start to finish.
Disclosure: Author is long NITE shares and short NITE options.
