Knight/Trimark Group Inc. ? 26 August 1999
2
Improving Cost Advantages
NITE announced an agreement whereby the company?s
Nasdaq/OTC market-making unit, Knight Securities, will
clear and settle trades through Merrill Lynch. Previously,
NITE had outsourced the clearing function to
PaineWebber. We view this mostly as a cost savings
driven strategy on the part of NITE and also to establish a
relationship with a firm that has global capabilities, while
NITE explores broadening its business model
internationally and in options market making. Specifically,
we see 2 cost-related implications:
1) We believe the pact provides NITE with
opportunities to improve on costs and profit
margins. Due to the significant order flow NITE
executes, the firm has managed to negotiate favorable
clearing and execution fees in the past. We believe
that NITE has further improved on its clearing fees
whereby the firm?s clearing costs are among the
lowest in the industry on a per trade basis. For 2000E,
we see potential cost savings of approximately
$10mm and pretax margins improving to nearly 40%.
2) NITE solidifies a low cost advantage in an
increasingly competitive environment. NITE?s
improvement on cost controls could have further
positive implications as the industry faces increased
competition among market makers and alternative
trading systems as well as the possibility of reduced
bid-ask spreads when stock exchanges switch to
decimal pricing from the current fraction pricing
environment in the Summer of 2000. When
decimalization occurs, we believe firms with high cost
structures may be forced to make a market in fewer
stocks, which could provide a boost in market share
improvements for NITE. In addition, reduced spreads
triggered by decimalization could provide
opportunities to improve costs as payment for order
flow is likely to dramatically decrease.
Summer Slowdown
Separately, we are reducing our 1999 earnings estimate
from $1.65 to $1.60 p.s. due to slower trading volumes.
We are lowering our 3Q estimate from $0.42 to $0.38 p.s.
Although we anticipated a seasonally slower trading
quarter, our estimate reduction stems from slight market
share slippage in Nasdaq/OTC volumes. Specifically,
market share has declined from 18.2% in 2Q99 to 16.5%
quarter-to-date, according to data compiled by AutEx. We
believe this decrease is due to slower trading activity this
quarter in small-cap and OTC bulletin board stocks in
which NITE holds an estimated 40% market share.
Though market share has dipped a bit, NITE still holds an
overall leading market share which is up from only 11% in
3Q98.
For 2000E, we are slightly reducing our revenue estimate
from $1,031mm to $997mm while leaving our EPS
estimate unchanged at $1.95 p.s. Because NITE?s business
model relies on trading activity and is heavily weighted in
small cap stocks, our revenue revision assumes a slightly
slower improvement in market shares. Our EPS estimate
remains unchanged despite lower revenue assumptions due
to improved profit margins from variable costs tied to
trading activity and reduced clearing costs through the
Merrill Lynch pact.
Valuation
We believe the stock is attractively valued given the recent
weakness in the stock over the last few months. We see a
12-18 month price objective of $60 based on our
discounted cash flow model. Our valuation assumes long
term earnings growth of 20-25%, sustainable ROEs over
30%, and a cost of capital of 17.5%. We reaffirm our
Accumulate/Buy investment rating.
[NITE] MLPF&S was a manager of the most recent public offering of securities of this company within the last three years.
[NITE] The securities of the company are not listed but trade over-the-counter in the United States. In the US, retail sales and/or distribution of this report may be made only in states where these securities are exempt from
registration or have been qualified for sale. MLPF&S or its affiliates usually make a market in the securities of this company.
Opinion Key [X-a-b-c]: Investment Risk Rating(X): A - Low, B - Average, C - Above Average, D - High. Appreciation Potential Rating (a: Int. Term - 0-12 mo.; b: Long Term - >1 yr.): 1 - Buy, 2 - Accumulate, 3 - Neutral, 4 -Reduce,
5 - Sell, 6 - No Rating. Income Rating(c): 7 - Same/Higher, 8 - Same/Lower, 9 - No Cash Dividend.
Copyright 1999 Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S). This report has been issued and approved for publication in the United Kingdom by Merrill Lynch, Pierce, Fenner & Smith Limited, which is
regulated by SFA, and has been considered and issued in Australia by Merrill Lynch Equities (Australia) Limited (ACN 006 276 795), a licensed securities dealer under the Australian Corporations Law. The information herein was
obtained from various sources; we do not guarantee its accuracy or completeness. Additional information available.
Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities or any options, futures or other derivatives related to such securities ("related investments").
MLPF&S and its affiliates may trade for their own accounts as odd-lot dealer, market maker, block positioner, specialist and/or arbitrageur in any securities of this issuer(s) or in related investments, and may be on the opposite side
of public orders. MLPF&S, its affiliates, directors, officers, employees and employee benefit programs may have a long or short position in any securities of this issuer(s) or in related investments. MLPF&S or its affiliates may from
time to time perform investment banking or other services for, or solicit investment banking or other business from, any entity mentioned in this report.
This research report is prepared for general circulation and is circulated for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific
person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that
statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each security?s price or value may rise or fall. Accordingly, investors may receive
back less than originally invested. Past performance is not necessarily a guide to future performance.
Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. In addition, investors in securities such as ADRs, whose values are influenced
by the currency of the underlying security, effectively assume currency risk. |
