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(Reuters) - Knight Capital Group Inc KCG.N, which nearly collapsed in August following a software glitch, is being bought by rival automated trading firm Getco Holding Co in a cash-and-stock transaction that values Knight at around $1.4 billion and creates a dominant player in the industry.
The deal, expected to close in late April or early May, ends weeks of speculation about whether Knight would retain its independence or be acquired by Getco or Virtu Financial LLC.
Knight is a top U.S. market maker, using computer models to match buy and sell orders in stocks and options, executing around 10 percent of U.S. equity trading volume. Getco also has market making operations, and is one of the biggest high-frequency trading firms.
"We will ultimately end up with a very formidable player in the automated trading market," said Aite Group analyst Sang Lee.
Knight's other operations include foreign exchange and bond trading platforms, as well as a stake of around 20 percent in No. 4 U.S. equities exchange Direct Edge. Getco is also a big player in the automated trading FX market and has been building up its agency brokerage operation over the past few years.
Getco head Daniel Coleman will be chief executive of the new, as-of-yet unnamed, company, and Knight CEO Tom Joyce will be executive chairman. The two said on Wednesday they had begun work on a new strategic outlook for the firm, which will be publicly traded.
"Tom and I are going to review all of the businesses," Coleman said in an interview. There were obvious areas of duplication between Getco and Knight, which will lead to sizeable cost savings for the combined firm, he added.
Knight closed up 5.4 percent on Wednesday at $3.51.
Knight shareholders other than Getco will have the right to pick either $3.75 per share in cash or one share of common stock in the new business.
The offer represents a 13 percent premium to Knight's closing stock price of $3.33 on Tuesday. It's also a 51 percent premium to Knight's closing price on November 23, when reports surfaced that the company was a possible takeover target.
But it was well below Knight's closing price of $10.33 on July 31, the day before errant software at the Jersey City-based firm sent millions of unintentional orders to the market over a 45 minute period, leaving Knight with a huge position it had to unload at a loss totaling $461.1 million.
With its capital largely depleted, Knight secured $400 million in rescue financing by a group of investors that included Chicago-based Getco and was led by Jefferies Group Inc JEF.N, in exchange for a more than 70 percent stake in the company.
Jefferies later worked with Getco on the deal to buy Knight and is helping it with financing.
Getco made its unsolicited bid for Knight late last month, which was followed by Virtu's bid, also unsolicited. Unlike Getco's proposal, Virtu's all-cash offer that topped out at around $3.20 a share, according to sources, would have taken Knight private.
"Because of what we've learned over the course of the due diligence process, we certainly came to appreciate the mutual assets each company had," Joyce said in an interview of Getco.
"I think it's kind of cool that the company will still stay public and give shareholders the opportunity to take part in the upside, because it looks to me like the upside is potentially significant," he said.
Knight investors with the Jefferies and Getco group have agreed to limit the cash they take in the current deal to 50 percent of their Knight shares so that other stockholders can receive up to $720 million in cash. If requests for cash top $720 million, they will be pro-rated.
Getco will borrow $1 billion to provide the cash for the exchange offer, as well as to refinance the various debts of both companies, Coleman said.
The new board will have nine members, with five from Getco and four from Knight.
Getco investor General Atlantic, as well as Blackstone and TD Ameritrade, were given seats on Knight's board as part of the rescue.
Reporting by Tanya Agrawal in Bangalore and David Henry, John McCrank, Jessica Toonkel, and Jed Horowitz in New York.; Editing by Sriraj Kalluvila and Bernadette Baum