An exposé on GameStop…

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I sure kicked up the hornet’s nest by making a video about GameStop. If you want to see the video and some of the angry comments, you can do so here. Some felt that I didn’t cover GameStop deep enough or give the Wall Street Bets (WSB) community enough credit. 

I absolutely stand by my video as a summary overview and warning for most new investors that are getting fear of missing out (FOMO) from social media. But Given $GME is up over 20% this morning to $92 per share and battle is clearly still raging, let’s do a deep dive into what’s happening.

  • Six months ago $GME was trading under $4.00 per share on fundamental concerns about the business. The business has seen a huge decline over the past five years due to being a brick-and-mortar video game retailer in a world where video games are increasingly downloaded over the internet.

  • GameStop gained prominent investors focused on a turnaround. 
    • Starting in August, Ryan Cohen bought a 10% ownership stake in GameStop, continued buying more shares, and basically took control of the Board of Directors and company. Cohen has a good track record, having founded and sold Chewy.com to PetSmart for $3.35 billion in 2017.
    • Cohen believes GameStop’s challenges stem from internal stubbornness and that the company can turn around if it cuts costs, hires talent, and pivots aggressively to e-commerce.
  • Some investors started getting excited by $GME stock based on this turnaround thesis. Indeed, if I had been aware of $GME at a less than $200 million valuation ($4.00 per share), then I might have been interested in a deep value play as well.
    • DOMO Capital Management wrote a bull thesis in September, which you can read here.
    • DOMO called out that $GME had a strong-enough cash position (>$5 per share) to get it to a strong console refresh cycle and a longer-term turnaround.
    • DOMO also believes GameStop’s most valuable asset is their database of tens of millions of PowerUp Rewards members that it can leverage to transition into e-commerce.
  • $GME stock had a huge short interest and was prime for a short squeeze.
    • The percentage of $GME’s float that was short was well over 100%, which if I recall correctly, implies that over half of $GME’s float was being used to short the stock. For reference any short interest over 10-20% is considered high.
    • One fund, Melvin Capital, had an over $55 million short position in the form of put options.

  • The Wall Street Bets community (WSB) saw these short positions and coordinated a buying of $GME stock in large volumes relative to its small float.
    • WSB is 2.3 million members strong and you can check them out here.
    • The scale of collusion is astonishing and seems to be a combination of seeking vindictive justice against “Wall Street” and Melvin Capital and fear of missing out (FOMO) on massive gains.
    • A redditor named “DeepFuckingValue” turned $50k of $GME call options into over $13 million in 3 months.

  • As a result of this buying activity, $GME stock has ripped massively from under $20 to $90 per share.
    • Firstly, we have a classic short squeeze, which is a technical phenomenon that can cause a rapid increase in the stock.
      • An increase in a stock’s price forces some short sellers to cover their positions. To cover their positions, they have to buy back the stock they borrowed to sell short. This, in turn, further drives up the price of the stock. 
      • Short sellers will have big losses on paper and those that used margin (borrowed money) can get margin calls if they’re down too much. This is where they are forced to cover the position, which further increases the price of the stock. This becomes a feedback loop and a vicious/virtuous cycle.
      • This usually happens in names with a small float, high short interest, and expensive borrowing costs. Many times short squeezes happen on companies on the verge of bankruptcy. This is not something WSB could do with a bigger stock like $TSLA, which has well over 10x the trading volume compared to even $GME’s artificially pumped volumes.
    • Furthermore, we’re seeing a “gamma squeeze” due to the massive amount of buyers buying short-term out-of-the-money call options.
      • When a dealer sells an option to a trader, it buys the stock to hedge the risk of the call option being “in the money” and getting exercised.
      • If the options are deeply out-of-the-money, then the hedges are small. But as the stock goes up closer to the strike price, then the sensitivity of the options to the stock price grows. 
      • This causes the dealer to buy more and more stock to hedge, which further increases the buying pressure on the stock. This is also a vicious/virtuous feedback loop.
  • Short sellers are hurting badly. 
    • Melvin Capital is down almost 30% from its GameStop fiasco and is now being funded by hedge fund giants. Ken Griffin’s Citadel is investing $2 billion and Steve Cohen’s Point72 is investing $1.75 billion into Melvin.
    • Citron Research is reportedly still short the stock as of this morning.
    • Despite the skyrocketing price, short sellers have not backed down. According to CNBC, short sellers have reloaded their bets and $GME’s short interest still stands at 139%.
    • To be clear, I think that these short-sellers are irresponsible and clearly foolish to underestimate the risk of a short squeeze.
      • Furthermore, the fundamental short case against $GME is actually not that compelling to me in the $20 per share range.
      • This trade just seems like an unwise and unnecessary one to make at an institutional level and I do take quite a lot of entertainment out of the drama.
  • At $90 per share, $GME stock is untethered from its fundamentals and is an ego-ridden battle between certain short sellers and the WSB community. 
    • It is now valued at $6.5 billion on negative EBITDA (cash flow). In order to believe in the valuation, you’d need to believe in a massive corporate turnaround and a successful entry into digital video game sales. 
    • Right now, $GME should only be thought of as a vehicle for gambling, not investing.
    • Despite the braggadocious stories of vast riches made by a pumped stock, eventually many innocent people are hurt when they FOMO in at the top at the behest of others. And these are the people left holding the bag when the community leaves, moves on to its next target ($AMC?), and the stock declines back to fundamentals.

We at Cents are investors (not short sellers). As you could’ve guessed, we will not partake in either side of this trade, but we will be watching with popcorn in hand.

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