Over the last couple of days, the New York Stock Exchange (NYSE) traded video game retailer GameStop (NYSE: GME) became the subject of one of the biggest short squeezes the financial market has ever witnessed. As a result, GameStop’s stock became the most-traded share on the NYSE, making every major news outlet’s front page and captivating social media. At its current provisional peak, the stock exceeded a price of $514 USD per share, skyrocketing the company’s temporary market capitalization upwards of $35.9B.
The Rise and Fall of GameStop
GameStop was taken public in February 2002 by Barnes & Nobles Booksellers, which owned the company before it became an independent company in 2004. In the following years until 2016, the company rapidly expanded in the U.S. and internationally. GameStop acquired several businesses in the process, including several retail store chains and game indie development studio portal Kongregate. By the end of 2016, GameStop operated more than 7,500 stores.
Alongside its expansion, the company grew its revenues significantly and surpassed $9B in sales multiple times in the years leading up to 2016. Between 2013 and 2016, GameStop generated annual net profits between $350M to $400M, while its stock price moved between $25 and $55.
In the wake of the market for physical game media yielding to the ascending digital market for games, GameStop reported a 16.4% decline in sales for the 2016 holiday season, while its stock fell 16% throughout the year.
GameStop’s further decline was represented in the rapid deterioration of its profits. Initially, the company’s net profits dropped from $353M in 2016 to just $34.7M in 2017. In the following years, GameStop reported losses of $673M in 2018 and $471M in 2019. Also for 2020, the company is likely to report another nine-figure loss for its fiscal year, which ends on Feb. 1.
GameStop Goes Esports
In an attempt to turn around GameStop’s downwards trajectory, it hired design firm R/GA and, in July 2019, presented plans to revamp its stores, focusing on competitive gaming and retrogaming. As part of its reorganization efforts, GameStop laid off around 170 employees.
Furthermore, Texas-headquartered GameStop signed multiple deals with local esports organizations in 2019. For instance, the video game retailer signed a three-year deal with Complexity Gaming to name its headquarters at Dallas Cowboy’s campus, The Star in Frisco, the GameStop Performance Center. It also signed sponsorship agreements with Texas-based esports organizations Dallas Fuel and its parent organization Envy Gaming; as well as with OpTic Gaming and Houston Outlaws, which were owned by Infinite Esports.
COVID Crushes Retail Sales
A couple of months after the decision was made to revamp GameStop stores, the U.S. government’s efforts to slow down the spread of COVID-19 required the company to close all of its remaining 3,500 stores in the country starting in March 2020. Before stores were allowed to reopen in May, about 65% of GameStop’s U.S. stores offered curbside pickup for orders. While the company reported a 519% year-over-year increase in digital sales for its fiscal first quarter of 2020, which ended on May 2, 2020, its total revenues dropped by 34%.
However, GameStop’s CEO George Sherman explained that he expected to recover from the losses in Q1 2020 by benefitting from the releases of Sony’s and Microsoft’s newest generation of gaming consoles in the second half of 2020.
Further positive news for GameStop followed in October 2020, when the company announced an agreement with Microsoft, which includes revenue sharing on all digital game purchases for the Xbox Series X and S sold by GameStop.
Support from Institutional Investors
While GameStop’s stock dropped below the $4 mark in 2019, Michael Burry, an investor who is famous for making a billion-dollar bet against the U.S. housing market in the 2008 subprime crisis and won, announced that he would be going long on the stock of which he owned 3.3% via his investment firm Scion Asset Management at the time. Scion Asset Management later disclosed that it bought 5.3% of GameStop at between $2 to $4.2 a share, spending around $15M in total despite GameStop’s negative earnings. By September, the firm reduced its GameStop holdings to 1.7%.
Aside from Scion Asset Management, GameStop is backed by several other institutional investors, including investment management firm BlackRock, which currently owns 13.2% of GameStop’s stock, and financial services corporation Fidelity.
In August 2020, Ryan Cohen, founder of pet food company Chewy, which he sold for $3.35B to PetSmart in 2017, took a 9% stake in GameStop via his RC Ventures fund to become the third-largest investor in the company behind Blackrock and Fidelity.
By the end of 2020, GameStop’s stock recovered from its all-time low in 2019 and floated around $20 per share.
Believed to be Dead
Whereas GameStop attracted new investors throughout its reorganization during a global pandemic, more and more institutional short-sellers started paying attention to the company. Believing that it is overvalued, several firms, including Citron Research, started short-selling the company.
Short selling a stock allows investors to profit from a company whose stock decreases in value. To short sell, an investor borrows a stock from a broker and sells it to a third party at the current market price. To close the short position, the investor has to buy back the stock and return it to the lender. Due to its nature, losses from short-selling can technically be infinite, while the risk of buying a stock is capped by the amount paid for it. Institutional short-sellers can be important actors in the financial markets. They usually specialize in finding overpriced or fraudulent publicly-traded companies and bet against them, often leading to regulatory interventions.
By Dec. 31, 2020, GameStop had more bets made against it than it had shares outstanding as more than 102% of its outstanding shares were shorted, which means that in case all short-sellers want to close their position at once, the share price of GameStop would increase infinitely since the demand for investors selling them stocks would exceed the maximally possible supply.
Cue in Reddit
In parallel to Burry and Cohen backing GameStop, several retail investors started placing call options on GameStop and shared their positive sentiment on the company’s future on the Reddit thread “Wall Street Bets” (WSB), which is known for its profane nature and allegations of users manipulating securities.
Call options are financial contracts that allow buyers to profit from a stock’s price increasing above a specified price within a set time limit. For example, GameStop traded around $470 just after the market opened on Thursday. A buyer purchased a one-week call option on GameStop that expired at 9:30 am Thursday and had a strike price of $200. The buyer’s profit would be $269, which is the stock’s price at the expiration of the option ($470) minus the price paid for the option ($1) and the option’s strike price ($200).
Following a surge of GameStop’s stock price associated with Cohen’s investment, more WSB users placed call options on the company and posts about the company became more frequent. The number of posts about GameStop stock in WSB further increased in December 2020, with some users betting on an upcoming short squeeze in the stock. In those conversations on the forum, the hedge fund Melvin Capital Management, a significant holder of GameStop short positions, was collectively chosen as an antagonistic figure.
The combination of Cohen joining GameStop’s board of directors on Jan. 11 and the ongoing hype about the recently-released PlayStation 5 and Xbox Series X game consoles re-sparked the subreddit’s interest in the company with several posts asking users to invest in it.
The situation was further escalated on Jan. 20, when Citron Research’s Andrew Left shared his bearish prognosis towards several stocks that are currently popular on WSB and several Redditors created posts instructing readers to buy call options of GameStop to squeeze short-sellers like Citron Research out of their positions. The use of call options enabled the Reddit community to leverage their investments enough to influence GameStop’s market price significantly.
The Big Short Squeeze
A short squeeze happens when a stock price increases over a specific threshold at which shorted investors cut their losses by buying into the stock to return shares to their borrower. This phenomenon can quickly push a stock’s price up several percentage points and in some cases double a stock price many times over as more and more short-sellers are pushed to their limit and have to cover their losses by buying into the stock.
Since the first leg of the short squeeze on Jan. 13, when GameStop’s price per share increased to $31.4 from $19.95 on the previous day, a series of short squeezes pushed the stock’s price to over $510 during pre-market hours on Thursday. The short squeeze was accelerated by several events on social media, including Tweets from Tesla CEO Elon Musk and Virgin Galactic chairman Chamath Palihapitiya.
GameStop’s stock did not increase in one upward motion because as its stock price increases, long investors collect their wins by selling their shares. Especially when institutional investors decide to offer a significant amount of shares to the short-sellers trying to cover their positions, GameStop’s stock price will drastically drop due to the increased supply of stocks. However, the stock price can go up again as soon as more short-sellers want to take advantage of the dip and buy into it to cover their positions, therefore driving the price back up.
In the stock’s process of reaching new all-time highs over and over again, it was traded hundreds of millions of times a day and trading was halted multiple times due to high volatility. By virtue of the short squeeze, GameStop short-sellers have lost several billion dollars in January. Melvin Capital Management reportedly had to get a $2.75B investment to stabilize the company after it took massive losses on its GameStop shorts.
Source: Read Full Article