It’s a familiar story. Some millennial sends me a text saying “Hey, I just bought my first LiteCoin on Coinbase!”. My response is “Jeebus, you probably paid a 2% commission, why didn’t you just use GDAX?”. I hate fees and Coinbase charged a 2% “I don’t know what this is, but my friends are doing it” fee. This was December 2017. During 2017 Bitcoin, Ethereum, Ripple, Monero and countless other nameless crypto currencies rose to internet fame increasing in value over 100x. Initial investors didn’t believe the hype, but Reddit coined the term ‘Hodl’ and we held on for dear life as our net worth bounced around 20% daily.
Then came the reckoning:
If you bought at the top, you lost 25% in a few days, 65% within a month and 90% by the end of the year. If you’re still holding today, you’re actually up! The price of ETH is $1,343 today, but that’s a completely different story.
Ok, Let’s Talk About GameStop
To be clear, there has been no news released by the company since January 11th, when it announced that their 9 week holiday net sales were $1.770 billion, a 3.1% decrease compared to 2019 (source). E-commerce sales were up, but as I said in an earlier post, both Playstation and XBox are trying to move to digital sales only for new games. Bears, like myself and a few other badly hurting hedge funds, thought this brick and mortar retailer was a thing of the past and would be swallowed by Covid closures. After my post about selling my short here, I stayed the hell away from GME, ironically, only because shorting was too expensive, meaning I still thought I was right, but not at that price.
Bulls had a good case, however. I’m going to embed this whole Reddit post here; it’s actually brilliant. In effect, u/delaneydi is arguing that given the companies strong cash position (it’s still strong), projected EBITDA, and ridiculously low EV/Sales multiple, the price of the stock doesn’t reflect it’s true value, which is modestly higher. As you can see, no one cared about this post as it generated a whopping 33 up votes. I can’t even link to the comment section, but in short, this user was lit tf up. Even r/WallStreetBets was short this stock in 2019
However, some major investors agreed. The first one was Michael Burry of Scion Asset Management, but you may remember him as played by Christian Bale in The Big Short. He quietly opened up a long position as shown in a 13F filing, which he bought in Q3 2018 worth about $6.7mm with a basis of $12.61 / share. He added to that position over the course of 2019 and even bought shares for as low as $3.50 mid 2020. However, towards the end of 2020, he liquidated 36% of his position at around $10 / share, which probably represented a measly 40 – 60% gain. According to his latest 13F filing, he still owns 1,703,400 shares, which would be worth $562mm, though that filing is a bit old.
My favorite part about Burry’s investment is that he actually saw the same value as the Reddit user. He issued a press release in August 2019 urging the GameStop board to use $237mm to buy back 80% of the companies stock. His reasoning was that during the month of August 2019, the number of GME shares traded exceeded the total number of outstanding shares. GME could theoretically buyback and retire 80% of the total shares, dramatically improving earnings per share. He then goes on to say that the GME missed lots of opportunities to move into the digital space, so while the company shows no large upside, a bit of financial maneuvering could yield a decent upside for shareholders. Smart guy. I wish I knew all this was going on.
Next up, the Ryan Cohen, the founder of Chewy, Inc announced his hedge fund dumped $5.8mm into GME stock in August 2020 and continued to add to the position, totaling $75mm at a price of $8.43 / share. That’s now worth north of $1.3bn. In the mean time, the shorts continued to pile on, reaching 120% short interest towards the end of 2020. It made sense, the company was burning $100mm per quarter and had no discernable digital strategy to address the new consoles. Bulls said that despite the fact digital was overtaking physical games, the demand for video games continued to go up, and, as they say, a rising tide lifts all boats.
The Big Short Squeeze
So here we are: GME is the most epic short squeeze in all of history. But how could it happen. Informed and successful hedge fund managers had LONG positions. Multiple posts on Reddit called out a the fact there was a 120% short interest (which cost 60% to borrow for the privilege) with a potential basis of $7 while the share price was hovering around $10. If the stock hit $15, that means the shorts were going to be out over 100% of their initial investment.
Side note: I’m never going to short a stock / I haven’t in years (I only did it to see how it worked, but I’m over it). When you short a stock, you effectively borrow the shares from someone (usually your broker), and sell them. Selling the shares creates downward pressure on the price (just think buyers only want to buy something if the deal looks good, and if you think the shares will go down, odds are other people do, but to a point. So they have a price, but it’s lower than what it’s currently at). Ironically, selling shares you don’t own creates downward pressure on the price and is good for the short seller! The catch is that the short seller needs to deliver those shares back to the original owner, basically whenever the original owner wants them. In order to borrow the shares, you pay the original owner interest. If the shares are volatile, the original owner charges a hefty premium. So by simply staying in the trade, you are losing the interest payment. On top of that, if the share price, say, triples, you have to buy the shares back on the open market and return them to the original owner. That means your exposure is literally infinite loss. So imagine borrowing $100 worth of GME at $7 (14 shares) and selling those shares. You owe the person you borrowed those 14 shares from, well, 14 shares of GME. If the price goes down to $3 and you want to give the shares back to the original owner, you buy 14 shares at $3 for $42 and voila, you just made $58. However, if the shares go up to, say, $330, and the original owner wants those shares back, you now have to buy 14 shares on the market for $4,620. You just lost $4,520 on a $100 investment. Great work. Oh, and your upside would have been $100, only if the company went bankrupt.
Main Street Crushes Wall Street
Ok, so back to the main event. In late 2020 and early January this year, Citron Research and Melvin Capital released statements that they are short GME. By January 12 the short interest on GME was 139.67%. That means there are more shares sold short than are floating on the exchanges. The short squeeze is simple, the price goes up, and over 100% of the shares need to be sold in order to return. If you’re wondering, short interest can exceed 100% because shares are borrowed and sold multiple times. It’s an utter disaster. When the price spikes, everyone wants their shares back because they’re afraid the borrower won’t be able to pay. In the case of GME, they should be afraid.
Ok, so Citron Research and Melvin Capital got crushed. Citron tried to live stream an event talking about their short position, but got shut down by hackers. Redditors, especially those on r/WallStreetBets really don’t like Citron Research. Citron, the notorious short sellers, released statements that they thought Palantir and Fubo were easy shorts, sending the price in a downward spiral after a meteoric rise. Now that both Citron and Melvin exposed their short positions on a low market cap stock with incredibly high short interest to begin with, Redditors saw a huge opportunity. Buy, hold, buy some more. If the price goes up, over 100% of the outstanding shares will need to be BOUGHT, forcing the price way up. If there are limited sellers, those sellers can demand a huge premium. That is exactly what happened. Main Street crushed Wall Street.
Somehow This Gets Political And IT NEEDS TO STOP
As of today, Robinhood stopped its customers from buying shares of GME, AMC, NOK and other heavily shorted stocks that experienced a short squeeze over the past week. r/WallStreetBets Discord stopped working – it looks like that was due to unprecedented volume – and its Reddit page went down for a bit. These things are concerning, but happen when growth is hyperbolic. The subreddit has gained over 1mm new users over the past few days. People are downloading RobinHood and buying GME as their first stock purchase ever.
To be clear, this is not Wall Street taking from Main street. It’s Main Street taking from Main Street. That is actually how America should work. I honestly think it’s common sense not to invest in anything you don’t understand, so if you do, I don’t feel sorry for you if you lose money. Nor should the government care. If it’s fraud, or something dishonest, yes, government please step in and enforce reasonable laws. But do not shut this down.
I was very disappointed to see this press release:
“With stocks soaring while millions are out of work and struggling to pay bills, it’s not news that the stock market doesn’t reflect our actual economy. For years, the same hedge funds, private equity firms, and wealthy investors dismayed by the GameStop trades have treated the stock market like their own personal casino while everyone else pays the price. It’s long past time for the SEC and other financial regulators to wake up and do their jobs – and with a new administration and Democrats running Congress, I intend to make sure they do.”Elizabeth Warren
The government has no business regulating hundreds of thousands of small investors (she literally doesn’t understand anything). They know the risks; it’s a casino and people just want to play. Hedge funds have been throwing their weight around for years, manipulating the markets in the shadows. It’s time for Main Street to do the manipulation and lay in the proverbial bed we made. Even Citron Research came out with this tweet, basically telling the SEC to stay TF out of this battle.
The WH should have more pressing issues than to investigate stock forums on Reddit. We are a nation based on free speech and capitalism. Citron has fought globally for 20 years for that right and no one trading phenomenon should eliminate it. *Our first political tweet ever— Citron Research (@CitronResearch) January 27, 2021
Put your political leanings aside (hey, I just called out Elizabeth Warren), AOC is dead-on here
Gotta admit it’s really something to see Wall Streeters with a long history of treating our economy as a casino complain about a message board of posters also treating the market as a casino— Alexandria Ocasio-Cortez (@AOC) January 27, 2021
The Wealthiest Man in the World Should Stay Out of This
Gamestonk!! https://t.co/RZtkDzAewJ— Elon Musk (@elonmusk) January 26, 2021
Not cool Elon. If you remember, Tesla used to have a huge debt problem. Citron Research was one of the loudest short sellers of Tesla, forcing it to constantly worry about its ability to pay back its massive debt load. Elon Musk (more than) entertained the idea of taking the company private because short sellers kept pushing the stock price down, making debt obligations more onerous. They were obviously wrong and short sellers lost $40bn shorting Tesla in 2020.
As of writing this, GME is down 62% (coming back though). No one should lose half of their investment in an hour unless they are fully aware it can happen. I don’t think we should regulate it, but rich people don’t need to purposefully dupe tens of thousands of people because of a grudge. That said, if I were him, I would have done the exact same thing. If you come at the king, you best not miss.