GameStop’s extraordinary rise in 2021 captivated the world’s markets. It marked a new generation’s stock market. The stock of a struggling retailer turned into the beacon of rebellion— the internet generation versus the entrenched elite. The rise rattled the stock market’s clearing systems. It even led to a congressional hearing. Retail investor Keith Gill turned a $50,000 investment into over $30 million with a combination of call options on the stock.
An attractive valuation, several fundamental catalysts, extreme short interest (and covering), and converging fund flows all combined created an explosive situation.
GameStop’s stock traded at cash levels. After many years of struggling sales and earning losses, GameStop’s stock was extremely cheap in September 2020. The total market capitalization was $750 million, roughly equivalent to the cash on its books of $730 million. The stock’s value implied an imminent bankruptcy risk, even though the retailer had enough cash to fully cover its $470 million in debt.
Two transformative catalysts emerged in the latter half of 2020.
Ryan Cohen’s activism. The founder and former CEO of e-commerce pet supply company Chewy acquired 13% of GameStop’s stock in August 2020. Cohen took a seat on GameStop’s board with a plan to turn the company around. He wanted to create an omnichannel business model, a combination of physical retail and e-commerce. This was enough to attract new investor attention to the company.
Gaming console refresh. At the same time, the arrival of next-generation Xbox and PlayStation gaming consoles prompted a console refresh cycle. New purchases of games for these consoles drove new sales growth for the retailer. GameStop’s sales volumes rebounded to over 16% y/y for 3Q, which it reported in December. Cash levels rose, and more debt was paid off. Earnings expectations started to move higher.
New investment thesis. By early 2021, some investors believed that GameStop’s losses were stabilizing. With Ryan Cohen’s involvement, the stock could re-value to a higher multiple, especially if it could grow again. Keith Gill also posted about GameStop regularly on the internet forum WallStreetBets, hosted on Reddit. Michael Burry (Scion Capital) also disclosed a sizable position. As GameStop’s stock rose in price, it started to attract retail buyers globally. On the other side were short positions on the stock from several hedge funds.
Extreme short interest. GameStop stock had a 130% short interest, making it one of the most shorted stocks in the entire market. The Reddit community, and other quieter institutional investors, understood the situation. A higher stock price could lead to heavy buying from shorts buying back or covering their positions to limit losses.
Shortage of shares. A closer look at the company’s shareholders indicated there could even be a shortage of stock. ETFs held close to 20% of GameStop’s shares and would purchase more shares as the price increased. Ryan Cohen held 13% of the shares and was committed to the company’s turnaround. Fidelity Investments, a mutual fund, also held close to 13% of the shares and was most likely invested with a long-term view. Only the remaining 50% of shares were potentially freely tradable. And there were three times as many shares already sold short.
Many investors recognized this as a dangerous setup. If GameStop’s stock price were to rise significantly, short sellers would have to buy shares to close their positions. This would lead to higher prices and trigger even more buying—otherwise known as a short squeeze.
Options momentum. Options accelerated the rise. As GameStop rose from $20 to $40, more buyers emerged. Investors fueled the momentum by buying options to buy the stock at much higher prices in the $70s. Thousands of new contracts were opened. As more buying pushed the stock price up to these levels, option dealers also bought more shares to be able to deliver shares to the option holders. New investors, option dealers, short sellers—all were buying stock. GameStop’s price rocketed to well above $100 / share in a few trading days. Short interest dropped to 20% as short sellers closed their positions.
Over the next few months, the stock price continued upward. Short interest declined to 8% as shorts closed their positions. The 4Q earnings release was another positive catalyst. It highlighted better sales trends from the holidays, and sales expectations rose after the release. New executive officers were recruited, and Ryan Cohen was appointed Chairman. The stock’s multiple re-rated to higher levels, and GameStop’s value was now comparable to growing retail companies. The stock stabilized at above $120 / share and reached $200 / share by the end of 2021.
This is an excerpt from Better Investment Decisions.
