The setting could have been straight out of the Showtime series Billions (spoiler alert): A bunch of retail guys take on big-name hedge funds that have over-leveraged on a company. Deca-billionaire hedge fund founder Bobby Axelrod sends in Dollar Bill to create some ruckus.
A couple of hedgies go down. Axelrod talks a sweet game about how it’s time for trading to be democratized and taken away from the hands of the few. A broker stops the ‘Average Joe’ from playing in the big leagues. More outrage. The authorities want to look into the whole saga. A couple of politicians get involved. In the end, Axelrod lines his pockets with millions. The retail investor is left holding the short straw. The company in question is destroyed.
What’s the real story behind the GameStop saga?
Contrary to most reporting, the story of the GameStop short squeeze doesn’t begin in December 2020 or even November 2020. It started in September 2019!
Before we get to it, here’s a quick background on GameStop: It says it is the “world’s largest retail gaming destination for Xbox One X, PlayStation 4 and Nintendo Switch games, systems, consoles & accessories.” Headquartered in Grapevine, Texas, its business has taken a pounding as customers prefer to shop online. It was previously trading at $45 in October 2015 but then fell steadily. By Jan 2020, it was trading at $4.75.
In September 2019, on a subreddit called Wallstreetbets, a user called DeepF***ingValue posted this image with the line: Hey Burry thanks a lot for jacking up my cost basis
It was an image about his long-dated call option on GME. From September 2019 to September 2020, he posted about his position once a month every month. The needle barely moved on GME stock and it continued to languish below $5 a share. There are multiple articles that talk about what GME is worth.
The reason why GME stock was trading at $2-$4 levels was that a large number of hedge funds had shorted it. Basically, hedge funds had sold shares they didn’t have, and they were driving GME stock price to the ground. Shorting a stock when you borrow a stock from someone and sell it on the market with an expectation that you will buy it at a later date (in the hope that the price of the stock goes down. If it goes up, you have to buy it at a loss).
The problem with GME was that hedge funds like Melvin Capital had sold 140% of the total shares. Essentially, they had sold shares that didn’t exist. The matter gets murkier here. Around 75% of GME stock is locked up in passive funds, GME board, and the C-suite.
The actual short position was in excess of 300% of the actual amount of tradeable shares (known as float). This meant that hedge funds like Melvin Capital were betting on the outcome that GME would go bankrupt and they would never have to buy back the short shares (this is called covering their position).
Was GME really such a bad company?
If one had taken a look at GME filings with the SEC, one would discover that there was no reason for the stock to trade at such low prices. The company seemed to have enough money to pay off its debts.
And that is exactly what DeepF***ingValue did. He, along with Michael Burry, had identified this mismatch. Michael Burry is known as the guy who identified the housing bubble in 2004 (Christian Bale played him in The Big Short). In fact, Michael Burry discovered the mismatch after DeepF***ingValue.
Michael Burry’s $17 million play on GME was worth $271 million at the peak of the Reddit-fuelled rally.
Clearly, GME wasn’t a basket-case like it was being portrayed.
How did a bunch of Redditors screw billion-dollar hedge funds?
Reddit is not a specific social network tailored to investing like say Hashtag Investing. But, it can contain “subreddits” like the one that caused the whole GME fiasco to begin.
Wallstreetbets has over 4 million members. After DeepF***ingValue kept posting about GME, he convinced enough of them that what he was saying made sense. And this is where matters got real. Redditors began buying all the shares of GME they could.
GME prices began to move up: From $7.65 on September 1, 2020, to $483 in January 2021. And remember the rule of shorting a stock? You have only borrowed the stock from someone and sold it on the market. At some point in time, the short seller has to buy back the stock.
What does one do when there are no shares to buy? Again, remember only 25% of GME shares were actually available to trade. And Wallstreetbets bought them all. All the hedgies had to buy back the shares but the shares were now trading at over 2,000% of the buying value.
Melvin Capital had to be bailed out by Steve Cohen’s Point72 and Ken Griffin’s Citadel who invested $2.75 billion in Melvin Capital as its short positions got hammered.
How do Elon Musk and Chamath Palihapitiya fit into the picture?
Elon Musk of Tesla, Cathie Wood of Ark Investment Management, and Chamath Palihapitiya, serial SPAC entrepreneur, have all been cheerleaders for the small guy.
From the discussions on Wallstreetbets, it became apparent that retail investors were taking massive risks to buy GME stock. People sunk their college tuition, education funds, and pandemic stimulus checks into GME stock because they wanted to stick it to the man.
The financial world was alarmed at this. This was the first time in history that a bunch of rag-tag people, who had never even met each other, got together and caused a run on a hedge fund. The narrative began to turn as people wondered who would be left holding the bucket when the party ended. Retail investors were buying GME stock as it went up.
The real Wall Street began to sound cautionary notes to retail investors. However, Musk, Wood, and Palihapitiya came out in support of the 4 million Davids. In fact, here is a great interview of Palihapithiya blasting CNBC.
In the middle of all this, Robinhood, the app that has lured millions of amateur traders to the stock markets, and where a lot of retail investors were buying GME stock decided to stop retail investors from buying GME stock. Other online brokerages, including Interactive Brokers Group Inc. and Morgan Stanley’s E*Trade, followed suit.
Elon Musk took Robinhood CEO Vladimir Tenev to task on audio app Clubhouse on his decision to ban trading.
What happens now?
While GME stock was not worth $4, its shares are clearly not worth $483 or $300 or even $200.
“Reasonable minds can disagree whether GameStop is worth $30 or zero,” said Michael Pachter, a stock analyst at Wedbush Securities who has followed GameStop for nearly two decades, “But not $200 to $300.”
Now, it seems like the short positions are unwinding on GME. According to this article, the sharks (big Wall Street investors) are in for the killing. GME stock is trading at $92 at the time of this article, down 81% from $483.
And what about DeepF***ingValue? As of February 2, he was still long on his GME position.