The GameStop (GME) Saga: Revenge of WSB
GameStop (GME) has been in the centre of the investing community for the past week. People are drawing similarities to David v Goliath story. It is the hottest topic out there now and there’s been so many talks in town about it – including in Malaysia where people are thinking to replicate what happened to our beloved glove counters.
So yes, BTM wants a piece of the action as well.
As a disclaimer, I do not – in the past, present or foreseeable future – own or will own any positions on the stocks discussed in this post.
Who are the parties involved?
Main Characters
- The Redditors – WallStreetBets
- Hedge funds
- GameStop
Supporting Characters
- Brokerage – Robinhood, TD Ameritrade, etc
- A lingering shadow in the background
The Introduction
Before anything else, we need to know who these characters are.
The Redditors refers to the community of people participating in the forum called Reddit. In Malaysia, we have LowYat.com. In this particular saga, we focus on a subreddit (i.e. category) called WallStreetBets which talks about investment. They are the main character here and kudos to their achievements!
Hedge Funds, which is the opposite camp in this saga, refers to professional investment managers who invests the pool of money of their investors aggressively. Think of… mutual funds but for people of a certain minimum net worth (i.e. accredited investors / rich people) and can employ a wider range of strategies.
GameStop is the company whose shares were the medium for the entire saga. They are engaged in the retail gaming industry, which means they sell gaming related items. A similar shop will be Gamers Hideout in Malaysia.
Brokerages are the platforms in which investors perform their trades / investments. It’s just like Rakuten Trade, MPlus, any bankers in Malaysia whereby we engage in our trading / investment in Malaysia.
Lingering shadow – someone important which shall be introduced at the tail end of this post.
Now that we got the characters introduction done with, let’s hop on to the hype.
GameStop’s Fundamentals
I am not going to spend too much time talking about this because the unfolding of the entire saga has NOTHING to do with fundamentals, but it warrants a key section because it may have an effect of what the future holds.
At GameStop’s peak, it acquired EB Games in 2005 for $1.4 billion. It easily has north of 6,000 stores across more than 10 countries.
In terms of financials (looking back up to year 2011 and boxed in red for easy reference):
- Highest revenue was $9.6 billion in year 2012
- Revenue suffered a decline in recent years (consecutively for 2 years since 2018 from $9.2 billion to $6.5 billion in 2020)
- Operating margin was declining for a continuous 4 years
- Net income (also known as profit after tax) dipped into losses in 2019 and seems to be reducing in losses
- Net income also suffered 3 years of consecutive drop from $403 million in 2016 to a loss of $673 million in 2019
- Book value per share (i.e. how much the net assets are worth per share) has decreased dramatically ever since 2018
- Take note that the shares outstanding dropped as well, but book value per share continues dropping at an alarming rate (If the net asset of the company remains constant, the decrease of shares outstanding should technically INCREASE the book value per share, but this did not happen here. That means the book value per share will be a lot lower if the shares outstanding did not decrease)
Interesting, right? What about the future of the business?
Prior to the Covid-19 pandemic, they were putting in efforts to revamp its business. However, when the pandemic hit, their business took a grave hit as well – as all retailers do.
And how has the share price performed?
For the past month (before the craze happened), it has been trading at a range of $10 – $40 of per share.
Then within 5 days it surged to a high of $483. That’s a 12x – 40x increase in value over 5 days!
The FOMO-vestor in me is knocking on my door, but I keep it away ~
So what happened (dumbed down version)?
Hedge funds short
In what seemed like a normal day, hedge fund manager took a look at GME and decided that the company would be worse off in the coming days, which would translate into lower share prices.
So, he decided to “short” the stock, which means he will borrow available GME stocks and sell it at the market at the current price.
- If the price drops in the future, he can then buy GME stocks at a lower price and return the stocks to the person he borrowed from because he sold HIGH and buy LOW
- However, if the price increases, he will have to buy at a higher price and return the stocks to the person he borrowed from, therefore making a loss because he sold LOW and buy HIGH
As all stories go, things never go as planned.
The rise of the Redditors
The entire saga began with a youtube trader – “Roaring Kitty” – who was bullish on GME as a stock. He shares his views and thoughts in his channel and also in reddit. At some point, this triggered a movement to ride GME “to the moon” (i.e. rise in value by A LOT).
It’s not clear who or how this movement actually began, but what is clear is that it is now about the retail investors making a statement to the hedge funds. They all unified and asked more people to buy and hold just to “get back” at the hedge funds for the years of “manipulation”, as they say it. Some even go as far as wishing that the movement will bankrupt these hedge funds, which is not the best logic in the first place. We’ll talk about this in the next section.
As more retail investors flocked into GME to buy the stock (thus, driving the prices up), the hedge funds’ “short” position start to turn into losses.
Remember, when GME’s price goes up, they would need to eventually buy at prices above their sale price to exit the trade [Buy High, Sell Low].
In come the “short squeeze”
You know what “short” is now. We will now talk about the famed “short squeeze” phenomenon.
The GME stocks that the hedge funds “short”ed are borrowed. So as the price keeps going up, the losses pile up. At some point, the hedge funds will have to exit the trade – either voluntarily or not.
As we all know, there is no maximum limit of how high a share price can go up. So the potential losses that they can get hit with is unlimited. Coupled that with an expiry date of when they would need to return the borrowed stocks, the hedge funds will need to make a decision.
“Short Squeeze” happens (or happened in GME’s case) when the hedge funds exit the trade as the share price continues to soar. To exit the trade, they would need to BUY the GME stocks, causing the share price to increase further because… well, they represent a huge volume in the market.
A twist of events: Brokerages
On Thursday, a few brokers – Robinhood, TD Ameritrade, Interactive Brokers – restricted trades on GME. Traders may sell or close out their positions, but they are not allowed to buy or enter new positions. GME share price halved as a result.
This decision was met with a market uproar as the public accused the brokerages to be siding with the hedge funds. They even started a class action lawsuit (i.e. collectively a group of people sue the company). #mindblown
Robinhood began to reverse a bit on their restrictions to allow limited buying. The Redditors also found a backdoor way to continue buying GME. The share price reversed once again and continued its uptrend.
Story to be continued… because this is the latest development so far.
BTM’s Views
Since we’re up to speed about the rah rah of GME, it is time to talk about serious stuff.
The Movement
Does not make sense.
Trying to get back at the hedge fund managers for the “short”?
That’s like saying mutual funds are manipulating the market and they want to go against the mutual funds. When in actual fact, it is in their business to invest according to what their assessment of the business is. There are in fact investment managers who buy into GME because they think that the business will improve.
By the way, they are managers. The real people who suffers from the losses are the investors behind them. Imagine your own mutual funds lose money because retailers rebel against them. Worse if you’re part of the movement. Just saying.
Take note: I’m NOT saying that no one should bet against these funds if you disagree with their assessment of the business. It’s the mentality that goes behind this that is worrisome.
Retailers
As we’ve all seen during the pandemic, the retail traders (i.e. small time investors like you and me) can be a force to be reckoned with. Momentum stocks gained a lot of traction in the share market. I believe all fund managers and institutional investors (aka the big boys) will not be able to ignore the retail traders anymore.
The Brokerages
In the US, investors are allowed to trade on margin – i.e. borrowing money from the broker to trade. Each “margin” account is allowed a certain limit above and beyond the cash deposited to trade. (Read more to understand here). And I haven’t even talked about those who used option contracts to trade GME – which a lot did because the option trades surged during this saga.
As mentioned, the decision to restrict the trading of GME was met with a heavy outcry. I think the outcry is ridiculous.
Yes, when things are going great (i.e. upwards), the restriction seems like it is intentionally stopping the movement.
What if it reverses and collapses? Then will the same public (especially those who are incurring huge losses) sue the brokerages for “allowing” them to trade big amounts and on margin? Huge reference to the big Robinhood fiasco where a trader committed suicide due to huge losses that appeared on his account (link here).
Of course, another feasible reason is because the brokerages cannot cope with the influx of trades as the process behind it requires the brokerage to come up with additional cash. In GME’s case, a lot of additional cash. To understand, please refer to this article as it sums up quite nicely.
The way I see it, they are protecting their business, and it is time to introduce our final character of this saga.
Enters the lingering shadow character
It is none other than the US Securities and Exchange Commission (SEC)!
This is akin to our local Securities Commission of Malaysia.
They released an official statement on the increased volatility of certain stocks that they are closely monitoring this and will protect investors (Read it here).
Why is this important? This is because they are the regulatory body that governs the capital markets and all brokerages are under their purview. Should the retail investors get burnt from this saga, the brokerages will have to answer to the SEC on the measures they have taken to protect the investors. If these brokerages fail to provide a reasonable response, they risk losing their business altogether!
Something is amiss
Did the fundamentals of GME changed in this week? Not that I know of.
Short squeeze do happen, mind you. When the “short” sellers make a wrong bet and the company reverses with a change of business that the market reacts positively to. I don’t see this in GME at all.
How long can a retailing business sustain a valuation of 4x revenue and negative P/E? The early birds would have very handsome profits, but if most of the Redditors are still holding, then when would they begin to cash out?
As investors know, we only make a profit when we exit the trade (i.e. sell the stock in this case), else everything is just paper profit. As we all saw in GME’s Thursday trade, it could easily half in value overnight.
The real question here is: When will the buy begin to taper off and the selling begin? If that happens, who is going to suffer the most?
Drawing a parallel to Ponzi
I can’t help but think of this to be similar to the money games / ponzi schemes / “one of those pyramid deals”.
It all started with the first few who started the movement that got in at the early prices. The movement continued to draw fresh blood into this GME (pun intended).
As the prices soar, the early birds continue to reap handsome paper profits (or even begin to cash out some). In between, we have traders who enter and exit to make quick gains. All of these without any change of the fundamentals of the business.
When the selling starts (at some point), the late comers will be the first to feel the burn as they accumulate their paper loss. The decision to cut loss or hold will then emerge – will you hold on to a stock with such fundamentals? If these traders start to cut losses, it will only add to the selling pressure. The early birds could cash out with profits regardless because their entry prices are low to begin with.
Sounds like a Ponzi to me. But it’s your money and you can do whatever you want with it.
Final Thoughts
What I’m doing? Frankly, I enjoyed the show. I don’t know what is going to unfold in the future, but I am definitely grabbing my popcorn and coke, and tuning in for Season 2 of the GME saga.
Yes, that means I’m going to sit and watch and want nothing to do with the action. Sheesh.
If anyone is going to enter the GME trade, just make sure it is not borrowed money and is something that you can afford to lose.
Have fun trading and stay safe!
As usual, follow BTM on Facebook and Instagram for more updates and contents!
