GameStop - The "Big Short Squeeze?"
There has been quite a bit of talk about a short squeeze in GameStop stock, given it's short interest is above 100%, but is it likely? Is Ryan Cohen the catalyst that GameStop's longs hope he is?
I’ve been a GameStop follower for awhile now, and I’ve had my ups and downs with the stock, hoping it will turn itself around. Given all of the new events materializing in this stock, I thought it prudent to write my thoughts down through my company, and I’d like to share it here if you are interested.
Please note, many of you will find this to be long and boring. It is a long thesis, but I do think it’s at least worth reading through, especially if this is still a publicly traded stock as of your reading.
Investment:
GameStop has been a stock hated for much of the past decade. Declining margins, falling revenues, and being in the “dead” business of used games have caused almost every single analyst to predict this stock is going to zero. For the past five years, shorting this stock has been a no-brainer, and the constant reshuffling of the board and the apparent disinterest of the executives on the earnings calls couldn’t support the shorts thesis any further if they tried.
I believe this is all about to change. Through multiple reports I’ve read over the past month, combined with an inexplicable disconnect in options pricing show that this may be a play with as large of an upside as those seen in shorting credit default swaps leading up to 2008.
Does this sound crazy? Absolutely. I can’t even believe it myself, which is why I’ve taken it upon myself to write this thesis, so that you can poke holes in my logic and show me where I am wrong. I will attempt to provide all of the information to support my thesis below, and if you agree, then I hope to be able to bring you along with me in the ride of a lifetime and make some life-changing returns.
Logic:
Why does the phrase “this time it’s different” apply here? There are a congruence of factors, which I will start with the one that has been around the longest and move towards the newer developments (that I think are the real game changer) towards the end:
1) The Short Interest
This stock has been a favorite for the shorts in the past five years. They’ve made a 94% gain over the fall of this retailer in that timeframe (if they didn’t average down into their position). Following the charts makes this stock a guaranteed win for short sellers. With all of the algorithmic trading currently employed, I wouldn’t be surprised if they’re even opening short positions on this stock as well.
As far as expectations of the shorts go, it’s easy to see them expecting this stock to go to 0 relatively soon. Prior to last weeks earnings call (which most said was quite awful, but I would say wasn’t too bad, to be explained later) the short interest hovered around 95% of “available” float. As it stands right now, that number is now closer to 125% of actual float. If we took out the shares owned by insiders and institutions, this percentage would be closer to 300%, but I digress.
Apparently the “smart” money is expecting this stock to go to nothing, which it very well could if nothing changes. As I’ll explain below, this is no ordinary cycle, and I do think something big will change the thesis over the next month.
2) The white knight
Has anyone here ever heard of Ryan Cohen? Yeah he’s the guy who started Chewy, went head to head with Amazon, and then three years later sold Chewy for 3.8b to Petsmart. I’d say he did the impossible, went up against the biggest baddest company in the ecommerce industry and won (not to say Amazon is bad, I love them, but they are a pretty hardcore business to compete with). I would say that factor alone qualifies him as an expert in the e-commerce space.
Now why should you care about some multimillionaire/billionaire who has been sitting on his money for a few years only investing in a few stocks? Well in January of 2019 he stated he only owned 2 stocks, mainly Wells Fargo and Apple. He likes to concentrate his holdings, as he says “it’s too hard to find, at least for me, what I consider great ideas…. When I find things I have a lot of conviction in, I go all-in.” With Ryan’s vast experience in the ecommerce space, I’m sure that a company such as GameStop, whose ecommerce sales grew 800% last quarter to make up 20% of their revenue, would me a massive value add to GameStop.
Why the heck would this matter in an article about GameStop? Well prior to 2019 he didn’t seem to have a stake in the company. Then, at the end of August, he filed a 13D showing he had accumulated a 9.6% stake by August 31st (70% of which was purchased in August).
This sounds like he’s willing to go all-in on GameStop, doesn’t it? Well if he’s wanting to go all in, why doesn’t he buy more? And why the heck did I bold the 13D above? Well, lets get into some of the weeds and talk about the 13D and then lets talk about a little law called the Hart-Scott-Rodino Antitrust Improvements Act (hereafter referred to as the “HSR Act”, since that’s a long name).
3) The 13D filing
Why is this filing important in this case? Well, to fully understand the significance, we’ll have to first dive into what the filing is, and who his lawyer is, as the two prove a significant point in my thesis.
3a) the filing itself; what makes it so special?
When we read what the 13D filing is, the definition is “Schedule 13D is a form that must be filed with the U.S. Securities and Exchange Commission (SEC) when a person or group acquires more than 5% of any class of a company's equity shares” according to Investopedia. Now he originally filed this form with the SEC on the 28th of August, but when looking into the report, the original was filed on the 18th, meaning he wanted to wait the full 10 days to disclose his stake, as he likely wanted to buy more. He did eventually purchase 2m more shares in the 6.50-7.00 range, prompting him to increase his stake to 9.6% by the end of August.
Now why is it so significant that filed this? Doesn’t it just show he’s taking a passive investment in GME? According to the Investopedia website “The form signifies to the public that a change of control, such as a hostile takeover or proxy fight, might be about to take place so that current shareholders in the company can make informed investing and voting decisions.”
What did he say his purpose was for picking up the shares? According to the filing Cohen stated the following:
Purpose of the investment: The Reporting Persons acquired the securities disclosed herein based on the Reporting Persons’ belief that the securities, when acquired, were undervalued and represented an attractive investment opportunity.
Actions to be taken by Cohen: This part in the Section 13D was a bit long so I’ll paraphrase. He can increase/decrease his position as he sees fit. He can engage in discussions with management, board, shareholders and other parties concerning the operations of the business and future plans of the issuer. And, the biggie, according to what Cohen deems appropriate, he can make proposals concerning changes to the capital structure, ownership structure, board composition or operations and strategy, “purchasing additional securities of the Issuer, selling some or all of its securities of the Issuer, engaging in short selling of or any hedging or similar transaction with respect to the securities of the Issuer, or changing its intention with respect to any and all matters referred to.” This sounds like he wants to be more than a mere passive investor, right?
Well hey, maybe he just filed the wrong report and meant to file the 13G (a much easier report, for passive investors picking up up to 15% ownership) right? He hasn’t tried to be an activist with Apple or Wells Fargo, or try a takeover of those companies (believe it or not this is an argument from the short sellers). Well to prove that wrong, his investment in GME has a total market value of ~$40m (~1-10% of his overall net worth, depending on who you believe). Would you be willing to go through all this filing trouble to file an “activist” report with the SEC on possibly increasing your net worth by a few percentage points if the stock doubles? I personally wouldn’t go through all that trouble, but maybe he’s different.
Maybe he’s just a crazy person and didn’t pay too much attention, or hired a lawyer who gave him the wrong advice. Well, lets look into his lawyer and prove that this is an activist play.
3b) the lawyer
According to his 13D, his lawyer is Christopher P. Davis Esq. of Kleinberg, Kaplan, Wolff & Cohen. Now why would we care who his lawyer is? There are thousands of lawyers in the United States and each is as good as the next right?
Well this guy is a boss when it comes to the activist investment arena. According to the description of the law firm itself, it is a “pure-play activist law firm” with Chris Davis specializing in Mergers & Acquisitions, shareholder activism, proxy contests and tender offers. Having talked to a few of my lawyer friends and getting their advice, with this individual being the top lawyer in his sphere of influence, it wouldn’t be crazy to put his hourly rate in the mid 4 figures.
If Cohen were just planning on taking a passive stake and not moving forward with an activist play, why hire the most expensive lawyer in the activist realm to file your schedule 13D? Sure he has millions, but if he’s only going to increase his net worth by 1%, why decrease your return by hiring the most expensive lawyer? Plus, the idea of Cohen taking a small stake in a company and wanting to diversify directly contradicts his concentrated investment style.
This all may be something I’m wishing upon a star happens, but why hasn’t he purchased more since the end of October? I posit there are two reasons he hasn’t. The first is the fact that he will have to file a new 13D/A (amendment) within two days of picking up 1% more of the company. And the second relates to the HSR Act discussed above.
4) The Hart-Scott-Rodino Antitrust Improvements Act (“HSR Act”)
Like me, you’ve probably never heard of this act, but also like me you probably don’t have 60m lying around that you’re willing to plow into a single stock. Ryan Cohen is different. He acquired 9.6% of GME, which came out to around $50m when he was buying (which he only purchased for 30m, so he already made a killing).
Well, according to this act, no activist investor can acquire more than $56.7m worth of shares in a company without first obtaining approval from the DOJ or FTC (with the exception of a 10% passive stake, which his is not). Now this approval can take at a minimum 15 days (if he’s planning to move forward with an all cash tender offer, after which it would be announced publicly upon approval) to 30 days (if he is wanting to move fast and purchase a large majority in the company). Once such a filing is made, the target company is notified and must make a responsive filing.
If I were a betting man (which you’ll see I am), as the 15 days have almost already passed with no word from the company, I’m willing to bet he’ll likely be wanting to buy a more concentrated position in the company and take it over. This lines up with his concentrated approach to investing, and if he were to gain approval, he could increase his stake drastically without having to report it for at least 2 days. This would drive up the price significantly, after which he could agree with the company to a tender offer at a decent price (I would guess somewhere in the 20’s, which I’ll explain later actually isn’t an insanely expensive price fundamentally).
Now, why wouldn’t he just continue buying up the available shares at the market? Well, because once he does start buying, the mother of all short squeezes is likely to occur.
5) The “Big Short Squeeze”
I told you I was a betting man, and this is what my bet centers on. I’ve been looking at the ownership structure of the company, and I’ve included it below (as of the last filing, with information obtained via Atom Finance):
Institutions: 68.54% ownership
Individuals (“Insiders”): 36.3% ownership
Now you’re probably sitting there saying, “wait a second, I can do math, and that adds up to more than 100%” and you would be right. In fact, it adds up to 104.84%. Now how can insiders and institutions own more than 100% of a company? Well, it’s due to something I like to call an infinite short circle (definitely not what it’s called, but it helps me visualize).
An infinite short circle works when one investor (let’s say Cohen) lends out his shares to a short seller to sell to someone else (say Burry, also an owner in the stock). A second short seller will then approach Burry and ask to sell his shares, which he’ll happily do (as the interest paid by short sellers to the original owners is currently over 20% APR). Then short seller 2 may sell the shares to Hestia Capital (another activist in GME). Lastly, let’s say there’s a third short seller who approaches Hestia and asks to borrow his shares. They’ll lend it to them and feed the short selling beast, but then the short seller sells the shares back to Cohen. In essence, this share made it all the way back to Cohen, but now we have 3 short sellers betting against the same share. This process can go on forever, until a squeeze occurs. Hence why both the short interest and ownership can be above 100%.
Now wouldn’t this type of a situation cause a problem? Well yeah. If there are multiple people wanting the same share of stock back, but almost all of it is stuck in the insider’s hands, then shorts are, in essence, screwed.
Looking at the number of actual shares available on the market at any given day, there are only 50-60k. With a short interest greater than 100% of the actual shares outstanding, it would take days of shorts covering their position to get out. Using historical examples (as explained in the Seeking Alpha article part 3), Blue Apron had a 20% short interest, but when it was squeezed, it 10x’ed in value in four trading days. Using the same logic (which is a stretch), GME could 100x in value easily with the small number of shares available on the market mixed with how many shorts are on the other side (granted shorts could be buying cheap OTM calls to mitigate risk).
From a risk management side, the only way to hold GME is to go long. Even a 1% allocation to this stock could bankrupt a short seller, especially if Ryan Cohen moves forward with his investment.
6) The “Big Short Squeeze” opportunity
Before I did this analysis, my brother and I entered into long dated options on GME, mainly the January dated options with strike prices between 10-30 dollars. Those can be good and will provide massive returns in the case of a short squeeze, but after looking over the option chains yesterday, I found a play that could be a massive windfall with very little investment.
Now I know what you’re thinking, options are betting instruments that more than likely fail. But with the probability and proof that Cohen is going to be making a massive move in the next month, this is a risk worth taking.
GameStop did not beat earnings, causing it’s stock to fall precipitously 25% from the high 7’s it hit in early September. I think this is a benefit to every one of us, because according to options math (and the math the algos work on) the probability of this stock hitting the high 12’s by the end of October is 0.07%. I would argue if Cohen starts making his move in late September/early October, it’ll hit that price. Right now, as of this past Friday (as option prices don’t move on the weekends), I found 14 options whose price to purchase was $1. Now you probably are thinking “if they’re priced that low the strike price has to be in the high 20’s low 30’s?” and my answer is no. October 9th call options are priced at $1 at strike prices of $8.50-$14. October 16th call options are priced at $1 at strike prices of $12-$13. October 23rd call options are priced at $1 at strike prices ranging from $10-$12.5. Finally, October 30th call options are priced at $1 at the strike price of $12.5. All of these are according to Robinhood’s options chain.
Let’s say you were able to capitalize on the low cost of options an went forward with this and put 100 on each of those options, buying 100 contracts (very unlikely as you’d have to pay up for these, but lets assume you get lucky and get them for a dollar each). Let’s also say it took until October 25th for the stock to rocket to $20. Sure you’d lose $1,300 on the options that expired worthless, but what would your gain be on the $12.5 call that you still held? Well say you borrowed $1,250 from your bank account to exercise one option, bought at $12.5 per share and then sold at $20. That would give you a profit of $750 on one contract, and you no hold 99 more. Say you rinsed and repeated the process and were able to sell all shares at $20. This would result in a profit, on a $100 investment, of $75,000.
Yeah, I know this sounds crazy, and it really is, but this is the purpose of me writing this really long and boring article. The opportunity for massive gains is there. If we lose, then ok, that sucks, but hey, risking $100 for a potential 750x return matches my mantra “heads I win (big), tails I don’t lose much” and is a risk I think is worth taking. Even if you were to buy these options at an average price of $10 (what they were trading at the morning of 9/14) it would still close to a 600x return.
Below I’ve included some websites and articles that support my argument, and provided me the information that I needed in order to make my own personal decision.
I would be more than happy to discuss this investment and have any flaws in my thinking pointed out.
Seeking Alpha articles:
https://seekingalpha.com/article/4373819-gamestop-chewys-founder-ryan-cohen-finds-whats-next
https://seekingalpha.com/article/4372597-gamestop-short-squeeze-part-iii-atop-caldera
Cohen Articles:
Investments in Apple and Wells Fargo – Concentrated approach
Ryan Cohen Interview – Includes his ideas on Retirement
Christopher P. Davis & Kleinberg Kaplan information:
GameStop Financials:
Cohen’s original 13D Filed 8/28
Cohen’s Amended 13D Filed 8/31