On January 4th, 2021, GameStop was a $1.3 billion market cap company with $1 billion in quarterly revenue and $295 million in losses over the previous 9 months.  It was also the subject of discussion on a Reddit forum called “Wallstreetbets” and as near as I can tell, this is the post that laid out the case for what COULD happen.  It was a sleepy story, little noticed, but potentially explosive, if only the entire world knew about it.

The point of this post is not to break down the nitty gritty of what’s happened to the stock since January 4th.  But, suffice to say, when I first heard of the story 2 weeks ago, their were two significant characters of which I took note: Michael Burry of ‘The Big Short’ fame and Ryan Cohen, the founder of Chewy.  In 2020, their collective but individual thesis was that GameStop was undervalued and could be restructured.  Dr. Burry in particular, (as he likes to be called, we know from the movie), wrote a letter to the GameStop board encouraging action last August.

Everyone knows, to have a good story, you need a hero and a villain.  At this point, I don’t know which is which, but I do know that on the other side of the ledger, we had Melvin Capital (who lost a cool $6 billion in January) and Citron Capital, along with a number of others who were short GameStop.  They thought the business was a disaster.  A has-been.  A ‘Blockbuster’ amongst ‘Netflix’, destined for destruction, and so they bet against it and went short.  And when I say short… I mean REALLY short.  So far, so good.

According to S3 Capital, the short interest in GameStop stock is 113% of the total float, which means more people have borrowed shares to sell than shares exist meaning you have a supply-demand problem. Arguably, this is the same phenomena that “Bitcoin bulls” point to: that is, there will only ever be 21 million coins so as supply dries up, pricing follows.

So what’s happened? Word got out, and the long buyers of the equity started buying.  In terms of volume, it’s moved up from 7 million shares trading hands on January 12th ($140 mm of value) to144 million shares trading hands January 13th, driving the stock up 62% (meaning $4.6 billion of shares traded).  By Friday January 29th, 50 mm shares traded hands at $325/share ($16.2 billion of capital in one day!).  It’s absolutely staggering.

To read the news or to have watched CNBC on Friday, you would have learned that the narrative was “a whole bunch of little guys got together to squeeze the big hedge funds” and drove close to a $20 billion loss (which is about 15x what the market cap of the company was January 4th).  The result of the carnage?  Melvin Capital was bailed out by Citadel and Point72 who infused $2.75 billion into the fund, and on Thursday, as the frantic pace of stock trading and cash settlement/margin calls/credit risk spiked, investors were limited by their brokers as to what they could buy causing outrage and cries of collusion (for details on the crazy mechanics of why things broke down, here’s a great thread).  Even Elon Musk got into the action, as the world’s richest internet troll, who loves to pick at the SEC.

With the aid of social media and the power of the platform, word travelled quickly and like the Capitol riots January 6th, the tragic death of George Floyd May 25th, the MAGA hat incident of January 2019 and countless other stories…. they take on a life of their own and our infrastructure is not well positioned to manage it.  And, with bots driving a huge amount of traffic (as much as 65%), posting, retweets and pushing the crafted narrative, we simply have no way to know what is true and what isn’t.

Ben Hunt, and his account ‘Epsilon Theory’, is pretty thoughtful, data driven and gets places before the masses do.  He posted ‘this’ Saturday morning.

This is real capital being put to work in a real situation where the structure of calls, puts, derivatives, social media, bots and greed.  For context, short sellers have lost $20 billion mark to market.  Sound familiar?  If you’ve seen ‘The Big Short’, it should.  Morgan Stanley famously lost $9 billion in a single position and was part of the $37 billion of losses it would incur that almost brought the bank down.  This single bet against GameStop is down $20 billion.

The financial infrastructure of a country is built on trust.  Trust that you will get paid.  Trust that banks will keep your money safe.  And trust that the playing field is fair, and regulations are in place to protect us.  If that crumbles, what do we have?  There is a reason for the term “Too Big to Fail” and it would seem that with unrestrained liquidity, a conviction to keep interest rates low and the asset market frothy, we are seeing a return to the same behaviors that brought the market down in 2000 and 2008.

My fear?  I don’t believe the “David vs. Goliath” narrative of small, retail traders making bets against hedge funds.  $20 billion a day??  Really?!  Let’s say each Robinhood’er put $5,000 towards this venture.  That implies 4,000,000 people felt really, really convicted to put a huge amount of their liquid net worth on a speculative bet.  $20,000?  Sure.  $100,000.  Why not?  4,000,000?  I call B.S. on that narrative.  Instead, I think tangentially.

The United States has been in a trade war with China since 2019.  And then, last January, the coronavirus, born in bat soup in Wuhan, made it’s way around the world and despite originating their, China has been left otherwise unscathed.  It’s economy is back on track, and more notably, this week, the PBOC reduced liquidity to prevent the Chinese economy from overheating (if only the Fed here would follow suit!).

And now, just as the United States is emerging from the economic damage arising from our self imposed lockdowns, modeled after China, a brand new risk arrives. Driven by loose monetary policy, margin lending, excess risk taking and exposing the fact that the inmates are truly running the asylum, some little known gaming company surges 1,600%.  All Robinhood’ers?  No.  All hedge funds?  No.  A foreign actor?  Perhaps.   In Tom Clancy’s ‘Debt of Honor’ from 1984, the Japanese attack on the United States was financial and centered on the stock market.  And truth is often stranger than fiction.  The story has yet to be told, but the narrative doesn’t ring true.  In March, Dr. Fauci said “masks don’t work” to prevent hoarding.  In January 2021, Jim Cramer said “Don’t go for the grand slam. Take the home run. You’ve already won.”  Is he talking about GameStop, or about the risks at the end of the bubble?

Regardless of the external forces, there is one thing I know for sure:  the CFO at GameStop has been given an opportunity they may never have again: raising equity at a crazy valuation.  I remember in 2006, I was doing my MBA and Anadarko had just bought Kerr McGee and Western Gas.  In my finance class, I needed to write a paper about an arbitrage opportunity.  I did, and the subject was Anadarko’s Pinedale asset.  At the time, Anadarko was trading at $60,000/boed and Ultra Petroleum, the pure play Pinedale asset, was trading at $240,000/boed.  My paper, and one I circulated inside Anadarko, made the following case: If Anadarko sold Pinedale, Ultra would have no choice but to buy it.  If it didn’t and it sold to the market at “$90,000/boed”, Ultra’s stock would fall 60%, so they have to be the buyer to protect their valuation.  The same situation exists today for GameStop and to the CFO, here’s some advice:  Never let a good crisis go to waste.  The longs have to buy the stock to protect their short squeeze profits, and the shorts need the stock badly.  Someone will pay up, the only question is who needs it more.  Make hay while the sun shines, and it never has to shone so brightly on GameStop, and it likely won’t ever again.