GameStop: A Story of David and Goliath

In April 2020, GameStop was a video game and consumer electronics retailer fighting for its future in the face of COVID-19. Already struggling pre-pandemic, posting losses of 470 million USD, GameStop announced the permanent closure of 300 locations as COVID-19 began to damage the company. However, despite no sign of improvement, the struggling retailer reached an intraday high of 483 USD and a 28 billion USD market capitalisation on January 28th, which exceeded half of all S&P 500 companies. Such a turnaround warrants an investigation into the causes of this event and the lessons that can be learnt.

 

GameStop’s business model involves selling video games and electronics in high-street stores. However, more gamers choosing to download games directly to their consoles and combined with the impact of COVID-19 on high street stores, the stock hit an all-time low and continued to trail major indexes throughout the summer. In August 2020, prominent investor Ryan Cohen took a 13% stake in the company and was appointed to serve on the board in January 2021. In the two days following this announcement, GME stock moved from 19.94 USD to 31.40 USD. At this point, institutional investors took out significant short positions against GME; in particular, Melvin Capital, a hedge fund that invests primarily in the consumer and technology sectors. In fact, short interest was 71.2 million shares, more than GameStop’s entire float. r/WallStreetBets, a Reddit Wall Street speculation group with 8.4 million members, saw the significant short exposure as both a profit opportunity and a chance to rebel against Wall Street. Using popular free-trading platforms such as Robinhood, the ‘Redditors’ bought stock and as planned, a short squeeze ensued. This short squeeze was magnified as short sellers rushed to cover their exposure with call options. GME stock rose by over 1700% from the start of 2021 to the end of January 2021 and as a result, Melvin Capital lost 53% in January; a fall in assets of 4.5 billion USD despite Ken Griffin’s Citadel and Steve Cohen’s Point72 providing a 2.5 billion USD cash injection.

 

The zero-fee broker Robinhood has been central to the short squeeze, allowing retail investors to quickly invest in firms, but on January 28th it limited trading in a group of stocks including GameStop. The restrictions limited the quantity of GME shares that users could purchase. According to Robinhood, these restrictions were based on investor protection and regulation obligations. Soon after, GameStop shares fell 60% on February 2nd, a fall so dramatic that further trading halts were triggered. GameStop has now fallen by over 80% since last week’s intraday peak while members of r/WallStreet bets have attempted to reinforce their ‘hold the line’ mantra. Hedge funds that persisted with negative bets are profiting once again as the Goldman Sachs Index of US stocks targeted by short sellers is now down 14% since January 28th. Many investors are blaming subsequent losses on the trade restrictions imposed by Robinhood. The House of Representatives Financial Services Committee has scheduled a hearing on the matter later this month and a class action lawsuit has been filed against GameStop in New York. The lawsuit claims that “Robinhood’s actions were done purposefully and knowingly to manipulate the market for the benefit of people and financial institutions who were not Robinhood’s customers”. However, there is currently little substance to the allegation, as market makers such as Robinhood aim to encourage activity.

 

The GameStop controversy is certainly a lesson in how social media can be harnessed, in this case, to target the financial establishment. Until now, small retail traders were weak, lacking the capital and organisation of the large funds. However, there is now evidence that platforms such as Reddit can provide individuals with influence and coordination. While the event certainly represents a low moment for institutions such as Melvin, many hedge funds are now having to rethink their risk management practices – selling out of stocks and covering short bets. Barclays strategist Maneesh Deshpande concurs stating, “The market action has been a wake-up call and retail traders are likely to continue to be a force to be reckoned with, which will probably permanently affect the business models of institutional investors”.

 

By Charles Fraser

Sector Head: Gregor MacDonald

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