In the last two days, the shares of the game retailer GameStop (NYSE: GME) on the New York Stock Exchange (NYSE) have become subject to one of the largest downturns the financial market has ever witnessed. As a result, GameStop actions became the most traded stock on the NYSE, occupying the front page of all major news channels and flooding social media message boards. At its current provisional peak, the stock surpassed the price of $ 514 per share, skyrocketing the company’s temporary market capitalization to $ 35.9 billion.
The rise and fall of GameStop
GameStop was launched in February 2002 by Barnes & Nobles Booksellers, who owned the company before it became an independent company in 2004. Over the following years until 2016, the company expanded rapidly in the United States and internationally. GameStop has acquired several companies in the meantime, including several retail chain stores and the independent development studio Kongregate. At the end of 2016, GameStop operated more than 7,500 stores. Alongside its expansion, the company has significantly increased its revenues and has several times exceeded $ 9 billion in sales in the years prior to 2016. Between 2013 and 2016, GameStop generated annual net profits of between $ 350 million and $ 400 million, while the share price fluctuated between $ 25 and $ 55 each. In the wake of the collapse of the physical games market to the digital market, GameStop reported a 16.4% drop in sales over the 2016 holiday season, seeing a similar contraction in its share price. The further decline of GameStop is represented by the rapid deterioration of its profits. Initially, the company’s net profits dropped from $ 353 million in 2016 to just $ 34.7 million in 2017. In subsequent years, GameStop reported losses of 673 million in 2018 and 471 million in 2019. Also for 2020 it is likely that the company will report further 9-figure losses.
GameStop tries Esports
In an effort to reverse the downward trajectory, GameStop took over the economy design company R / GA and, in July 2019, it unveiled plans to renovate its stores, focusing on competitive games and retrogaming. During its reorganization efforts, GameStop laid off approximately 170 employees. Additionally GameStop, which is based in Texas, has signed several agreements with local export organizations. The video game retailer has signed a three-year agreement with Complexity Gaming to name its headquarters on the Dallas Cowboys campus, GameStop Performance Center. It has also signed sponsorship deals with Texas-based esports organizations such as i Dallas Fuel and their parent organization, Envy Gaming; as well as with OpTic Gaming and the Houston Outlaws, which were owned by Infinite Esports.
Covid crushes retail sales
A couple of months after the decision to revamp GameStop stores, the US government’s efforts to slow the spread of Covid-19 required the company to close all its 3,500 stores in the country starting in March 2020. Before stores were allowed to reopen in May, about 65% of GameStop’s US stores offered video game takeaways but wasn’t very successful. Although the company experienced a 519% year-over-year increase in digital sales for the first fiscal quarter of 2020, ending May 2, its total revenues decreased by 34%. However, GameStop CEO George Sherman explained that he expected to recover from losses in the first quarter of 2021 by benefiting from the release of Sony and Microsoft’s next generation game consoles in the second half of 2020. Further positive news for GameStop followed in October 2020, when the company announced a deal with Microsoft, which includes some sort of revenue share on all Xbox Series X and S digital game purchases sold by GameStop.
Support from institutional investors
While GameStop shares fell below $ 4 in 2019, Michael Burry, an investor famous for winning a billion dollar bet against the US housing market in the 2008 subprime crisis, announced that he would hold his GameStop shares (of which he owned 3.3% at the time) through his investment company Scion Asset Management. Scion Asset Management later revealed that it bought 5.3% of GameStop for between $ 2 and $ 4.2 per share, spending about $ 15 million in total despite the company’s negative earnings. In September, the company reduced its stake in GameStop to 1.7%. In addition to Scion Asset Management, GameStop is supported by many other institutional investors, including investment management firm BlackRock, which currently owns 13.2 percent of GameStop’s shares, and financial services firm Fidelity. In August 2020, Ryan Cohen, founder of pet food company Chewy, which sold for $ 3.35 billion to PetSmart in 2017, acquired a 9% stake in GameStop via his RC Ventures fund to become the third largest investor in the company behind Blackrock and Fidelity. By the end of 2020, GameStop’s stock has recovered from its 2019 low and hovered around $ 20 per share.
Left 4 Dead
While GameStop has attracted new investors thanks to its reorganization during the global pandemic, more and more short sellers began to pay attention to the company. Believing that the value of the shares was overvalued, several companies, including Citron Research, have begun short-selling the company. There short selling of a share allows investors to profit from a company whose shares decline in value. To sell short, an investor borrows a stock from a broker and sells it to a third party at the current market price. To close the transaction, the investor must buy back the security and return it to the lender. By its nature, the losses from short selling can be technically infinite, while the risk of buying a stock is limited by the amount paid for it. Short sellers can be important players in the financial markets. They usually specialize in finding over-listed or fraudulent companies and gamble against them, often leading to regulatory intervention. By December 31, 2020, GameStop has received more bets against itself than its total outstanding shares: 102% of its outstanding shares were sold short, which means that in the event that all the short sellers wanted to close their transaction at the same time, the price of GameStop would rise indefinitely as the demand for investors who they sell their shares would exceed the maximum possible offer.
Reddit enters the scene
Parallel to Burry and Cohen supporting GameStop, several small investors have started placing call options on GameStop and shared their good feelings about the company’s future on the Reddit thread Wall Street Bets (WSB), known for its borderline nature and allegations of market manipulation. Purchase options are financial contracts that allow buyers to profit from the increase in the price of a share above a specified price within a set time limit. For example, GameStop was trading at around $ 470 per share just after the market opened on Thursday. If a buyer bought a one-week buy option on GameStop that expired at 9:30 am on Thursday and had a strike price of $ 200, then his net profit would be $ 269, which is the stock price. upon expiry of the option ($ 470) minus the price paid for the option ($ 1) and the strike price of the option ($ 200). Following the price surge of the GameStop shares associated with Cohen’s investment, multiple WSB users have entered purchase options on the company and posts about the company have become more frequent. The number of GameStop shares in WSB increased further in December 2020, with some users betting on an upcoming share squeeze. In those forum conversations, the hedge fund Melvin Capital Management, a significant holder of GameStop’s short selling positions, he was collectively chosen as the antagonist figure.
The combination of Cohen’s entry to GameStop’s board of directors on January 11 and the constant hype on PlayStation 5 and Xbox Series X game consoles recently released have reignited the subreddit’s interest in the company with several posts asking users to invest in it. The situation worsened further on January 20, when Citron Research’s Andrew Left shared his bearish prognosis on several currently popular titles on WSB and several Redditors have created posts instructing readers to purchase GameStop purchase options to disprove the positions of short sellers like Citron Research. Using buy options has allowed the Reddit community to leverage their investments sufficiently to significantly affect GameStop’s market price.
The Big (Lost) Bet
A short squeeze occurs when the price of a stock rises above a specific threshold at which short investors reduce their losses by buying the stock to return the stock to their lender.. This phenomenon can quickly push the price of a stock up by several percentage points and in some cases double it as more and more short sellers are pushed to their limit and have to cover their losses by buying the stock. Since January 13, when GameStop’s per share price increased to $ 31.4 from $ 19.95 the previous day, a series of short squeeze has pushed the stock price to over $ 510 per share during market opening hours on Thursdays. This phenomenon was accelerated by several social media events, including tweets from Tesla CEO Elon Musk and Virgin Galactic president Chamath Palihapitiya.
The shares of GameStop did not rise in a natural upward movement because in that case the long-term investors would have collected their winnings by selling their shares. When institutional investors decide to offer a significant amount of shares to short sellers it is because they are trying to cover their losses. It is inevitable that GameStop’s share price will drop dramatically due to the increase in stock offering. However, the share price may rise again as more short sellers want to take advantage of the drop in prices and buy to cover their losses, thus bringing the price back up. In the process of reaching new all-time highs, the stock traded hundreds of millions of times a day, and trading was stopped several times due to high volatility. By virtue of the short squeeze, GameStop’s short sellers lost several billion dollars in January. Melvin Capital Management reportedly had to secure a $ 2.75 billion lifesaving investment to stabilize the company after suffering huge losses on its bets against GameStop.