Whitney Tilson Covers GameStop Short

| About: GameStop Corp. (GME)

Albert Einstein's genius extends far beyond physics. In regards to learning the ropes from successful mentors, he put it best: “If I have seen farther than others, it is because I was standing on the shoulders of giants.” In finance, we have the unique opportunity of seeing multiple times per year what the whales of the industry think about the state of the economy (and particular securities) and what they are doing in their portfolios to prepare for the future; these are opportunities to get inside the heads of the best and the brightest in the world of money management.

Whitney Tilson of T2 Partners has been in the news a lot lately, and there has only been one thing to talk about: Netflix (NASDAQ:NFLX). This short, which has moved significantly against T2 over the past year (returning more than 250% for long investors), has been in the spotlight, especially since an article by Tilson (here) was rebutted by none other than Netflix CEO Reed Hastings (here). For investors who side with Tilson, this is the perfect opportunity to piggyback a position that has become significantly more attractive for shorts than it was when T2 initiated their position (based on valuation alone).

But one short that has received little attention among investors over the past few months was T2’s short position in GameStop (NYSE:GME). T2 Partners has been short GameStop for more than two years, and featured an article by Thomas Eidelman of Eidelman Capital outlining the short in Value Investor Insight (a newsletter Tilson co-manages) back in August 2009 (here). So what is the importance behind all of this for investors? As of the filing for quarter end 9/30/2010, T2 has completely covered their position in GME (40,000 shares).

The question: why? As Mr. Tilson noted in the article outlining the Netflix position,

Our favorite shorts generally involve some or all of the following characteristics: outright frauds (our very favorite), industries in decline or facing major headwinds, lousy or faddish business models, bad balance sheets, and incompetent, excessively promotional and/or crooked management. In general, we prefer to short businesses with these traits, even when their stocks trade at seemingly low valuation multiples, rather than shorting the stocks of good businesses with strong managements, even at high valuations.

Let’s apply this to GameStop: There is no sign of fraud or incompetent management, and the balance sheet is strong. Based on that reasoning, this leaves two possibilities which led T2 to covering: either the industry/company is not declining as quickly/facing as strong of headwinds as predicted, or the current valuation (less than 10x TTM earnings) scares them despite a combination of these negative characteristics. Regardless, this should jump out at interested investors, long or short; when a top money manager ends a position that they have been vocal about and have held for more than 24 months, it is time to reassess the situation.

I feel that the case for a short and long position has been sufficiently discussed by SeekingAlpha contributors Ben Strubel (here) and Dollarwise (here) over the past 2 months, so I’ll let readers review their articles/comments to check the reasoning and numbers rather than add my own. Regardless, T2 has said what they are thinking on GameStop by covering their short position; investors looking at GME (both bulls and bears) should listen.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.