GameStop: A Different Conversation

Summary

• Evidence indicates GameStop may be better understood as a momentum play rather than a short squeeze candidate.
• Reddit community behind GME's meteoric rise showing signs of internal conflict.
• GME's new application for a secondary offering worth $1 billion equally bullish and bearish, depending on the weight assigned to dilution versus bootstrapping.

This article will represent a divergence from my normal securities analyses on Seeking Alpha, because let's face it, GameStop (NYSE:GME) has been anything but a normal stock. Rather than rehashing the usual bull versus bear arguments with financials as supporting evidence, this article will attempt to do a deep dive into a few of the data points that make GameStop such a unique name on the market today. This part usually goes at the end, but for this piece, I'm going to put it at the beginning: the author has no current position in GameStop. He sees the stock as a once in a lifetime black swan event that is a dangerous entry for bulls and bears alike, and is following this story purely for fun.

Consensus in the investment community is that GME is no longer a MOASS (mother of all short squeezes) candidate; Ortex reports GME short interest at 26% of the float, versus 100%+ in January. Retail investors at r/wallstreetbets, the Reddit community that originally launched GME into the stratosphere 3 months ago, beg to disagree. One often proposed theory in WSB is that hedge funds are purposely misreporting their short positions and willingly eating the fine as the price of doing business. Another argument, advanced by KIA Investment Research as a blog post on Seeking Alpha, is that investment firms may be creating the illusion of covering their shorts by writing call options and buying synthetic long shares. Conspiracy theory or truth? Personally, I lean more towards taking the reported SI numbers at face value, a quick check with my broker verified that GME shares are available to borrow at 0.5% borrow rate, indicating that they are likely not in scarce supply (the due diligence reposted by KIA Investment Research also recommended this method of estimating immediate short interest).

If GameStop's second rally which has thus far been sustained near $200 a share cannot be understood as a short squeeze opportunity, then what is it? Because of all the excitement and profits generated by GME's meteoric rise, the stock now has a massive following of retail investors who believe its potential has yet to be unlocked and are willing to pour more money into it with every dip. Case in point, GameStop crashed from $180 to $120 after the last earnings report only to fully rebound the very next day. How much purchasing power do these GME loyalists command? No one knows for sure, not even the community itself, but WSB recently collectively donated $350,000 to the Dian Fossey Gorilla Fund for no reason except the meme potential. Their total investment in GME is no doubt orders of magnitude larger, with some "diamond handing" positions worth hundreds of thousands, even millions of dollars (see Keith Gill). As such, it may be more accurate to think of GME right now as a momentum play fueled by an enthusiastic base of true believers, with a potential short squeeze only a part of the overall thesis.

That communal core may or may not be fracturing. After January, the most hardcore Reddit supporters of GME had already moved on from r/wallstreetbets to their GME specific subreddit, r/GME. On Monday, r/GME imploded from a civil war amongst the subreddit moderators where popular mods u/rensole and u/redchessqueen99 were banned by the others. Outraged, many in the community followed them to a new subreddit, r/superstonk, with half of r/GME's 200,000+ subscribers migrating to the new forum within 12 hours. Will Reddit's GME community be able to sustain its momentum going forward after such a split? Time will tell.

Meanwhile, GME management unveiled plans to sell up to $1 billion in new shares on the secondary market to take advantage of the massive run-up in its stock price. SA contributor Logan Kane called this move with stunning prescience a week ago by keying in on the recent resignation of the majority of GameStop's board. Kane predicts that such a sale would significantly depress GameStop's share price, but I'm not so certain. In a 2001 Berkshire Hathaway shareholder meeting, Warren Buffett shared his thoughts on overpriced securities:

You'll see way more stocks that are dramatically overvalued than dramatically undervalued. It's common for promoters to cause a stock to become valued at 5-10 times its true value, but rare to find a stock trading at 10-20% of its true value. So you might think short selling is easy, but it's not. Often stocks are overvalued because there is a promoter or a crook behind it. They can often bootstrap into value by using the shares of their overvalued stock. For example, it it's worth $10 and is trading at $100, they might be able to build value to $50. Then, Wall Street says, "Hey! Look at all that value creation!" and the game goes on. [As a short seller,] you could run out of money before the promoter runs out of ideas.

In the case of GME, there was no promoter or crook (according to Reddit, the crooks are the hedge funds who were manipulating and shorting the stock), but the same principle of bootstrapping applies: by selling shares at current valuations, GME management is capitalizing on market forces to create real value from perceived value. If they raise a billion dollars, then the company is now worth a billion dollars more. For short sellers who are hoping for a quick plunge back to intrinsic value once the market mania passes, any move that grows intrinsic value is bad news. It is true that the dilution may trigger a selloff of GME, but it's equally possible that the reverse will happen.

So where will GameStop go from here? I have no idea. From the standpoint of traditional fundamental analysis, I would tend to agree with the camp who believes GME to be grossly overvalued in terms of opportunity for a successful digital transformation versus associated risks. Analysts have a median price target of $27, with Stephanie Wissink and Anna Glaessgen of Jefferies the sole outlier at $175 (the conflict of interest is obvious given Jefferies will likely be the underwriter for GameStop's ATM secondary). However, it's been clear for a long time that GME is no longer trading on the fundamentals, and for many people, its story has become something else entirely. If you're brave enough to trade GameStop on either the long or short side, it might be time to throw the old rulebook out the window. Two pieces of advice from the world of memes may be particularly timely: "Modern problems require modern solutions," and "Improvise. Adapt. Overcome."

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.