GME shares tank after short squeeze; 4Q earnings due

4 min read | February 02, 2021 04:41 PM AEDT | By Team Kalkine Media

GME shares tank after short squeeze; 4Q earnings due

Redditors’ bull case thesis

Since 2015, GME shareholders were deprived of shareholder returns as GameStop share prices nosedived to around $2 levels during the March sell-off. With closed stores, it was apparent that bears saw an expected bankruptcy, owing to legacy brick and mortar business and falling sales.

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GameStop has over 5000 stores across ten countries. During the holiday period, the company recorded net sales of $1.77 billion, which is in addition to rest of 4Q 2020 sales. Although total sales declined 3.1% in a month-long holiday period, comparable-store sales and e-commerce sale rose.

Likewise, the consumer electronic shop was vocal on the unprecedented demand for new gaming consoles. It was understood that total sales fell because the retailer is implementing de-densification strategy, subdued store traffic, and temporary store closures due to restrictions.

The third quarter for GameStop marked the end of the seven-year long console cycle, and its net sales fell around 30%. It had achieved an 11% reduction in stores. Cost optimisation delivered $315.9 million in the nine months to 3Q, while cash and restricted cash stood at $602.6 million.

Incidentally, the Reddit thesis for GameStop has played out very well. Not only the retailer reported sales of over $1 billion in 3Q and visible demand for new console cycle, but Chewy founder Ryan Cohen has also picked up Board seats and substantial interest in the firm.

Chewy.com is an online retailer for pet food and more. On Monday, Chewy had a market capitalisation of approximately $41.86 billion. Mr Cohen built an e-commerce firm, which is among handful of firms competing against big tech cos like Amazon.com at a time when antitrust concerns in Corporate America are rising.

GameStop had missed out on making early capital decisions to improve shareholder returns. In his letter to GME Board, investor Michael Burry, of the ‘Big Short’ fame, notes that a popular video streaming service Twitch – primarily used by gamers – was acquired by Amazon in 2014, not GameStop.

All of this has been a catalyst in the build-up to this rally in GME shares and short squeeze of institutional investors. More importantly, GameStop will report full-year and 4Q earnings soon.

A short squeeze will cause pain

In what has been dubbed as a move against the establishment on the subreddit page wallstreetbets, the rally in GME shares has caused colossal losses for wall street hedge funds as mark-to-market payments blew at brokers.

It raises further questions on the solvency of counterparties at clearing houses and depositories. Robinhood, a free trading app, blocked trades on many heavily shorted stocks and raised a billion dollar from existing investors on Friday.

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On Monday, the commission-free trading application reported that $3.4 billion was raised to ‘invest in customer growth’. Ribbit Capital led the funding round while existing investors also participated.

Related: GameStop (NYSE:GME) 8-day gain swells to over 400%

Other US brokers also raised margin requirements, and many small brokers suspended trading in across stocks. However, retail traders can trade on many different platforms, especially those with deep-pocketed owners.

Citron Research, a research firm, has reversed its business model only to provide long calls. Founder Andrew Left said Citron Research has been exposing fraudulent companies for over 15 years before the firm suspended short calls.

Melvin Capital held a large short position in GameStop along with many other institutional investors. According to reports, Citadel and Point72 Asset Management pumped billions of dollars into Melvin Capital as leveraged positions succumbed heavy losses.

(Currency is USD, unless or otherwise stated)

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