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Short selling strategy guides --

Gaming the system: How GameStop stock surged 1,500% in nine months

New board members and a massive short squeeze cause stratospheric
short-term growth.

Kyle Orland - Jan 19, 2021 6:04 pm UTC

When will this stock [game]stop rising?
Enlarge / When will this stock [game]stop rising?
Aurich Lawson

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80 with 58 posters participating, including story author

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Further Reading

Game retailer GameStop says it can't sell itself, sees stock dive 27%
Nine months ago, GameStop stock bottomed out at $2.80 a share, a
reflection of the myriad problems facing the retailer specifically
and brick-and-mortar game retail as a whole. As of Tuesday morning,
though, that stock price is hovering around $40 a share (peaking at
$44.74 as of this writing), with the vast majority of those gains
coming in the last couple of weeks.

Is GameStop really worth up to 16 times as much as it was back in
April? Is the company's ambitious turnaround plan finally (and
suddenly) turning things around? Is GameStop roaring its way back to
the nearly $10 billion market cap it enjoyed at the height of the Wii
phenomenon?

Probably not. Analysts suggest the recent surge in GameStop's stock
price is the result of a massive short squeeze bubble that will pop
eventually. But beyond the sky-high valuations of recent weeks,
analysts also suggest there's some reason to believe GameStop's
long-term health is more robust than last year's stock doldrums
suggest.

Here comes Cohen

To understand GameStop's current stock market run, you have to go
back to August, when investor Ryan Cohen bought in to a roughly 10
percent ownership stake in the retailer. Cohen is best known as the
founder of pet food superstore Chewy.com, which sold to PetSmart for
$3.35 billion in 2017. Since that sale, Cohen has tended to invest
his billions in big, safe stocks like Apple and Wells Fargo, so his
major investment in the much riskier GameStop attracted notice.

Since August, Cohen has bought even more GameStop shares, and he and
two former Chewy executives have been named to the company's board of
directors. That gives Cohen, along with fellow activist investors
from Hestia, the potential capability to steer the company in a new
direction.

And Cohen hasn't been shy about identifying what he sees as the
problems for the company. "GameStop's challenges stem from internal
intransigence and an unwillingness to rapidly embrace the digital
economy," Cohen wrote in a bold, italicized, underlined, and all-caps
portion of a November SEC filing.

"GameStop's challenges stem from internal intransigence and an
unwillingness to rapidly embrace the digital economy"

The company has to "promptly pivot from a brick-and-mortar mindset to
a technology-driven vision," he continued. "If GameStop takes
practical steps to cut its excessive real estate costs and hire the
right talent, it will have the resources to begin building a powerful
e-commerce platform that provides competitive pricing, broad gaming
selection, fast shipping, and a truly high-touch experience that
excites and delights customers."

Even as GameStop's earnings reports continue to be uninspiring,
Cohen's bold talk about a new, less physical path forward for
GameStop got some investors excited. "[Cohen's involvement] has given
the market confidence that this profit will be spent wisely to grow
the company into an e-commerce competitor, similar to Chewy, instead
of doubling down on the brick and mortar strategy," DOMO Capital
Management President Justin Dopierala told Ars. "GameStop's most
valuable asset is their database of tens of millions of PowerUp
Rewards members that no other competitor has the ability to
replicate. GameStop will be able to leverage this data to become a
fierce e-commerce competitor over time and has many unexplored
avenues to monetize the data."

"[Cohen] seems to have a vision of what the company should be in the
future," Telsey Advisory Group analyst Joseph Feldman told Ars. "It's
more experiential, it makes sense given the changes in the market, so
maybe it'll help speed that along. It's certainly something worth
watching."

"Because you're buying a month's worth of pet food every month,
you just keep going back like groceries. The game business isn't
like that."

Others are more skeptical that a strategy used for selling dog food
will be so simple to apply to selling video games. "[Cohen]'s
real-world experience is selling commodity products like pet food and
toys into a market that has recurring demand for that," Wedbush
Morgan analyst Michael Pachter told Ars. "Because you're buying a
month's worth of pet food every month, you just keep going back like
groceries. The game business isn't like that. In the pet food/toys
business, there is no virtual download, [whereas with] GameStop, all
the games they sell, you can buy digitally at the same time."

The big squeeze

Whether Cohen can turn GameStop around or not, the investor
excitement around his new strategy presented a problem for the many
investors who had shorted the stock (i.e. borrowed shares that they
expected to go down in value). As their short positions came due,
those short sellers found themselves having to buy shares at the new,
higher price to cover that earlier borrowing.

Ah, for the carefree days when you could wander into a GameStop and
not worry about keeping six feet from other shoppers...
Enlarge / Ah, for the carefree days when you could wander into a
GameStop and not worry about keeping six feet from other shoppers...

"Demand started with some Robinhood-type retail investors, but once
it started going up, then you had shorts that were like 'Oh shoot,'"
Pachter said. "And the shorts were getting killed, so they started
covering. And that was a feeding frenzy. Light supply, heavy
demand... so the stock's just getting ripped up... I've never seen
anything like this in my life."

Meanwhile, investors who continue to think the stock price is
overinflated are continuing to borrow more short positions, confident
that the price will come down to earth eventually. Interest has
gotten so hot that Thursday saw a trading volume of 144 million
shares of GameStop stock, even though there are only about 45 million
actively traded shares available.

"I would not be chasing the name here. The smart money already
got in and probably got out."

It's this kind of feeding frenzy that has led GameStop stock to more
than double in the last week, analysts agree, rather than anything
fundamental about the real value of the company changing in that
time. But that cycle has to end eventually as short sellers run out
of capital and available shares to buy. And that peak could be coming
relatively soon, according to some analysts.

"There was a massive short position in [GameStop] and I would be very
interested to see what happens to the share price when things calm
down and the short sellers have to cut their losses on this,"
Standpoint analyst Ronnie Moas told Ars. "It could be another new
wave of short sellers could come in, but I haven't closely analyzed
the situation... I would not be chasing the name here. The smart
money already got in and probably got out."

Others think this short cycle could keep going for a while, though.
"If a short squeeze does occur... the shares could certainly rise
over $100 per share in the short-term as the number of shares short
currently exceed shares outstanding," DOMO Capital's Dopierala said.
"So far, the short sellers have proven resilient, which leads us to
believe that they are very well capitalized and will not exit until
the moment that GameStop is able to show tangible results that prove
they can successfully transform."

Pretty much every part of that "Buy Sell Trade" sign is suffering
recently.
Enlarge / Pretty much every part of that "Buy Sell Trade" sign is
suffering recently.

While Dopierala was heavily invested in GameStop very recently, he
told Ars he cashed out of his position on Thursday. That brings up
the issue of when other investors might start to look at GameStop's
quickly inflating stock price and see an opportunity to cash out
(which would help bring the price down to more reasonable levels).

Pachter notes that an insider Hestia investor sold 812,000 shares of
GameStop last week, according to SEC filings, and suggests more
investors might take their profits and run soon. "What's [Cohen]'s
strategy?" Pachter asked rhetorically. "Get the stock to $300 or get
the stock to $32 and make 300 percent profit? You have to ask, does
he actually think he can take it higher than this by remaining a
shareholder?"

The fundamentals

While Dopierala continues to be bullish on GameStop as a whole, even
he admits that the company's transformation "may not happen as
quickly as suggested by the current stock price." Analyst consensus
suggests GameStop could settle at a price of around $10 a share based
on the fundamental health of the business.

"There's nothing wrong with GameStop," said Pachter, who has a target
price of $16 for GameStop stock. "I'm absolutely convinced they're
going to thrive and survive. They don't have net debt, so they're not
going bankrupt or anything. And with the new console launch, they're
probably going to sell a lot of consoles and be fine."

"There's nothing wrong with GameStop. I'm absolutely convinced
they're going to thrive and survive."

"You would think next holiday season should be another very good year
for the video game space, just considering the installed base, and
people want the new consoles," Feldman added. "[GameStop] continues
to reduce its store base, increase profitability, and they've been
doing a better job consolidating."

There are still plenty of headwinds for a business like GameStop, of
course. "The problems GameStop has--many of these problems are not
going away any time soon," Moas said. "The world has changed in the
last few years as you can see with all of the shopping mall closures
and the disruption Amazon and others have caused GameStop and others
in the industry."

But as long as there's demand for new and used physical games, there
will be demand for GameStop, Pachter suggested. "The people that
value trade-ins don't want to buy digital. If you do trade games in,
you look at every game you purchase as a $20 bill on trade in. People
think that way. So they're going to keep buying physical--those who
care to trade them in--because there is value there. They're not going
to give away that value."

Promoted Comments

* Fatesrider Ars Tribunus Angusticlavius et Subscriptor
jump to post
Quote:
"If GameStop takes practical steps to cut its excessive real
estate costs and hire the right talent, it will have the
resources to begin building a powerful e-commerce platform that
provides competitive pricing, broad gaming selection, fast
shipping, and a truly high-touch experience that excites and
delights customers."

Corporate BSpeak to English Translation.

"IF we eliminate almost all of our stores, and hire a bunch of IT
people, we can create a website that competes with 1000 other
websites in trying to get something out of selling you digital
content, praying like hell we can get profits from volume at very
low margins."

Yeah, I'm not going to hold my breath there. They need to work
out more than just gaming. (and wtf about shipping? Parts? Amazon
does it faster and better. NewEgg, and others are established,
too.)

Basically, they're dropping their real estate anchors,
centralizing product sales to an online distribution and hoping
like hell people bother to go there, instead of to their usual
places like Steam or the manufacturer's site to get their games.

It MIGHT work, but as I said I wouldn't hold my breath.
13936 posts | registered 11/17/2012

reader comments

80 with 58 posters participating, including story author

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Kyle Orland Kyle is the Senior Gaming Editor at Ars Technica,
specializing in video game hardware and software. He has journalism
and computer science degrees from University of Maryland. He is based
in the Washington, DC area. Email kyle.orland@arstechnica.com //
Twitter @KyleOrl
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