- When GameStop Corp (NASDAQ: GME) Became a Meme Stock
- A Short History of What's Happened Since
- Did GameStop Corp (NASDAQ: GME) Just Change The Equation?
- What Comes Next and What Does a Win Look Like For Anyone Involved?
Score one for the apes.
If that makes sense, this article probably isn't for you. If that does not make sense, hold onto your butt. We're going to dip into one of the most contentious and convoluted corners of the stock market.
I'll admit to being an outside observer, and impartiality – my aim – is in the eye of the beholder and may seem very reductive.
By now, you've probably tuned out meme stocks. This isn't a judgment. It's a matter of odds. Few people are invested compared to the stock market's total size.
The market is filled with far more stocks and stock ideas than we can process, let alone capitalize on. And most investors have no exposure to them.
Yet the struggle over meme stock valuation is real and going strong.
Pumped up and pulled down by competing interests of a kind of crowdsourced collective – on one side – versus centralized insiders – on the other – tug of war, it's an emergent kind of activist investor battle over the mechanisms of valuation of a stock.
None more so than GameStop Corp (NASDAQ: GME).
Quite frankly, if you don't want to make it a time sink on the verge of obsession, it might be for the best that you haven't paid much attention to it since it blasted into the news in early 2021.
That doesn't mean it isn't worth checking in sometimes, especially after the latest quarterly results.
What we're going to look at today is what has changed. It's a big shift that may fundamentally change how the stock is viewed.
We will do that with a basic overview of what has happened in the last couple of years, how it makes GameStop (NASDAQ: GME) a unique stock, and (hopefully) doing it without dragging you too far down the rabbit hole.
When GameStop Corp (NASDAQ: GME) Became a Meme Stock
Most of this should sound familiar since it was such a big story a couple of years ago.
GameStop Corp (NASDAQ: GME) was feeling the weight of a massive short squeeze. It was a retail business when retail businesses were essentially shut down.
It also had plenty of issues to juggle. It was renting retail space that was not driving sales. It had a physical presence when both computer and console gaming had transitioned to online sales and downloadable content.
What happened next shouldn't have seemed possible. The short positions – those that borrowed shares at the time with the promise to return them later, hoping to make money on a drop in share prices over time – had reached what should seem like impossible levels.
In January 2021, when all this kicked off, short positions accounted for 140% of the share float, or the number of shares available in the market.
Yes, this seems impossible. No, it is not. After all, these are derivative investments with agreements between two private parties. You can borrow shares by shorting, but the counterparty can also promise to buy shares later to cover their exposure to your position or pay accordingly. It's a daisy chain of shorts, the kind derivative markets are all too familiar with.
The problem comes when that position is so far out of the realm of possibility, especially in the short term, that the lenders of shares demand collateral money as part of this agreement.
In January 2021, share prices soared between 20 and 30 times over – price discovery was murky, especially with a large volume of both feigned and actual transactions – as share prices moved beyond the terms these agreements would tolerate without the borrowers, those with short positions, putting up cash.
That meant closing out the positions at a loss which, in turn, meant buying shares at far higher market prices to return borrowed shares. That resulted in a chain of liquidity problems that ultimately led to the collapse of several hedge funds. White Square Capital and Melvin Capital, in particular.
It also exposed some previously poorly documented agreements between popular online brokers and some massive market makers and clearing houses, along with the relationships between them.
Robinhood took a big blow as it halted trading in the stock with no advance notice. A key beneficiary was Citadel, a significant investor in Robinhood and one with a “payment for order flow” with the commission-free broker.
This maxim is true – if you are not paying for a service, you are the service.
Ultimately, the high bar for proving intentional collusion between Citadel and Robinhood removed any potential consequences. Yet the fact remains that both had vested interests.
Citadel and clearing houses could demand far more intraday collateral for Robinhood traders than it could stake. Robinhood could halt trading with its broad terms of service and contracts with users.
It may not have been intentional, as in preconceived, but it was most definitely a feature and not a bug. One designed to purposely exclude actual shareholders.
A massive drop in share prices resulted as “price discovery” only included one side of the buyer-seller balance involved.
Hearings were held in Congress. A case went to federal US district courts before ultimately being tossed out. It was clear that an entirely legal countermove against insanely leveraged positions in the company was not honored because middlemen, some with vested interests, could halt the momentum working against them through dubious, if also legal, means.
A Short History of What's Happened Since
The Reddit and social media trend changed strategies, processing the shock and with many participants losing fortunes.
Since then, it's been a long slog with a sustained and concerted campaign to work against the mechanisms short sellers can use to manipulate share prices and borrow shares beyond what is available in the open market through secondary deals with market makers.
A vital feature of the move against short selling is direct share registry. This is not ideal, but it does change some aspects of ownership.
Essentially, you register your partial ownership of a company, via shares, with the company itself.
After the fallout of the initial GameStop saga, shareholders realized they owned shares by proxy through their brokers. They had an account with statements that tracked share prices, but the brokers controlled how shares were used. This allowed them to be traded by the brokers to short sellers and others as long as some kind of price tracking and equivalence was involved.
The shortcomings of the terms and limitations of that equivalence were exposed in the GameStop stock shenanigans in late January 2021.
Since then, the crowdsourced movement has embraced direct registry as a way to move shares out of contention. Some 30% of GameStop shares are now directly registered.
That limits the shares short sellers can pull in intraday and virtual trades for liquidity in secondary deals, thus increasing risk and price movement. It isn't a decisive advantage, but it is a massive outlier compared to other publicly traded companies.
In the process, it exposes some fundamental flaws in the “free market system” we assume in the stock market.
- What does it mean to own shares through a proxy?
- What should the role of intermediaries and brokers be in capitalistic ownership?
- What limitations should be imposed if middlemen can pursue nonfiduciary interests with stocks their clients “own” stocks if the clients take all the risk involved and do not benefit from secondary profit-taking?
It strikes at the core of the gatekeeping for stock markets that date back to their founding but are exploited by privileged parties with inherent advantages.
These questions have largely been ignored by the primary stock market and publicly traded company regulators – the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), and the Financial Industry Regulatory Authority (FINRA).
Both the crowdsourcing effort to buy shares of GameStop and directly register shares and the short sellers are not backing down, and it's become a “David versus Goliath” struggle the latter has a distinct advantage for, though the effort to force attention to the conflict is building over time.
Did GameStop Corp (NASDAQ: GME) Just Change The Equation?
Over two long years of hardship and contention might have just been upended by something of a surprise.
GameStop was a losing company. Namely, it was a company losing money. That changed in the first quarter of 2023. It posted its first quarterly profit in two years.
The company generated net sales of $5.927 billion for the fiscal year, compared to $6.011 billion for fiscal year 2021, marking a slight loss. Net sales were $2.226 billion, compared to $2.254 billion in the fourth quarter of 2022.
Cost-cutting measures outweighed everything else, though. A big part of that was a reduction in inventory from $915 million a year ago to $682.9 million in the latest release.
GameStop ended up with a $48.2 million profit for the quarter, compared with a $147.5 million loss in the fourth quarter of 2022.
Ultimately, it turned from a $0.49 per share loss a year ago to a $0.16 profit in the fourth quarter of 2023.
The considerable reduction in costs and inventory raises the question – can these results be maintained?
Don't ask the company. It stopped giving guidance years ago. For whatever it's worth, it claims it has a path to net profitability for the year without details.
What it does have working in its favor is low debt and over $1 billion in the bank.
The profitable quarter, very low debt burden, and cash on hand give it room to turn itself from a meme stock predicated on exposing and exploiting over-exposed short positions to a company in a turnaround position.
The margins it can maintain while attempting this will be a focus. Can it effectively use its money? Will it sputter out and depend on issuing more shares when its share prices are at about half their 52-week high?
If it can, GameStop will leverage a position and a dedicated base of shareholders to counter short positions that still control nearly 20% of outstanding shares.
If it can't, it will continue to depend on the goodwill of a base of shareholders that have suffered as shares have dropped from $125 – adjusted for a share split – to just under $25 now.
The results sent shares soaring some 40% in intraday trading and up nearly 44% for the week.
It was a huge move. It paled compared to a roughly 80% loss from all-time highs a couple of years ago, but that isn't what people are tracking anymore, is it?
What Comes Next and What Does a Win Look Like For Anyone Involved?
Through this whole rigamarole of competing narratives and stock manipulation – yes, on both sides but far more insidious on the institutional investor side – GameStop suddenly seems to have done what companies ultimately need to do, and something it hasn't in a long time – make money.
It's one thing to say that a company is undervalued even when it's on a downward slide. It's more complex to say the downward slide is overdone and force a short squeeze. It's another thing when it starts making money.
Is this meme stock even a meme stock anymore? When does it transition to being a contrarian or even a rebound play?
If GameStop maintains profitability, will continued pressure from short sellers remain?
If GameStop investors continue registering shares directly and short-selling interest subsides, will they move on to other companies facing similar plights? Or is the buy side genuinely interested in the company?
Time will tell, and despite the conviction of those involved, nothing else will.
Yet GameStop seems to be on the cusp of something – moving from a meme stock to a contrarian stock or even a momentum stock. But where do we even draw the lines between all when company metrics take a back seat to such deeply seated investment strategies, so long struggling against each other?
It's certainly worth watching, though maybe not investing. That's for you to decide. The only thing I'd bet on is that it'll be a wild, unprecedented ride, now with more fuel poured on the fire.
Take Care,
Adam English
The Profit Sector
