The rise, fall, and rise of GME

From the February 2021 print edition

This column is being written on Friday January 29, prior to the 9:30am opening of the New York Stock Exchange (NYSE). Yesterday, the publicly traded company, GameStop (GME), which is listed on the NYSE, closed at $193.60. It opened at $265. Soon thereafter, it climbed to $483, pulled back to $112.25, then rallied to $193.60 at the final bell. There is no rational economic explanation. But this story isn’t about valuing a company based on any systematic basis. This is a story about how “amateur” investors turned the table on the pros. However, it strikes me that there are broader implications that could be profound.

GME is a niche retailer that sells video games. Some years ago, it had been a high-flier. But it fell on hard times and seemed to be on the brink of bankruptcy even six months ago. It hit a low of $2.67 per share. On January 11 GME reported its holiday sales and the results were better than many people expected. Online sales had surged, and the stock rallied, moving up to the $20 range. The “smart” money thought it was over-valued and began short selling it heavily.

What’s short selling?
Short selling is a strategy that allows an investor to profit from a decline in the share price. Typically, an investor hopes to buy low today in order to sell high tomorrow. Short-selling reverses that. Investors, through their investment dealers, borrow shares from other investors (without their knowledge), and sell those shares on the market. The short seller hopes to buy back at a lower price. A tried-and-true tactic of hedge funds has been to execute short sales, then do everything in their power to talk down the share price. The only honest way to describe it is that it’s a form of market manipulation.

There were several hedge funds that had short sold a significant number of GME shares. On the same day that Joe Biden was inaugurated president, one had scheduled a meeting to explain why GME was destined to head to zero, which they hoped would have led to panic selling. But there was a Reddit group, dedicated to investing, that started bombarding that hedge fund with emails, and the meeting was pulled. That did not satisfy the Reddit members. They realized that if they started buying up shares, this would force the price up, leading to large losses for hedge funds when they were forced to off-set their positions.

On Friday, January 22, GME shares opened at $42.59 and eventually closed at $65.01. By the following Monday, it soared to $159.18 before closing at $76.79. Tuesday’s trading was flat, and it appeared that the rally was over, when a tweet by entrepreneur Chamath Palihapitaya re-energized Reddit members, and the price finished close to its daily high of $150. Then Elon Musk got into the fray, seeming to endorse the company (even while he really didn’t) which led GME to go ballistic. It more than doubled overnight, crushing the hedge funds.

What happened? Reddit members, amateurs, beat the pros at their own game. For years, hedge funds had taken positions in companies, then used media outlets like CNBC and Bloomberg News to talk the price down. This time around, seeing that the short sellers were vulnerable to a sharp increase in price, the Reddit members “stormed the gates”, buying shares of a company whose chances of surviving in the long run seem slight to many.

But as John Maynard Keynes quipped: “In the long run, we’re all dead.” In the world of trading, a day can be eternity, as we witnessed with the price action.

Going forward
What could this mean for the future? Small investors, linked through social media, now have the ability to band together and if not move entire markets, at least individual companies. How’s this for a hypothetical? What if small investors realized that they could couple their buying power with tangible action? Let’s imagine that next time around, the Reddit people target the shares of a restaurant company that specializes in high-end dining. Take Cheesecake Factory as an example. There are about 300 locations across North America. I’m guessing that each one seats about 100. There are
45 million shares outstanding, and the current price is $45 per share. What if 10,000 Reddit members each short sold 1,000 shares? That’s only 10 million shares or 22 per cent of the float. Then what if for one month, each Reddit investor reserved large tables on Thursday, Friday and Saturday nights at 6pm? Then their parties ordered tap water, studied the menu for two hours before ordering the cheapest items, and then took two hours to finish their meals. Revenues would plummet and the share price would collapse.

Would that be a form of market manipulation? Of course. But I’m not sure what anyone could do about it and I would not be surprised if we saw a lot more of this in the future.

Toronto-based Michael Hlinka provides business commentary to CBC Radio One and a column syndicated across the CBC network.