GME Short Squeeze: An In-depth Analysis

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by nafizzaki

Seeing that a significant interest has developed around the fabled GME short squeeze, I have written this post and I hope this writing provides an overview of the situation.

The case for a squeeze:

The entire argument for a short squeeze hinges on the possibility that either the management agrees with Ryan Cohen’s plan and addresses it or he decides to pursue a hostile takeover.

In this spirit, we urge you to quickly provide stockholders with a credible and publicly-available roadmap for cost containment, prioritizing profitable retail locations and geographic markets, and building the e-commerce ecosystem gamers deserve. (from the letter)

This is Ryan Cohen’s plan in its most raw form. Or to put it more simply, he wants GameStop to become the ultimate destination for gamers by leveraging its 55 million PowerUp members, its brand power; reducing lossmaking operations in Europe and Australia and to make investments in a Chewy like website for gaming.

Has management been doing anything? Yes. A lot.

It’s hiring talents for building a successful online gaming store. Entered into a multi-year revenue-sharing agreement with Microsoft.

It has also received a saving grace by the newest console cycle in which some people thought(like me) diskless gaming is going to be the leader. But the reality turned out to be quite the opposite.

Add to that, the Nintendo Switch sold like wildfire in the US and is going strong, you have a winning combination for GameStop which would likely result in good quarters for the coming quarters.

Management has also started a rebranding effort with some changes being made to its logo, items that are kept in-store and online etc.

It seems like management is likely to address Cohen’s concern and the lifeline it has received or will be receiving from the newest console could be its saving grace. If it can turn around or the management gives guidance that it CAN turn around its business model a short squeeze is imminent.

Why would it be inevitable?

Notice that short interest is almost 3 times higher than its float and more than outstanding shares,

GME as a company is still relatively undervalued (assuming it doesn’t go under). If the shorts realize that this company is not going to 0 as they have probably assumed, they will be forced to cover their shorts.

The above-mentioned condition of short interest would guarantee that they have to cover. Also considering the average daily volume, this squeeze can last much longer(3-4 days may be) than the other historical squeezes like Volkswagen short squeeze when it became the most valuable company in the world for a short while.

But given that the scenario surrounding GME is unprecedented, there is no telling how it could end up other than to say that it will be MASSIVE.

Some shorts are already under water. Some of them are likely covering as noted by various Redditors and retail investors who are looking at the stock tick by tick. Also considering that short interest rose to a whopping 309.83% and is now down to 297.13% (as of this writing from Morningstar data), it’s obvious that some of it were covered.

The recent stock price appreciation could be a result of that plus the expectation of good quarterly earnings report.

Retail mania: There is considerable retail interest in this stock. Considering that this stock is being heavily promoted in r/wallstreetbets and driven by that a lot of people are buying shares. According to a survey conducted there(not that reliable, but a good indicator of interest), that subreddit alone has enough ownership to get a board seat.

Open Interest in call options is also huge considering that this is only a $1B market cap company. It’s filled to the brim with OTM call options(from December 4 to April and further). And market makers and option sellers would have to hedge to serve this crowd, in turn increasing the stock price.

This, in turn, could create a feedback loop where the shorts have to cover their positions, leading to a further increase in stock price, which would force market makers to purchase more shares which could increase stock price and on and on until it triggers a squeeze of epic proportion.

Likely improving financial health: GME announced voluntary redemption of senior notes. Management has decided to redeem $125M of its senior notes. This is signalling that the company has managed to generate enough cash flow to cover its debt early.

It could even help improve its credit rating which would help it attract institutional investors more and other perks that come with improved credit ratings.

Declining debt is necessary as it would ultimately help deleverage the company and put it in a more sustainable footing which is ultimately what is needed for avoiding bankruptcy.

Technical analysis: This is not my forte. I have bare-bones knowledge in TA and only use it for entry and exit purposes.

But according to some retail investors in Reddit and tradingview GME has formed a cup and handle bullish pattern.

Analyst Upgrades: Analysts are upgrading GME stock. Well, that’s good, I guess.

The Case For Bankruptcy

The scenario in which a short squeeze doesn’t occur is PROBABLY the scenario in which GME ultimately faces bankruptcy.

As the thesis for short squeeze is laid out, the thesis for the short sellers is also crystal clear.

After all, GME is STILL a large brick and mortar store that is trying to sell a product that could be very easily purchased using the power of the internet.

The revenue of GameStop for the past few quarters is in steep decline. The company is overly leveraged and has many stores that are loss-making operations.

Its online store has much lower visibility and investment and is lacking in many aspects(in my personal view).

Its credit rating is not that good and Cohen himself somewhat criticised the management for trying to hang on to its old ways of doing things.

Gaming and associated products are bound to thrive and grow at a CAGR of 9% and had grown even more in the past.

Yet GameStop FAILS to capitalize on this trend and is continuously losing market share while destroying its financials. This is a clear sign that something is inherently broken within the company.

While the management does seem to be trying to fix things, it could prove to be too little too late.

To change its fortune it needs to turn around its business models like Best Buy or Walmart. Yet it seems pretty unfeasible judging by its financials.

GameStop had adequate time to change with the times and become an early adopter but its backwards-looking culture and late entry made its journey full of competition.

Short sellers believe that ultimately GameStop wouldn’t be able to achieve a business turnaround and gain a critical mass of customers in its online space and management incompetency will ultimately lead to its bankruptcy. Thus its faith would be like the numerous mom and pop shops or the various retail giants that were.

Even if GME share rises due to retail mania and market maker hedging; institutional investor ownership could decline, leaving retail investors as the ultimate bagholders. The shorts may bite their tongue and keep on paying interest as long as they believe no fundamental change in the business is going to happen.

Which means they may not need to cover their position as long as the company becomes bankrupt, thus the fabled short squeeze may never materialize.

After all, most shorts are probably institutional investors like Melvin Capital who can always maintain their margin requirements(if any) and like the retail investors they can also figure out what the retail investors are trying to do and thus avoid triggering any short squeeze.

Conclusion

The next two or three quarters are pivotal for GME.

If
"Management decides to address Cohen's concerns and manages to show their roadmap to success and improves its financials within the next two quarters = Short squeeze"

Else If
"Cohen declares hostile takeover or something close to that line= Short squeeze"

Else If
"Management addresses Cohen but fails to deliver within the next two quarters and has disappointing earnings=Unsure" #improbable cause next two quarters are expected to be good or at least the guidance which is more important

Else If
"Management doesn't fully address Cohen's concern, Cohen also doesn't make any move yet the business improves still= Likely short squeeze"

Else If
"Management fails to address Cohen's concern, Cohen disassociates himself, business fundamentals detoriorate= Retail bagholders"

Else
"I don't know really, imagine your own scenario, you are not bound to my conclusions. In fact my conclusions could be entirely off the mark. We are trying to predict the future here. Hope you come to your own conclusions. :)

Disclaimer

There are various nuances that I avoided writing(which are probably even more important to write) cause it might have taken too much of my time. Writing this post was a good exercise for me and I decided to ride on the GME train after doing so. Before you decide to do anything, you should do your research. This is not financial advice.

Further Reading

You better read this one even if you didn’t read mine.

Ownership survey.

Hmm.

 

 

Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.

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