What's Going On?
GameStop Corp. (NYSE:GME) is a specialty retailer that provides games and entertainment products through its stores and e-commerce platforms in the U.S., Canada, Australia, and Europe. Basically, GME sells new and pre-owned gaming platforms, accessories, gaming software, in-game digital currency, digital content, and full-game downloads. The company also offers collectibles, apparel, toys, trading cards, and gadgets. Additionally, GameStop engages in digital asset wallet and NFT marketplace activities.
Over the years, GME's share price has fallen systematically - against a backdrop of declining sales and a depressed trend in other key financial figures. In general, the video game industry has evolved quite rapidly during this period and is a highly competitive environment, in which GME's business model already seems outdated. In 2020, belief in GME's performance was bolstered by enthusiasts on Reddit who helped the stock break out of its multi-year downtrend and become one of the first "meme stocks" - a term now recognized by the vast majority of even older investors.
One of those enthusiasts was Keith Patrick Gill, also known as Roaring Kitty (or "DFV"), who was one of the first to point out that the probability of a short squeeze in GME was high, as the stock was heavily shorted at the time.
After a series of events in 2020 and 2021, Roaring Kitty disappeared from the media spotlight - but it was only a few weeks ago that he resurfaced. More specifically, his mysterious tweet reappeared, in which he didn't directly call for anything, but it was enough to send GME back into the stratosphere ("to the moon," as Redditors often say).
Today, June 3, 2024, we received another significant piece of news - Keith Patrick Gill announced a significant stake in the company worth ~$115.7 million. Gill shared a Reddit screenshot showing his purchase of 5 million GameStop shares at $21.27 each and 120,000 call options worth $65.7 million with an exercise price of $20, which expires on June 21. While Gill's post did not appear in the WallStreetBets chat room, he used the same username he had during the 2021 craze. As a result, the stock is now up 68% on pre-market:
In my opinion, despite this meteoric rise, investors should stay away from GME and sell their shares on this rip (assuming, of course, they had a position in GME to begin with).
Sell GME's Rip
I want to warn readers right away that I'm not calling for a short GameStop just yet - borrowing fees have risen significantly recently and are at 14-16%, according to Fintel data, which makes borrowing shares to open a short position costly.
But why am I encouraging you to close your long positions if you had them speculatively?
I'm trying to understand what Roaring Kitty's motive is and why the news came out. Let's look at short interest - at the close of the last trading day, GME had ~22.34% of its shares sold short (as of total), which is the highest level in the last 3 years. Most likely, Roaring Kitty has decided to take advantage of this and force the short sellers to get out as soon as he discloses the information about his stake in the company to his wide audience. I think he has seen growth potential equivalent to the previous highs of past rallies in 2021 and even 2022:
Now in pre-market trading, the stock is near $40 - that's about the bottom of the relatively strong supply zone, where there will likely be many limit orders to sell, which may stop the further spread of this sudden rally.
Also pay attention to the structure of Gill's announced position in GME - almost half of the $116 stake is made up of the call option that expires on June 21, 2024. I'm no lawyer or judge, but it seems to me that this is a classic manipulation to get out of positions as quickly as possible with good profits. If I'm correct and Gill closes his option position and then decides to exit his remaining stock position, that would give the market an additional 1.6% of all outstanding shares (5 million shares out of 305 million outstanding shares = 1.64%). This pressure is transferred to those who decide to buy GME immediately after the pump.
Another reason to get out of GME stock as soon as possible is the actions of the company itself. GME management has repeatedly used the market hype created by Reddit activists to issue shares at a higher price (to get more cash at "the market" price).
However, the biggest reason to avoid GameStop is its fundamentals, which continue to leave much to be desired. Although the stock price has risen so much over the last 5 years, gross and EBITDA margins remain stagnant. As another Seeking Alpha analyst, Anna Sokolidou, wrote in her recent article, GameStop's return on equity (ROE) is a very low 0.5%, compared to an average of 13.84%, reflecting poor profitability. Additionally, the cash flow from operations to total debt ratio is negative (-0.15), well below the benchmark of 1 or higher, indicating potential liquidity issues. Although GameStop has ample cash reserves of $921.7 million, down from previous years, the company is struggling with declining sales and low profitability, reflected in a modest net income of $6.7 million.
With no obvious reason to change the fundamentals going forward, GameStop trades for literally thousands of next year's GAAP earnings - the stock is overvalued relative to every metric we look at today.
Your Takeaway
In my opinion, what we see today at GME is either an obvious manipulation (creating an opportunity to exit a position) or a coincidence. I find it difficult to believe the second. We are a little over two weeks away from the expiration of Roaring Kitty's huge call option position, and I think he may start to gradually get rid of his stake after today's jump. This will create supply pressure on retail investors who want to ride the wave up.
I urge you not to fall into this trap by buying GME on this upswing. Instead, if you already hold GME stock in your speculative portfolio, I encourage you to consider exiting on this rip. I give it a "sell" for the fundamental lack of explanation of the pre-market rise and the extreme valuation levels.
Good luck with your investments!
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