A thread on short squeezes, Gamestop (GME) and value unlocks. 1/

Y/D it was announced that Ryan Cohen became a 9% holder of GME. Shares ripped over 40% in a couple days. So why the GME saga important in considering how to think about event-driven and value investing?
$GME

2/ Gaming retailer GME has been through hell and back. As game makers began to push digital download and sub models, B&M game stores suffered even more than their B&M peers in other sectors. Console makers spent a lot of $ building

3/ digital marketplaces and publishers embraced new sub models. In early 2016 GME was a $29 stock, and had been desperately buying back stock. Hardware offered poor margins (~10%) and GME focused on the used game return market that generated ~45% margins.

4/ With +ve FCF at the time, but headwinds mounting, GME began a large buyback program (2015-16), increasing EPS as Net Income and FCF struggled. GME took on a $350 term debt piece due in '19. This was unsustainable at the time and was at least partly predicated on

5/ driving out shorts who were all over GME. There were some acquisitions that tried to help GME pivot. Geeknet (2015) and Spring Mobile (2013) were weak attempts at moving sideways on product offerings. GME had gone through 5 CEOs in 2 years into early 2019.

6/ The acq's doubled down on the B&M exposure. This is similar to what Blockbuster did while NFLX pivoted to an entirely new model. Even after these missteps, GME still had a quiver of real options. in Q1/19, GME had $540mm in cash, which it was using to repurchase debt.

7/ Meanwhile passives were major holders (IJR/IWM), and ETFs held around 20% of shares. Shorts were piling on to GME as "everybody understood" that physical games were a relic of the past, right? FCF was still ok, this was front run the ETF trade plus the "obvious" decline

8/ Dividends were still permitted under covenants through 2019. With shares around $4 last Aug after a failed sale process, Michael Burry started buying stock. He wanted a $220mm buyback. Short interest was ~60%. Shares rallied to almost $7 by Nov/19

9/ Burry's thesis was that the game streaming narrative was overstated, the B/S was better than people thought (pre buyback anyways), and optical disk drives were in the cards for future consoles. But a big debt maturity loomed in '21

10/ Even if Burry was right, the upcoming console cycle would only buy GME time. In between, maturities had to be solved for. The long game would require some sort of transformative change.

11/ Activists Hestia and Permit became involved and demanded debt and stock buybacks and board/mgmt changes. GME addressed some of their concerns a year later, but it wasn't enough for the activists. They launched a proxy battle this past March

12/ wanting board representation. At this point, short interest reached 97% (!) of shares outstanding. At this point, the large passive investors (56% of float at the time) created uncertainty on which way the vote would go. This led to speculation

13/ around active holders calling in their shares from lending pools to affect a squeeze. As the proxy date approached in April/20, shorts kept firing away, despite the $570mm in cash and $66mm in revolver draw available. Borrow costs hit 140%. But what was the credit event?

14/ The March '21 maturity was looming. In June, GME launched a note exchange, offering 95 on $414mm of '21 notes in exchange for higher coupon '23 notes. 52% or so were taken up and exchanged. $216mm of those pesky '21 notes remain outstanding.

15/ Covenants were also relaxed on the revolver. GME also owns 1.1 mm sq. ft of real estate and sale-leasebacks were now on the table. If the Q4 console inflection hit, FCF could have eclipsed the entire market cap of a $4 GME.

16/ The most recent short squeeze began when Ryan Cohen filed a 9% stake in GME. This is the guy that sold Chewy to Petsmart before it was IPOed. He beat Amazon, created value, and had a vision for how to do this.

17/ He used to work with new GME board member Symancyk, who used to be CEO of Petsmart and is on the CHWY board. SI% was about 40% going into this epic rally. What is Cohen's play here? It's hard to know, but safe to say it's unlikely a quick flip.

18/ Presumably he has something more visionary in mind than the original activists (buybacks, new board, debt reduction). This is what I refer to as a creative activist vs a structural activist. Don't ask me what it is

So what are the takeaways here?

A) Shorting companies with large real embedded options (even if in secular decline) is a risky game. Particularly when there is no upcoming credit event. Real options: liquidity, cash, loyal customer base, recent FCF potential in this case.

B) Value investors are making the bet that the convex, or at least flat slope part of the S curve will continue longer than the market has priced. It's been a hard case to make that aside from unlocking value from sale-leasebacks and kicking maturities, there was anything

at GME that would resemble building a new S curve on top of the last one. The presence of Cohen now has at least some speculating he has 'something' up his sleeve. Who knows, he beat Amazon in the pet supply game.

C) Asymmetry matters so very, very much. With short interest anywhere between 40-99% over the last 18 months, 100%+ borrow costs, bonds trading bid, activist involvement, and an upcoming console cycle, you're going to short a $200-300mm market cap company?

It's hard to find investments that offer both resilience and optionality. Both change non-linearly. Going from (and being priced at) 2/10 on some sort of resilience scale ( imminent demise) to 4/10 changes outlook superlinearly.

Optionality reprices similarly but is more widely understood.

D) It can take much longer than you think for an event-driven catalyst play to work. Path dependency matters - the missteps of the past take time to work through.

People, egos, legacy stakeholders, debt, industry change - all of these wind into a complex knot that needs to be at least largely unwound until many of these situations work.

E) Don't ignore mechanics: passives, shorts, borrow recalls - on small float equities can be /end