I was reminded today of a signal that has produced some of my biggest investment winners. One of the best “tells” that there may be a great investment opportunity is when there is a very large cohort of the public speaking in absolutes, especially in emotional and certain terms, about a company/service/protocol. My absolute favorite one is “never”, and I call it investing in Neverland.
To illustrate what I mean, I’ll share the story of the run-up and follow through of investing in a very hated company, GameStop.
My History with GameStop
The seeds of the idea of getting involved in GameStop were planted back in 2018, when I moved into my new condo. Around when I closed on my unit, my broker at the time was helping another family sell their condo in my building. That other family, was of the late CEO of GameStop Paul Raines. He was in ill health at the time, and they were in the process of selling his condo that he used to visit family in the area, which was a few floors down from mine. He sadly passed away in March of that year.
It’s strange what sticks with you, and when some things reappear in your life.
It was during this time that GameStop was going through a very tumultuous period coming off of a misguided move into mobile phones and generally languishing sales. Add to that, they expanded their store count to unsustainable levels, so much so that you could have several stores within too short of distances from each other, cannibalizing sales and adding to the growing overhead of the company. I glanced through the company’s financials in 2018, and the stock looked terrible, so I put it back down.
Then enters Dr. Michael Burry (of the “Big Short” fame played by Christian Bale). He released his letters to the board in the summer of 2019, and I think in part due to those seeds planted in 2018, I took notice:
I remember being at home and reading the article on MarketWatch, and with too much time on my hands, decided to try to find out what Dr. Burry saw. Over the course of a couple of months, I received a massive education on both thinking critically, and understanding all aspects of the business model. To be frank, the business was a mess, but what Burry advocated was that since the stock was at historical lows, and the company had the cash to do a massive repurchase, they could pull it off. For context, they had the opportunity to repurchase nearly 80% of the outstanding shares with the cash on hand. This was also at a time when the short interest in the company was 63%.
He was right about another thing, on the horizon was the release of the next generation of gaming consoles from Microsoft and Sony. Historically for GameStop, a new console cycle always lead to a big increase in revenues for the company for years, and they all had disk drives. Why was this important? Because the highest margin good sold at GameStop was used physical games. If the next generation consoles had disk drives, it gave the business model several years of runway to right-size the business and update the model to include other sources of revenue. Couple that with an opportunity to repurchase a substantial amount of outstanding shares, while getting back to free cashflow positive territory, and you have an opportunity on your hands.
So In mid-2019, I followed Burry and initially purchased shares in GME, to then convert those shares into call options in October of 2019, with an expiration date in April 2021. The bet being, following the Q1 results on the heels of the console’s releases in November 2020, and after a big share repurchase, all while right-sizing the business, things will be better than today at roughly $3.50 per share. I wont disclose the exact amount, or the strike price, but suffice it to say it was well out of the money at the time, to an embarrassing degree.
What transpired shaped how I understood market sentiment, and the power of understanding what you own.
For the next 10-12 months, I received an unrelenting barrage from every message board, news outlet and TV show that GameStop would “never” make it and bankruptcy was inevitable.
“I never shop at GameStop”
“When was the last time you’ve been to a GameStop”
“They’re out of money, they’re a garbage company, its going to zero”
“They’ll never make it”
And Lord Almighty, the Blockbuster references were everywhere. I remember how that was always the first line of attack on why GME was a loser and I was a loser for being involved:
Thinking back on it, it reminds me of the scene in the second Matrix movie when Neo is fighting the swarm of Smith clones. It just made me laugh, because that is exactly how it felt:
So why did I stick with it? Because if you read through the numbers, although things had gotten way out of hand with the merry-go-round of CEOs following the passing of Mr. Raines, the component parts to rebuild were there. They finally got a good management team in place, and they subsequently repurchased approximately 30% of the outstanding shares, and closed numerous stores, with many slated for closure, while lowering the company overhead and putting the company on the path to profitability.
You can imagine the reaction from the general public of closing stores. Part gloating that it’s “going under” with plenty of grave dancing of pictures of closed stores plastering Twitter, the WSJ, you name it. I learned that whatever I said wasn’t going to change anyone’s mind, and I knew the strategy, so I let them have their time. We also followed what they did in their test stores in Oklahoma, it was a precursor to what direction the retail space could take, and honestly it they looked great. They had cleaner inventory displays, retail lighting, even potentially renting out gaming space in the back to “parties” in which you bring 20 kids into the store for a few hours to all play Fortnite together. Sounds dumb at first pass, until you think of having your key customers in your store for a few hours will do. They even had “retro” test stores with huge CRT Tv’s set up in the store to play old games, with the inventory focused on retro gaming. So while unprofitable stores closed, they were thinking through how to make the rest of them more profitable and attractive.
As things went on, I remember being on a conference call and the CFO indicating that 96% of the remaining opened stores were “four-wall EBITA positive”. What did that mean? That means a vast majority of the stores were profitable on their own, and that most of the losses are coming from the corporate side. Thus, they did sale-leasebacks on their headquarters and distribution centers, to add additional cash to clean up the balance sheet (from approaching maturing debt), and continued working on lowering costs in anticipation for the upcoming console launches. They even did a Dutch auction for more share buybacks. Its hard to go bankrupt when you pay off your debt.
The board at GameStop in 2019 was a slew of entrenched members who had virtually no experience in the video game and/or retail space. It was the purest definition of a disinterested board. Burry’s moves in 2019 set in motion a removal of several members, a wild and contentious proxy fight by another investor group (that was a bit of a mess, but they had good points, albeit cost the company some cash to defend), and what resulted was some excellent new board members, like the former CEO of Nintendo USA Reggie Fils-Aimé. Always just known as “Reggie” in the gaming world, he was beloved (by me included) and I was thrilled to have him on board, so to speak.
I could honestly go on, and to be fair things were also moving in the wrong direction in some places, as revenues were taking a hit as customers delayed purchases until the new consoles came out. It was not an easy road sticking around when things looked really rough, because in some sense they were rough. Add a pandemic in and everyone’s holding on tight. Yet I knew that business better than anyone, short of the management team, and it gave me this quiet confidence to roll with the punches. It is important to emphasize that the stock was priced for immediate bankruptcy, it was trading so far below liquidation value that there wasn’t really anywhere else to go.
The most interesting thing was most “takes” on the business were from outlets that knew very little about the business at all, and it included everyone, WSJ, CNBC, etc. The cliché “Blockbuster” label was easy, convenient and got clicks, and man, everyone that had a bad experience at GameStop, let everyone else know. But my small group of like-minded investors found the Reddit boards where the managers of the stores would talk to each other, and we got an actual sense at what was going on in the stores. I went to a couple of stores as well to talk with the employees, to see how things were. They always had great people working there, who generally loved video games and knew their stuff.
As time went on, the short interest continued to grow, to such a degree that on paper it well exceeded 100%. At the time there was disagreement in the calculation, but a group of us followed the margin costs for borrowing shares, and kept strict counts on what was available out there. Naked short selling exists, and it is as dangerous as you think it is. I remember a firm that specializes in calculating various nuanced things like actual short interest (given its only reported every two weeks) stated at the time that it was more likely around 58% or so. Either way, there was the risk that I was very wrong and there were some smarter people that knew something I didn’t. Yet I was confident that I knew that business better than they did, especially since I knew video games so well.
Then one morning I was watching the pre-market trading around 6:00 a.m. and the stock popped from around $4.00 to around $6.50. I remember laughing so loud I’m sure I woke the neighbors. This had been a long year in a sea of negativity, and things were finally potentially turning.
What I was watching were the initial purchases of Ryan Cohen (founder of Chewy) buying his shares in the company. He was attempting to purchase millions of shares in the pre-market, and it was too illiquid to do so. Funny enough, we didn’t know that was him until weeks later. Then things snowballed, Ryan announced his intention of taking a large share in the company, then to essentially taking it over.
And you know how the story ended.
I wanted to share that experience, because I never tell people I was involved in GameStop. Once the fireworks started, I hit the exits. The same strategy that lead me there, also led me out, which is to say the prices didn’t reflect the business anymore, and this party was way too crowded for my taste. The only people that knew what had happened were my family and a couple very close friends. I feel better sharing it now because it seems like the moment has passed, and it doesn’t feel as embarrassing to say I was involved in GameStop, because for a while there, everyone was.
When it looks like Neverland
So to come back to my original premise, the way I frame what happened, and how it shaped me as an investor, is that it gave me a heightened sense when sentiment is too negative to be true. When I hear too many absolutes being thrown around, and how this or that will “never” return, “never” work, I see doors opening. Proclamations like these are more of a signal to me that there’s an information asymmetry, rather than wisdom of the crowd. There’s also an element of certainty in negative sentiment that catches my attention. In the very least, it becomes a signal for me to look deeper into whatever has everyone’s negative attention, sometimes the crowd is right, but those special and exciting times when they’re not, I feel like I’m in my element.
That’s what being invested in the most shorted company in the world for 12-18 months until anything positive happened, while virtually everyone in the english speaking world yelling at you that it is garbage and is going bankrupt, to then have that happen, will do to you.
Will