Senvest Capital is basically a publicly-traded hedge fund with a great performance track record. They had a large Gamestop position ahead of the short squeeze and outline their thesis and eventual exit in their Q1 MD&A:
The investment in videogame retailer Gamestop (“GME”) contributed approximately 50% of the net change in fair value of equity investments and other holdings. Without question, the investment in GME was our single most successful investment to date in terms of absolute dollars, return on investment, and IRR. As a result, it is worth recounting the thesis and the management of this investment.
GME’s financial results and its stock price had been suffering for years for several reasons. Most notably, the late-stage maturation of the gaming console cycle and the increased digital distribution of video games adversely affected the company’s retail and physical disc-based distribution business model. The Covid-19 pandemic exacerbated GME’s issues as mandated economic shutdowns led to the closing of retail stores and as stay-at-home consumers increasingly downloaded games digitally. However, a reconstituted board and new executive team came in during 2019. They started to implement meaningful changes in the business, including cost-cutting, the sale of assets, reduction in working capital, a significant reduction in debt, and the buyback of stock. These changes positioned the company to capitalize on the new console cycle and fortuitously enabled it to better handle the challenges posed by Covid-19. Moreover, these are some of the hallmarks of change and transformation that we look for in the investment process.
Two additional pieces of our fundamental value case included the imminent launch of a new gaming console cycle by Microsoft and Sony, which we believed would catalyze sales at Gamestop, and the involvement of an activist investor, Ryan Cohen, the co-founder of Chewy.com, a leading online retailer of pet supplies (and also originally from Montreal). Cohen not only had the experience of beating Amazon in e-commerce, but he also made a fortune selling Chewy.com to Petsmart. We believed that if Cohen were to become more involved with the company, he could provide valuable input as well as credibility in any plan to transform Gamestop’s business model. Such a plan would entail evolving beyond physical retail by leveraging relatively nascent e-commerce and digital strategies. We also thought GME’s 64-million-member loyalty program and its preeminent online gaming publication “Game Informer” represented underappreciated assets.
We also believed that Wall Street sell side estimates significantly underestimated Gamestop’s future earnings and cash flow potential once new console inventory became readily available. While we established the core of our investment in the fourth quarter, all but one (of eight) analysts had either a “hold” or “sell” recommendation on the stock. The disconnect between consensus expectations and what our research suggested helped support our conviction in the fundamental, value-based investment thesis.
A final important consideration in our thesis was the unprecedented level of short interest in GME shares, with more than 100% of shares outstanding short and an even greater amount of the effective “float” being short. We believed that GME was the most shorted stock on the US market, and in the entirety of all our careers, we had never seen such a level of short interest. This setup gave GME “coiled spring” potential for any change in the company’s narrative. From what we could tell, the short thesis was that all videogames would be distributed digitally and that GME would go bankrupt. Our research indicated that GME faced little risk of bankruptcy. We believed that the circumstances for a potential “short squeeze” created a non-trivial chance of a huge upside move and created an asymmetric risk-reward profile in GME.
We spoke to sell side research analysts as well as understanding the short interest/stock loan at the major prime brokers and through third-party short interest data providers. Furthermore, as we do with virtually all our investments, we engage in dialog with management teams and, at times, we engage with other shareholders. In this case, we communicated both with the company and with Ryan Cohen. Based on a letter Cohen sent to the GME board and made public on November 16, 2020, it appeared he was dissatisfied with the company’s progress in transforming into an e-commerce and digital gaming outlet and also rejected the company’s overtures to him with the offer of a single board seat. After the release of this letter, we felt compelled to communicate our opinion to the company: a potential proxy fight with Ryan Cohen would be damaging to the company, and since Ryan Cohen would win such a battle anyway, it would make sense to settle with him. We believed he could add great experience and credibility in helping the company’s transformation. Considering that Senvest was one of GME’s largest shareholders with roughly 7% of its shares, we suspect our views carried some weight with the company.
We did not foresee the unusual catalyst for the short squeeze which occurred in GME starting on January 25th. Reddit’s “Wallstreetbets” participants effectively crowdsourced the short squeeze that sprang the coiled spring. After trimming the position on Friday, January 22nd, we went into that weekend with greater awareness of what was happening. Pre-market trading, while it officially opens at 4am EST, rarely gets going until an hour before the market opens at 9:30am EST. On Monday, January 25th, however, GME stock began its incredible surge at 4am EST, and we began to trade the stock in those early pre-market hours. We exited roughly half of the position on that day, which provided us with an extraordinary gain from which we had the flexibility to “play with the house’s money” and to see where the stock could go. A tweet on Tuesday, January 26th, from social media business darling Chamath Palihapitiya sent the stock higher and we sold more. Finally, after the market close on that same Tuesday, the titan of all business social media, Elon Musk, who has a particular disdain for short sellers who he has regularly battled publicly, tweeted a single word – “Gamestonk!” – which sent GME investors into a frenzy. We believed that things couldn’t get any better than that in terms of the immediate term trading mania, and as a result, we sold our remaining GME shares in the post-market trading hours and into Wednesday, January 28th regular trading. Many have questioned when the individual investor would come back to the stock market. It appears that the individual investor is back with a vengeance, armed with the power of the internet.
