The GameStop Dumpster Fire

Do you think the GameStop market surge represents a new chapter in investing, as the masses finally can compete with the big Wall Street funds?

It is always dangerous to opine on events as they unfold, as yet-to-be-discovered facts have a way of making contemporaneous commentary look foolish.

Of course, it is natural to feel a little Schadenfreude at the funds that were crushed by the sudden surge of trading, but I am not convinced. The current narrative is that a band of scrappy traders took down arrogant hedge funds who cratered the economy and got bailouts instead of their deserved comeuppance. We are, the narrative goes, witnessing the revenge of the trading nerds: the outsiders used the tools of the insiders to play them at their own game.

Perhaps I am too cynical, but I believe the real story, when the dust settles, will be that a small group of early movers manipulated the market to make a huge sum by convincing large masses of later traders through a David and Goliath story to pump a stock into the stratosphere. Large trading blocks in the tens of millions of dollars are inconsistent with stray day traders. And many of the late-to-the-party eager day traders will lose massively as there are no fundamentals to maintain the stock at the nosebleed prices they paid. In that case, the early birds to the party will make a lot of money and a lot of people will burn.

Schemes to manipulate novices are as old as markets, as are bloodthirsty squeezes on shorts. The squeeze strategy works when the squeezed shorts must buy back shares at any price to cover their positions, but it can also go wildly wrong for the squeezers, especially latecomers, when the bottom falls out. This particular squeeze may have better PR branding and a populist narrative worthy of a Michael Lewis book, but market manipulation is as old as open markets.

In the end, it is just crowdsourced manipulation. That is the brilliant/sad part of this sordid situation: a few are making a mint while convincing average people to pay for it out of rage trading, ignorance, a sense of justice, or a fleeting feeling of owning the insiders — the Zeitgeist of the last four years played out now in the financial markets.

Does any of this matter for innovation?

First, fundamentals are fundamentals in the long run. GameStop will eventually return to appropriate valuations. Financial engineering of any nature is a short-term cocaine hit to the system, but the crash can debilitate you. You are the value you create for your customers. I urge entrepreneurs and those who value innovation to avoid hype and bubbles. Focus on sustainable, long-term value creation for your customers (and harvesting some of that value for yourself) coupled with revenue, margins, and profits as the keys to ultimate enterprise value.

Second, never let a good crisis go to waste (a quote attributed to so many). The Board of GameStop should have announced a solid registered secondary offering at these higher prices as a lifeline to pivot its business model to an online strategy, a la Netflix, to compete with Steam, Epic, and others. Perhaps can even parlay the scheme into a company that could actually generate excitement and justify its crazy valuation.

Third, zero sum games are antithetical to innovation, as they encourage blood sport ruination of others for fleeting gain, making value creation vulnerable to exploitative plays. The ability to create extraordinary wealth together aligns startups and their investors in ways that are rarely replicated in the public markets. Restricted private securities simply cannot be gamed by sophisticated rogues systematically (putting aside how some hedge funds strip companies of their assets, but that is not venture capital).

Fourth, disruption of tired business models and industries is usually a great business model, especially when rage against historical monopolies is highest. The taxi industry honestly had Uber coming to it. And the funds that shorted more than 100% of the GameStop market also had it coming to them (naked short selling is illegal, so how this happened is yet to be determined).

But what are you replacing the system with? Making the tools of easy trading widely available counts as a significant market disruption, but watching a mob burning down the house with themselves inside of it hardly sounds heroic. And if you think the mob is angry now, just wait until many lose their retirement savings.

Finally, the rules still apply, even to the crowd. There is a rich history of securities actions and sanctions for those who manipulate markets. Whether any of the manipulation can be proven or is legally actionable will be for time to tell, but I expect investigations and a few indictments before this story ends.

Some see what happened as progress. But it represents progress the same way Elizabeth Holmes and Theranos represent progress for gender equality. In the end, I mostly feel disdain for all parties involved in this dumpster fire.

Addendum January 31, 2021:

I have had a number of discussions since the original post regarding the second point, how this crisis could be used to promote the cause of innovation.

I️ would love to see GameStop find a way to raise serious capital and become highly valuable. I am not sure if GameStop has significant treasury stock it can sell or if has to do a registered offering, but with $2-3 billion, it could engage in significant internal development as well as invest in dozens of new startups businesses with innovative models. With a high market cap (and stable price…) it could also acquire a number of other gaming companies with successful models but without the capital to expand. GameStop could therefore become the preferred path to public liquidity for the best next-generation gaming companies, be they publishers, platform developers, equipment companies, or other technologies. Industry roll up strategies of this sort are fraught with risk, but upside is huge if GameStop can execute it.

Gaming is today a tough business, filled with inefficiencies and challenges to growth. If GameStop can build, buy, and invest, it could become the dominant player in a fractured space, as well as stimulate earlier round investing from other funds given that another viable exit strategy now exists for gaming companies. This outcome would be an awesome end to this saga. The best way to eviscerate the short sellers is to build real, sustainable value.

Addendum January 31, 2021:

I believe the most likely regulatory outcome will be limits on how short selling occurs, whether a cap of 30-50% of short positions or other restrictions. Short selling has a legitimate place in the pantheon of public market tools, but a 139.57% float sold short is absurd.

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