The hedge fund that had been short-selling the stock of video game retailer GameStop for years and which saw massive losses during last year’s Reddit-based small-investor frenzy around the retailer’s shares will be liquidated, The New York Times reported Wednesday.
Gabe Plotkin, the man behind Melvin Capital, wrote to his investors that he had concluded the “appropriate next step” was to liquidate the hedge fund’s assets and said he was going to “step away from managing external capital.”
Plotkin became public enemy No. 1 during a populist small-investor uprising last year that saw amateur stock-buyers turn Melvin Capital’s dubious investment strategy into rubble.
(Here at The Western Journal, we chronicled the GameStop saga — and what it meant for both small investors, Wall Street and Washington bureaucrats who wished to limit trading on so-called “meme stocks.” We’ll continue to press for individual freedom in matters of finance. You can help us by subscribing.)
Melvin Capital had long bet that familiar brick-and-mortar outlets like GameStop would see tanking stock prices as their market share dwindled due to e-commerce, streaming and downloading. In fact, Plotkin told Congress the hedge fund had been short-selling GameStop stock since 2014 under the belief that downloads would make the retailer’s business model obsolete, The Wall Street Journal reported.
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Short-selling is when an investor borrows shares from another investor, then turns around and sells them, betting that the stock price will go lower. If it does, the short-seller makes a profit when it returns them to the initial investor. If it doesn’t, the short-seller is out the difference.
However, short-selling GameStop was a risky bet because, as Forbes noted last February, short positions on the retailer’s stock stood at a whopping 140 percent of shares available for trade-in January of 2021.
Analysts from Goldman Sachs found that short positions on a company’s stock issue have only exceeded 100 percent 15 times in 10 years. That made those with significant short positions in the company exceedingly vulnerable if the price rose.
It did, and how. Propelled by users on Reddit’s “wallstreetbets” subgroup — some who believed the company’s stock had been driven too low, some who were engaged in what Axios referred to as “nostalgia trading” and some who simply wanted to stick it to Wall Street once they learned of institutional investors’ extensive short positions in the shares — GameStop shares hit a high of $347.51 on Jan. 27, 2021.
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According to CNBC, that put the stock’s gains in that month alone at 685 percent; GameStop shares had been worth merely $6 four months prior to the rally.
Therein lies the other risk with short-selling: The potential for losses is unlimited. At worst, an investor who buys a stock “long” — as in, expecting it to appreciate — can lose 100 percent of their original investment if it goes to $0. However, while unusual, a short position can see losses well over 100 percent should the stock double in price. Even if it doesn’t, losses can still mount, particularly due to the costs involved with maintaining a short position.
In Melvin Capital’s case, it started 2021 with $12 billion and lost 53 percent of that in the first month of last year alone, necessitating huge cash infusions from lenders and investors.
It wasn’t only the GameStop short squeeze that put an end to Melvin Capital.
While Plotkin had managed to redeem the fund’s performance in 2021 somewhat, according to Bloomberg — only reporting a 39 percent loss for the year — it was down more than 23 percent through April of this year.
However, The New York Times reported last February that GameStop’s short-sellers lost an estimated $13 billion during the trading frenzy.
Putting Melvin Capital out of business isn’t exactly going to fix the institutional problems of Wall Street, but it serves as a cautionary tale.
At one level, short-selling a stock for seven years running, as Melvin Capital did, represents a dangerous move. Even if Plotkin believed downloads were going to surpass brick-and-mortar sales of video games and that physical retail was on its way out, short sales are costly and are intended to be well-timed investments, not a long-term investment strategy — particularly if 140 percent of available shares are being short-sold.
However, institutional capital is too often bailed out by the government when it makes poor investment choices, especially after the 2008 financial crisis. The damage from the GameStop stock rally was too limited and its targets too unpopular for this, however.
There’s also the fact institutional short-selling can be used to batter a company’s stock for the benefit of a select group of millionaire and billionaire hedge-fund investors. This is what was happening with GameStop, a brand which carries significant nostalgia cachet for millennials. Lo and behold, these were the Davids in this tale, slinging their rocks at the Goliaths on Wall Street.
At least one of those Goliaths has fallen, even if it took a little while.
