The GameStop Board of Directors are Asleep at the Wheel.
The GameStop Board of Directors is Asleep at the Wheel.
The GameStop (NYSE: GME) stock saga was all the rage in recent days. From the war on hedge funds to everyone in the world talking gamma short squeeze and even some brokers restricting trades to avoid a potential liquidity crisis — this had everything. One thing is certain — this event captured the attention of the media, retail investors who cashed in and made it a personal vendetta against hedge funds, hedge funs that lost (and made billions), regulators, governors, academics, brokers, YouTube influencers, and more (even my Mom called and asked me about this!)
What caused this astronomical rise in share prices? Was it a short squeeze? The decentralization of the markets thanks to low-cost trading? It is hard to point to a single factor. One thing is certain — most are defining this situation as a critical event when it comes to the stock market — whether it be nonsense, crazy, nuclear, a rude awakening, or payback. And there is almost certain to be dire consequences for all stakeholders — GameStop included.
While the conversation of the world is ablaze with rhetoric, there is one party that is all silent — and almost a silence that is too unseemly. It is the GameStop board of directors. And while it is common and appropriate for companies not to comment on “unusual stock market activity”, it becomes a little more difficult to take that stance when there is complicit involvement in an event such as this.
A brief review of GameStop’s performance and history the past few years suggests the firm, its executives, and board of directors did not quite have their hands around the changing world or even the company’s ethical behavior — even before COVID-19 hit. Failed acquisitions and strategic exit attempts, compensation policies that resulted in misrepresentation to customers and stressful working conditions, and musical chairs in the C-Suite. Their poor execution drew the ire of investors, such as Michael Burry (best against the market prior to 2008) and Ryan Cohen (former CEO of Chewy), who were so agitated by GameStop’s problems, they jumped in the ring. And for these guys, in the words of Charlie Munger (Warren Buffet’s First Lieutenant), “it is not that “hard” to make money somewhere else with less irritation.”
The board of directors was already not stepping effectively to address these internal issues — and it is no surprise they were not taking proactive roles in addressing this situation before, during, and after. And it is a mess — it was before the rise of GME stock price to 300+, it was during the event, and it will be after.
The Board Showed Zero Interest in GameStop’s Short Interest
GameStop has about 70 million shares outstanding and in the winter of 2020, it was reported that close to 100% or even more than 100% of GME shares outstanding were sold short — meaning, investors betting against the company. I am not here to debate about the merits, morals, or place short selling has in our marketplace. There are various debates — the reality is, it is here, and it is not going anywhere — we can save that discussion for later. And this 100%+ short interest did not happen overnight — it was the buildup of years of activity.
At the end of the day, the goal for a CEO and a board of directors is to have a short interest of 0%. Why? That tells you that nobody has the desire to bet against the performance of the company or its share price. That is a good thing. And while impossible to achieve for many reasons, some firms are doing pretty well with it. For example, high-flyers (companies you think may be due for a fall) feature manageable short interest rates. Amazon and Facebook are less than 1%; even the hated Tesla is about 30% (which many would say is high).
While no board or CEO can put a gun to an investor’s head and say ‘do not press the execute short sell button ever,’ they can take a proactive stance in showing to investors they are not a good short candidate. How? First, by executing a sound strategy and growing the business (which can take some time). Second, by actively building relationships with investors and institutions (e.g., Elon’s anti-short tweet, incidentally, are an unconventional way to discourage short selling). Third, by fighting — which reverts to the first point and other board authorized activities, such as buying back stock.
The latter technique was urged heavily my Michael Burry in the middle of 2019 (of course, after Burry acquired his stake), but his rationale (apart from wanting to lift the value of his shares) was correct. Even more spectacular, there was not a single repurchase of shares throughout 2020 and there was an outstanding authorization to do so. GME did a decent job of buying back about 45 million shares prior to November 2019, but ceased all activity since then. Certainly, business concerns and the pandemic may have led to some hesitancy of continuing these repurchases, but the outright stoppage, especially as the business stabilized.
GameStop did none of this. Perhaps the only activity they did was to reduce the dividend in 2019 as a way to save cash. Great move, except did a move like this encourage further short selling? When an entity goes short on a company’s stock, one that pays dividends, that entity typically must pay borrowing fees and dividends paid by the company to the lending shareholder. For example, if you are short 100 shares (-100 shares) and the company pays a $1/share dividend, $100 will be deducted from your account to pay for that dividend. When GME cut the dividend, which perhaps it had to considering its declining business situation, it did not do anything to further discourage short selling.
The Board Looked the Other Way to Possible Naked Short Selling
There is also the issue of naked short selling. It is an illegal practice but absolutely happens and often is not enforced. However, is that an excuse to not monitor short interest in the best interest of your company. GME’s board of directors failed to act here in many ways. A fundamental rule (e.g., law) says that any shares sold short must be backed by actual shares — an actual shareholder willing to lend its shares to support the going short transaction. For example, if a company has 1,000 shares outstanding and someone wants to go short 1,500 shares, it cannot, by law, happen. Well, clearly it does — as shown by GME’s 100%+ short interest.
It should be nearly impossible to ever have a 100% short interest ratio. Some shares are outstanding or restricted; or held in certificate form in a safe deposit box; or mandated by the shareholder to not allow his or her shares to be available to support a short transaction. These items take shares out of the marketplace that can be matched to a short seller.
Monitoring the short interest and reporting violations to enforcement authorities (perhaps ultimately futile) or at least actively speaking out against it (a la Elon Musk) may not bring any arrests, but it may encourage a fund or investor to close our or not further support a short position. Other items, which I do not have the answer to, include, does the board have a policy that prohibits directors and officers from making their shares available to sell short? Even if shares are held electronically at a broker or bought on the open market, the shareholder can put in a request to the broker to disallow these shares to be used as short collateral. It makes sense to have a policy like this anyway — since the person lending the shares in a short transaction will earn fees (e.g., borrowing, dividends) — and officers and directors should be prohibited from profiting from an activity that is done at the expense of the organization they represent (we may have some self-dealing coming up here).
Having a depressed stock price makes it more difficult to raise capital, acquire companies with stock, or even pay out shares as compensation to officers and employees without suffering undue dilution.
If investors want to go short against a company, that is their prerogative. However, it is the board’s responsibility to discourage this activity as much as possible. GameStop’s board was silent on these matters and took little if any, proactive measures to discourage investors from building a short position in the company that exceeded the number of shares outstanding.
Where is the Capital Raise? The Board Remains Silent.
There comes a time when a company needs to or should raise capital to support its future growth. GameStop has been granted a gift due to this short squeeze — and there has been a failure to execute to capitalize and continue to fight another day. As the stock started to rise (even to levels it had not seen in many years), the board should have been ready to authorize a share issuance to raise capital to support a potential turnaround effort. A 1% at the market offering could add another $250 million of cash to the balance sheet; a 5% at the market offering could add enough cash to retire all the company’s long-term debt.
Other companies, such as many vaccine companies, have quickly capitalized on rising stock prices to secure cash to ensure survival and growth. Momentum investors dislike stock offerings because they add supply to the marketplace, slowing down appreciation, but overall when done right, are an important part of supporting growth — which is ultimately rewarding to all stakeholders. For example, in October 2020, DraftKings announced a $1.6 billion stock offering — and the shares subsequently corrected by about 20%. However, the company has since recovered its market value and now is armed with additional cash to support growth. While there is no guarantee, for example, DraftKings will thrive with this added capital, it is clear the board and management had a strategy and were prepared to execute on a timely capital raise. This is clearly not the case with GME.
Perhaps a stock offering is coming soon — and GME wants to see where the dust settles. However, no action has been taken thus far. Once again showing GME board of directors may be asleep at the wheel. The company’s stock price is multiples higher than it ever has been — and there is resistance to raising cash at these prices? The company was awfully quick to cut dividends and stop buying back shares to preserve cash. And now, a non-dilutive financing opportunity arises, and the action so far is to do nothing?
A stock offering would be extremely responsible right now at these levels — especially since the company repurchased 35 million shares the past couple of years. One of the most long-term shareholder and stakeholder friendly things GME could do right now is to execute an offering. And nothing has transpired.
Fear of lawsuits? Perhaps GME knows its shares are severely overvalued and does not wish to sell stock at prices it knows or believes are artificially high? Great stance but taking care of shareholders has not really been on GME’s mind the past few years. And lawsuits — they are coming anyway — even without a stock offering. It is going to be a lot easier to try to turnaround a struggling business with some added cash on the balance sheet — especially if the company will be fighting lawsuits (even if they are without merit).
Lastly, the failure to raise capital suggests complicity and acceptance of the volatility GME stock is experiencing. Long term investors dislike volatility — traders do not. Injecting the market with additional shares will not unwind the challenge entirely, but it will slow the tide and add some stability to the marketplace activity.
Prepare for New Ownership & Distractions
Another outcome of the GME situation is the transfer of ownership to new shareholders. We have seen many institutional funds dispose of their shares and with hefty profits. GME is now in the hands of new ownership. Ryan Cohen owns more than 10% and he seems excited to take on the challenge of helping GME transform. Where is the other 88%? Most of it is not in the hands of its former owners any longer — and some may argue that many holders exist among the Reddit WallStreetBets (WSB) group.
This has significant challenges for GME going forward. There is a benefit to building long-lasting relationships with shareholders. If GME had any conversations with its existing investors amidst this action, it did little to discourage the selling of the company’s stock. Of course, funds and investors are allowed and entitled to take profits — and they should. However, the illustration of many funds liquidating their entire stakes shows that GME has done little to convince these investors that there are better days ahead — and that the rise of stock price reflects the transformation GME is going to undergo.
These days, it is difficult enough for struggling brick and mortar retailers to transform and thrive going forward — although it is possible (e.g., Wal-Mart and Nordstrom are on the right path, perhaps? Let’s see what their boards are up to!). However, it is going to be more difficult for a board to oversee and navigate a strategic turnaround while being faced with investigations, lawsuits, and building relationships with a new set of shareholders.
It is not fair to say that the GME board of directors wanted these outcomes — or even forecasted them as possibilities (although, maybe they should have — some investors saw the potential turnaround and short squeeze some time ago). And these concerns were made public — both from some small retail investors and more visible investors — on multiple occasions. And amidst GME’s 2020 market value rise from $200 million to $22 billion, the board remains silent without taking any efforts to communicate a turnaround strategy or face the realities of the past, present, and future status of the company. This is not a great place for a board to allow a company to get to.
The GameStop Board of Directors are Asleep at the Wheel. was originally published in Terence Channon on Medium, where people are continuing the conversation by highlighting and responding to this story.