GameStop's Final Blow to the Short Sellers

So as we've been following over the last couple of months, Gamestop shares have literally been flying all over the place in the aftermath of the Reddit-fueled short squeeze that happened at the end of January. Over the past couple of months, myself and Hamish over on the podcast have been joking, wouldn't it be funny if Gamestop just came out and did a massive capital raise? Well, now it actually looks like they are going to do that. So in this video, we're talking capital raises and whether this big fat capital raise by Gamestop is actually a smart idea. Let's get started.

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Now, a capital raise is simply where a company wants to, you know, raise some fresh money, but they don't want to take on a big fat loan in the process. So what they do is they magically create some shares out of thin air and they sell them to new investors. They add the shares onto the pile and then they've profited from the sale. Typically, what you see is that companies will do this; they will raise capital when they need the money to fund some sort of big growth project.

But the thing is, there are good times and bad times to do a capital raise because, in the process of the capital raise, you are diluting your pre-existing shareholders. So pre-existing shareholders get pretty cranky in the process because say you owned one share, and that equaled one percent ownership in the company. Then the company goes out and it capital raises, adds another 20 shares into the mix; well, the same pie is now being cut into more slices. So that one share that you hold as a pre-existing shareholder is now only worth 0.83 of the company.

So pre-existing shareholders lose out in a capital raise. But the management team can still be nice about it because what the management team is really trying to do with the capital raise is they want to raise a certain amount of money. Okay? So they have to sell a certain number of shares at around about the current stock price in order to raise that specific amount of money. But if the management team can sell these new shares when the stock price is really high, then they get the most bang for their buck and they also don't annoy their pre-existing shareholders as much because they are able to effectively sell fewer shares; so less dilution to raise the same amount of money.

And that's exactly what Gamestop has done because, despite the sharp short squeeze of January, you know, being over, the share price of Gamestop is still feeling the after effects of that short squeeze. The share price is currently 187, which is up 908 percent year-to-date. So because this external war between Redditors and short sellers has raged and has driven the stock price up so high, Gamestop management are now using that to their advantage, and they're going to sell a whole bunch of shares at this inflated stock price.

So they've decided to raise 1 billion dollars, and according to CNBC, the company said it intends to use the proceeds to further accelerate its e-commerce transformation as well as for general corporate purposes and further strengthening of its balance sheet. I find this quite funny because the reasons for the capital raise are the reasons that all of those short sellers were ganging up on this stock in the first place, because their balance sheet was weakening, and the short sellers did not believe they had a strong enough competitive position in the e-commerce space to survive.

And that's why I find this situation so comical because it's probably those big short sellers that were betting against the company that are actually going to be the reason that the company is going to thrive into the future. Because if you think about it, it was those that heavily shorted the stock that enabled the short squeeze to happen, which drove the stock price up like crazy and has now enabled Gamestop to raise a billion dollars fairly cheaply to literally claw themselves out of the hole that they were digging.

Now, I just hope that the money that is being raised does get put to use effectively and actually does solve some of the problems that the business is facing because remember, as a shareholder, you don't really like capital raises. That is unless the long-term outcome of that capital raise more than pays for the fact that you got diluted in the process. Because as a shareholder, generally speaking, you should actually be quite cautious of companies that raise capital, you know, for general corporate purposes or balance sheet strengthening purposes.

Because generally, what's happening in that case is the company is using the shareholders to, you know, raise money so that they can plug a hole in their business, but they're not actually focusing that money on addressing the root cause of their problems. And if the root problem is left unfixed, then you can bet your bottom dollar that it's only going to be a matter of time until, you guessed it, the company shows up with another capital raise for general corporate and balance sheet strengthening purposes.

So in Gamestop's case, their number one problem is that they need to transition their business model to an e-commerce business model. They need to get their physical retail stores online as video games switch completely digital in the future. So as a Gamestop shareholder, you would absolutely hope that most of the money this capital raise is actually going to funding that transition.

But with all that said, in the case of Gamestop, I actually wouldn't be too worried about this raising money for, you know, general corporate balance sheet strengthening, you know, reasons. I wouldn't be worried unless they showed up and did a future capital raise saying the exact same thing. Because the reason that I think that is because there's a saying that companies should raise capital when they can, not when they must.

And with a company like Gamestop, where you're seeing just extreme volatility in their share price, if you're sitting there as a CEO of Gamestop and you think that at some point in the not too distant future, you might need a fair chunk of money in order to do something, I would still very much prefer for them to take their opportunity to raise money right now when the volatility has jumped the share price up very high, than waiting until they absolutely need to raise that money for that future project.

Because at some point in the future, you know, Gamestop's share price—what was it, like 180 or somewhere around there—might be 150 dollars, or it might be 100 dollars, or 50 dollars, or 20 dollars. Because don't forget that, you know, towards the start of the year, not three months ago, that's what Gamestop's share price was at: 20. So if Gamestop needed that cash at some point in the not too distant future, you would definitely much prefer for them to raise that money now; less dilution, share price highest, raise a whole bunch of money without diluting your pre-existing shareholders, than actually just wait and wait until the time comes where you really need that money right now where the share price may not be as high as it is today.

And there's a perfect example of this that happened last year, and that is Carnival Cruises. Now, their business obviously suffered heavily due to the lockdown, which forced them to raise 500 million dollars of new stock, alongside billions of dollars of new debt. However, in this instance, Carnival Cruisers got completely caught out because they raised that 500 million of new stock after the share price had crashed 83 percent.

So have a think about this, I've written this down: to raise 500 million dollars at a share price of 51.90, which is where it was before the lockdown, that takes just 9.6 million shares. But to raise 500 million at the share price where it was after the lockdown at 8.49, it takes 58.9 million shares. So that's the difference between raising money when you can versus raising money when you must.

And that's the reason why, if I was a shareholder of Gamestop, I wouldn't be overly concerned about them raising money right now, even if they say it's for general corporate blah blah blah balance sheet purposes. The only reason I'd be worried is if they showed up again in a couple of months and did the same thing and said the same reason, and then another couple of months they showed up, did the same thing for the same reason. That's when I would get worried.

But overall, that is the lowdown on the one billion dollar capital raise that Gamestop wants to do. Overall, I think it's pretty smart because the share price is just so extremely high versus where it was like three months ago. You definitely want to take advantage of it. We've seen companies like Tesla—Tesla did this as well when their share price went up like 10x; they took advantage and raised a whole bunch of money.

So it's not uncommon. I think it's probably smart to do it right now, and I hope that they do use that money effectively to really transform their business because they've effectively been given a lifeline. Their business was dying; that's why it was so heavily shorted. So if now the short squeeze allows them to raise money, which they can spend that money on transforming their business for the future, it could be a fantastic, crazy turnaround story where the short sellers have effectively helped the business thrive in the long term.

So anyway, guys, that is it for today's video. I hope you enjoyed it. Leave a like on the video if you did or if you found it useful, and of course, subscribe to the channel if you'd like to see similar content to this. Check out my own business if you would be interested in supporting the channel. I don't do donations or anything like that; I don't really believe in kind of getting money for free. So I've made a couple of in-depth investing courses for passive investing and active investing, and if you'd like to support the channel and support my efforts here on YouTube, feel free to have a look at those courses. Links are down in the description below; that will take you over to Profitful.

But that will do me for today, guys. Thank you very much for watching the video, and I'll see you guys in the next one.

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