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Were the Short-Sellers Right About GameStop and AMC After All?

By Rich Duprey - Feb 6, 2021 at 9:18AM

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Just because hedge funds got greedy doesn't make their view of these companies wrong.

Now, as the mania surrounding GameStop (GME -4.79%), AMC Entertainment (AMC 3.48%), and other volatile stocks subsides, can we finally agree that despite everything, the short-sellers really weren't wrong?

While the hedge funds were greedy in their mad rush to capitalize on the expected declines of these troubled stocks, their opinion of the long-term prospects for these companies wasn't far from the mark.

Golden bull and bear on stock tables

Image source: Getty Images.

Right ... but still wrong

The stock-buying rally that saw GameStop rise over 1600% and AMC 500% was certainly a fun ride, as seemingly small retail investors banded together to give the short-sellers a run for their money.

While it has been characterized as a populist market uprising and a David-versus-Goliath situation where hedge funds lost billions of dollars in the debacle, the feeding frenzy was never about protecting beloved, unfairly targeted companies. Rather, it was all about making money, just as the hedge funds originally tried to do.

Both GameStop and AMC Entertainment are in dire straits not wholly as a result of mismanagement, but they made enough mistakes that the global COVID-19 pandemic was able to further expose existing fault lines.

The boost their shares received from short-term tailwinds -- the console upgrade cycle for GameStop and new rounds of cash infusions for AMC -- meant there was a good chance their stock prices would eventually resume their decline as they still had to confront unresolved long-term challenges. Betting on that outcome by shorting the stock was a smart financial play. It was just that the hedge funds went overboard and overplayed their hand.

Especially in GameStop's case, they shorted 140% of the retailer's float (the amount of stock available to trade). The Reddit investors merely sprung a trap that the hedge funds had set for themselves.

The case for a decline

Yet the short-sellers were right about GameStop. While it's currently riding the wave of the upgrade cycle in gaming consoles, its future is still murky -- doubtful even -- after the initial fervor around the next-gen consoles from Microsoft and Sony fades.

As has been well documented, the migration of gaming to digital downloads and in-game transactions poses the question of what GameStop's business will be in the future. What will consumers buy from the retailer a few years from now? Even as its collectibles business has done surprisingly well, that's not what investors are looking for in the stock, and it doesn't hint at being a growth business.

AMC has its own woes as well. It kept warning it was on the brink of bankruptcy if it couldn't raise enough money, and that was only to keep the lights on through 2021. If movie studios continue to prioritize their streaming services over movie theaters when it comes to new releases, the cinema owner may need to think about how it will raise more cash in 2022 and beyond.

Having taken on an enormous debt load in its bid to consolidate the industry under its broad umbrella, even as theater attendance was largely in a secular decline, AMC was setting itself up for financial trouble. The coronavirus merely exacerbated it.

Not stepping foot inside

Data analytics firm analyzed foot-traffic patterns at both GameStop and AMC and showed that consumers were visiting their stores and theaters less often even, well before the pandemic struck.

In 2019, GameStop saw monthly average foot traffic drop 3% year over year, while it was down more than 8% at AMC. The lockdowns and stay-at-home orders wiped out traffic even further, dropping monthly averages 28% for GameStop and 72% for AMC in 2020.

Yet even as the stores and theaters have reopened (albeit under strict capacity limitations and with social-distancing requirements in place), the situation hasn't improved. While AMC can be excused perhaps because there are no new major films to show yet in theaters, GameStop is still experiencing significant declines in customer visits.

Over the last three weeks of December and the first three weeks of January, data shows the video game retailer is still seeing double-digit average declines.

Chart showing GameStop foot traffic Dec-Jan

Chart source:

A ray of hope after all?

Ethan Chernofsky of points to the growth of e-sports as a potential way to revive GameStop's business, while the transition to a luxury theater experience that AMC began before the pandemic could be what it needs.

Chernofsky said, "Both AMC and GameStop are facing significant challenges to reaching their fullest offline potential. Yet, both have opportunities in front of them that could lead to very successful futures."

Unfortunately, those challenges include the ability to purchase any video game and console online, and the option to watch new blockbuster films from Netflix, Walt Disney, or Warner Bros. on their respective streaming services instead of going to the theater.

So while Reddit traders were able to punish hedge funds for betting the house against GameStop and AMC Entertainment, the short-sellers were right: Without dramatic changes to their business models, both companies face a bleak future.

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Stocks Mentioned

GameStop Corp. Stock Quote
GameStop Corp.
$135.21 (-4.79%) $-6.81
AMC Entertainment Holdings, Inc. Stock Quote
AMC Entertainment Holdings, Inc.
$12.47 (3.48%) $0.42
Netflix, Inc. Stock Quote
Netflix, Inc.
$190.85 (5.03%) $9.14
The Walt Disney Company Stock Quote
The Walt Disney Company
$97.78 (3.69%) $3.48
Microsoft Corporation Stock Quote
Microsoft Corporation
$267.70 (3.42%) $8.84
Sony Corporation Stock Quote
Sony Corporation
$85.64 (2.26%) $1.89

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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