Even Before WallStreetBets, Shorting GameStop Didn't Make Sense

In this episode of MarketFoolery, host Chris Hill is joined by Motley Fool analyst Jim Gillies to talk about the latest stock market news. 3M (MMM 0.38%) wraps up the fiscal year with better-than-expected profits. Pepsi (PEP -0.50%) teams up with Beyond Meat (BYND -0.14%), sending shares of the latter up 20%. Jim analyzes those stories and discusses the escalating battle between retail investors and short-sellers over shares of GameStop (GME -19.73%).

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on January 26, 2021.

Chris Hill: It's Tuesday, January 26th. Welcome to MarketFoolery. I'm Chris Hill. With me today from the Great White North, it's Jim Gillies. Good to see you, my friend.

Jim Gillies: Good to be seen, Chris. Yeah, it really is a Great White North this morning. It's hard to see across the street from where I am.

Hill: We're going to talk about GameStop today. We have a new partnership we're going to discuss, but we are going to start with Minnesota Mining and Manufacturing, better known as 3M, which 3M is wrapping up the fiscal year in style, fourth-quarter profits came in higher than expected, shares were up 3%-4% today. Although, that makes shares of 3M flat for the past 12 months, and considering they make respirators and N95 masks, among other things, I thought they'd be doing better at this point.

Gillies: Well, so 3M, which is a long favorite company of mine, just to kind of stake where I sit, I don't own it presently unless you count via index funds. But 3M is more than just N95 masks, or other masks, or things that will have profited from COVID and the pandemic. They got something like 40 core technologies that they deploy into tens of thousands of products, so like, there's abrasives. One of my favorite examples is they have an adhesives division. You hear of adhesives. Well, that makes the sticky stuff on the back of the iconic post-it notes. That's a product of their adhesives technology division. But adhesives also produce certain products that are basically strong enough to meld parts to get it to go into aircraft structures. So, it's the same basic core technology, but two very different outcomes, and I'm always like, well, I hope they don't mix those two up. I don't really care if my post-it notes don't work terribly, but I do care if my aircraft parts stay together.

It was a perfectly acceptable quarter. Revenues up about 5%-6%, depending on how you want to measure it in terms of, do you take it in reported currency or do you break out in the local currencies, stuff that interest only financial walks, frankly. Did about $2 billion, just over $2 billion of free cash flow for the quarter, full-year, did about $6.7 billion in free cash flow, returned about $3.8 billion of that to you via dividends and share buybacks, which is a little lower than they've done historically, the buyback that is. But given the pandemic, I think it's prudent that they've husbanded some of that cash. They reduced their debt by about 7%, I believe, their net debt, so that's debt-less cash on hand, that got reduced by almost a quarter. They say, "Hey, we expect about 5%-8% sales growth next year, $9.20 and $9.70 in EPS. Right now, they're trading at about 20 times trailing EPS. This is a solid company, this is a solid report. They are the bluest of the blue-chips. They're just not going to make you rich, they're going to go up 5%-10% a year capital appreciation, and you'll get the dividend and if you like some bedrock stocks, widows and orphan style stocks, 3M is for you, buy it and put it away.

Hill: Real quick before we move on, you mentioned the guidance. It was a little bit higher than Wall Street analysts had penciled in for 2021, reasonable to expect that instead of being flat over the next 12 months, we can see some appreciation in 3M?

Gillies: I think so. Everything of course is contingent on how does the pandemic slake off or slop-out like, are we done? I mean, because where I am, we're back into lockdown that's similar to what we were last spring. Hopefully, this is the last gas, but hopefully the vaccine efforts do largely push the pandemic finally off the headlines. I don't know about you, but I'm enjoying my own day 310 of the 15 days that we were originally told this is going to take to flatten the curve. I think we're all done with this, and so if we truly are done, maybe as we head into the summer, then yeah, I think there's a lot of money looking for a home and a lot of people looking to do a lot of activities, and I think economic activity will follow the subsidence of the pandemic. So yeah, I think it's reasonable.

Hill: Shares of Beyond Meat up 20% this morning after the company announced a joint venture with Pepsi. Financial terms were not disclosed, but Pepsi and Beyond Meat are going to be teaming up to make plant-based snacks and drinks. That news was enough to make some short-sellers head for the exits.

Gillies: Maybe I'm dense, probably. No comments on the peanut gallery out there. But sugar is derived from...

Hill: Plants.

Gillies: Right. Corn chips are...

Hill: Also plants.

Gillies: Quaker oats come from...

Hill: I'm sensing a trend here.

Gillies: PepsiCo, in their snack line, there's not a lot of meat-based products there. I mean, the only one I could think of off the top of my head is they've got beef jerky line under the brand Matador. The diet purist will probably say, "Well, Jim, they're not looking for vegetarian -- we're not talking about meat, but we're talking about a vegan product." What is the market opportunity for, say, vegan-based Doritos? Frankly, PepsiCo already is plant-based. I have a teen boy living with me who's probably about 50% Doritos by weight. He's not looking for a vegan option. There's supposedly cheese, and buttermilk, and whey protein in your Doritos. I'm guessing that what Pepsi and Beyond Meat are going to try to do is push things in a vegan aim, which is good. I'm being a little snarky, but I think that the more you can take down some of the harmful aspects of animal-based husbandry and eating, it's good, on balance. Not everyone has to be a vegan or a vegetarian, but I think the less meat thing is good.

As I look at this deal, my read is, Pepsi is already plant-based, what my point was. But customers don't associate them with that. I look at this, I think it's a mutually beneficial deal. You've got Pepsi going, "We're getting the halo of the perception of Beyond Meat is greener or healthier." It's not, Fools. Beyond Burgers are basically a p-protein and a vegetable oil matrix. They're good, but this is not healthy food. But I think Pepsi is looking to get the halo effect of being perceived, as I've described, greener, healthier, plant-based. I think Beyond Meat is getting more distribution and contacts. Because I've held for a long time this plant-based space, there's not a lot new here. There's multiple choices for these next-generation vegetarian burgers that taste like meat. You've got Beyond, you've got Impossible, you've got Lightlife here in Canada. It's not patent protection or novelty that wins the day, it's the land grab in the grocery store. It's much like Coke and Pepsi. You go to your grocery store, you got Coke and Pepsi on the shelves, and then what? You're going to go to the grocery store, you got Beyond and Impossible on the stores, and then what? I think they both get something out of that here. Good for them. Again, I'm just not too sure of the market potential for vegan Doritos.

Hill: Neither am I. But you hit on one of the keys here, which is the distribution pipeline that Pepsi has. For all the times we've said on this show about Domino's, this is a tech company, it's all about the app. It's the same thing with Coca-Cola, and especially with Pepsi. These are distribution companies. I understand the short-sellers out there who have looked at this deal, even though financial terms are not disclosed, and saying, "Thank you very much. Check, please. I'm out." Because whatever you think of Pepsi, they have a lot of cash. [laughs]

Gillies: I like Pepsi actually. Again, Pepsi fits in the 3M category. They're a bedrock.

Hill: But in some ways, the fact that financial terms are not disclosed makes this even more ominous for anyone who's betting against Beyond Meat. Because Pepsi's got a lot of cash. As you said, do they need to do this deal? Need is probably too strong a word, but they are getting some benefits out of, as you said, the halo effect of Beyond Meat. I'm curious to see where this joint venture goes, but in terms of the short-sellers, again, I totally get why someone would say, "I'm done betting against Beyond Meat."

Gillies: It's not a great environment for short-sellers right now in general, which I think is going to dovetail nicely for the next topic.

Hill: I was going to say, speaking of short-sellers.

Gillies: Speaking of short-sellers. [laughs]

Hill: Let's talk about GameStop, because shares of GameStop at this point are up -- let's just ballpark 400% this year; not in the past year, in this calendar year, shares of GameStop are up 400% because we have this escalating war between, on one side, hedge funds that are shorting the stock, and on the other side, to some degree, maybe to a large degree, people from the Reddit group, WallStreetBets, who reportedly are going through the list that is widely available of the most shorted stocks on Wall Street, and saying, "We can make a quick buck here by driving this stock up." We've talked a couple of times on this show about the most recent results in terms of holiday sales for GameStop were good. They've got the founder of Chewy on the board. They've got some activists in there. Even if you didn't have this group in Reddit trying to run the stock up and make a short-term buck off of this, there's reason for optimism with GameStop, but you put it all together and you have one of the more entertaining things in the past year or so. I say this as someone who does not own GameStop. I have no plans to buy it. I have no plans to short it. I'm just sitting here with my bucket [laughs] of popcorn curious to see how all of this plays out.

Gillies: Once I said, before we started taping, as someone who is recommending this stock internally at $5, I feel very seen, very heard, I am greatly enjoying this, but that said, this thesis is now very different than the one that I was using to back-up my $5, $7, $9 thesis.

Hill: The thesis at $87 a share is different, you're saying?

Gillies: Slightly different, yes. Look, God bless the WallStreetBets crowd. This, as you say, it's been very entertaining. I'll even go back. GameStop was an idiotic short, and any of these funds who have shorted them, I question your analytical capabilities. I will put it out there. Because you had more cash than debt. You had a greatly misunderstood thesis. Andrew Left from Citron Research, I'll put the air quotes up there, came out and he tried to take it down before he ran away in less than 48 hours. Literally, Andrew Left, last week trotted out the tired old wrong argument that this was the next Blockbuster, proving that you never cracked open the filings for how bad Blockbuster was at the end. I did, it's not. I'll put that out there.

But these guys, they were short and there were more shares in shortage of GameStop than exist in GameStop, which is what's called 'Naked Shorting.' That's a dangerous position to be in. Let's say, rather than what's happened with the WallStreetBets crowd, although you're seeing this now. Let's say that GameStop was acquired by Ryan Cohen, and that's $30 when the stock was $5. How do all of the shorts close their position simultaneously if there are more shares short than actually exist? That would've been more entertaining than what we've actually seen, actually, [laughs] I think. But you know what? There's talk that certain hedge funds, Mellon Capital, were aggressively short a basket of the most shorted names out in the market, including GameStop. They've had to go get new money within the last 24 hours. Citron Research, as I said, got wailed on and gave up their nonsense in less than 48 hours. Good. Because frankly, I find the ethics of their business model dubious. But what this is at its core is what has come to be called colloquially as a 'Gamma squeeze.' I apologize in advance because we're going to have to walk down into the terrible angle of calculus and options math. I'm sorry.

Hill: Be gentle and make it quick.

Gillies: Gamma options have various [...] Greeks. Basically, it's how does the options price change with regards to a certain underlying thing? The first thing is called Delta. First derivative of an options price vis-a-vis the stock price, rate of change is what basically Delta is. Then Gamma is the second derivative or it's the first derivative of Delta. The long and short of it is, is that basically, you can provoke what's called the Gamma squeeze by buying near-term at or out of the money call options from a market maker. A market maker is not in the business of selling short calls on GameStop, which have unlimited loss on the downside. They are in the business of making a market, hence the name 'market-maker.' What they do is, they take the proceeds from you, because you bought the calls, you've given them money, and they go out and hedge that position. There's a concept called put-call parity. It's a little more complicated than this.

The basic just is they go and buy shares to offset that position. They're short to calls, they're long to stock. That amounts to buying pressure. If everyone en mass from Wall Street is buying calls on this thing en mass, then the market-makers en mass are buying stock which drives the price up and the shorts either get dragged along and start getting margin calls and have to get extra money, hi there Mellon Capital, or they're going to start closing their positions. But either way, you can spark a fairly short-term but fairly rapid rise in the stock price. The trick is going to be how much money does the WallStreetBets crowd have and how long do they think they're going to do this? Because at some point, the music will end and you don't want to be the guy standing up when the music ends in this game of musical chairs, because as fast as this has gone up, and I know the WallStreetBets crowd, going to praise you for what you've done, but this can work the other direction and if you guys are buying all these calls, GameStop at $150 a share, they're going to lose rapid value when this thing turns over. Have fun with the speculation, that's what it is. It's speculation, not investing, but it's been fun to watch, fun to see.

Hill: Last thing as you and I were chatting before we started recording. If you're making a quick buck off of this, that's great. Just remember, your tax rate will vary, [laughs] and by vary, I mean, people who invest for the long term pay lower taxes. People who make a quick buck on GameStop, that's great. Now, Uncle Sam would like the 35% cut, please.

Gillies: Yeah, the taxman cometh. Look, there are stories of certain people on WallStreetBets turning $50,000, $60,000 into eight figures.

Hill: I'm sure that's all true. I'm sure every one of those stories is true.

Gillies: The one I'm referencing actually has, they provide at least some snippets from their portfolio. God bless them, good for them. But yeah, just be aware, this can go the opposite direction. As long as you pay your taxes, enjoy the fruits of your, shall we say, aggressive bet.

Hill: Somewhere, Joey Roman is smiling. Jim Gillies, always good talking to you. Thanks for being here.

Gillies: Thank you.

Hill: As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of MarketFoolery. The show is mixed by Dan Boyd, I'm Chris Hill. Thanks for listening, we'll see you tomorrow.