GameStop Top Glove Short Squeeze: Who is Right Who is Wrong

By now almost every news either online, daily or weekly, they would have mentioned something about GameStop. Personally, I have never heard of this company before prior to this. The thing about this event is that it created a movement where seemingly for once the small guys have gotten ahead of so called the bad guys - which is the Wall Street guys. 

If we look at the price chart below on GameStop - Never in my life I have seen stocks moving in this kind of trajectory over my 30 years of investing life. The thing about this story is that GameStop did not discover gold, oil or have gotten a cancer drug approved. It is a company actually suffering from the current behavioral challenges as gaming has now moved into online and homes from its traditional distribution channel.

The story about GameStop is pure adrenaline, power of social, smartness of some and ignorance of the new batch of retail investors combined. Adrenaline is because of the hate towards Wall Streets where the community had never liked Wall Streets and they wanted a way to get back. Obviously, it was further pushed by several social media evangelists. The funny thing is that people like Chamath Palihapitiya, Elon Musks themselves do not really belong to the Main Streets group but they did inspire these new investors to jump in. The new group who do not clearly understand the meaning of valuation and business and investments. They are just followers.

In Malaysia, a similar group albeit smaller is trying to create a similar movement through Reddit. They claimed that JP Morgan in the runup to short sell Top Glove starting on 2 Jan 21 had tried to downgrade the stocks valuing the company at a valuation of RM3.50 (at the time, Top Gloves were trading at around RM7.00) which was way lower than the price provided by other investment houses. On 2 Jan, when short selling were allowed (with much limited conditions), Top Glove's stock were sold down with the short selling playing a substantial part. The Reddit group under Bursabets initiated under a pseudo-name  Revenant claimed that the company was wrongly targeted as it wanted to short the stock.

After that rally call, Top Glove's stock had a runup by as much as 13% the following day. Both Bursa Malaysia and SC had asked the investment community to be cautious of social media chatrooms not long after that.

Now my question about all these is, who are in the wrong due to all these?

In the GameStop's situation, some guys saw a huge weakness in the shorting of the stock. It was shorted by 140%, obviously way over-shorted (by this actions, we see that by allowing the stock to be shorted way more than the stocks available, it is already wrong) - and the group that rallied the retail investors knew that by getting the community to come together, it can cause the shorts to get into trouble. There is no fundamentals in getting the stock to $400 a stock, but so is the over-shorting of the stock to 140%.

In Top Glove's case, yes we know that JP Morgan is a licensed advisor. It is allowed to provide a call even though the advise can be totally ridiculous? Then are they allowed to short sell the stock even after making a controversial call? (We do not know for real whether JP Morgan did the short selling, but we know that several foreign funds did short sell Top Glove and JP could have acted on their behalf)

Bursa and SC will not apprehend JP Morgan for sure. Now my question is, can Bursa and SC get all these so called licensed advisors to be fair. Can they get these guys to not pick when to release their analysis i.e. releasing to their clients first then only to the public? Can they get the investment houses to not be making any trading on the stocks which they make a call? One must know, in the social media world, the calls by these licensed advisors can be even more assertive and viral. 

Gloves makers: Dividends, buybacks and share dividends are the way to go

When I wrote my earlier piece (around April to May 2020) on the gloves, I think few sees what's coming. It was huge profits and prices but not even today's gloves price. Even during the early days some of the founders of the gloves makers were taking profits by selling some shares. (I remember Hartalega's Kuan and Kossan's Lim were selling (see below) some shares, and I do not think it was to mislead the market. Why would they?) Some of them bought back the shares later on.

Today, and until today the prices of the gloves (not stocks but actual gloves) have gone through the roofs - up to 5x its previous prices. Whether these prices are here to stay, I think the big 4 gloves makers are not able to provide a definitive answer. What is more than certain is this. Top Gloves is probably expected to make Net Profits of around RM12 billion to RM13 billion for its FYE 31 Aug 2021. Remember it used to make around RM400 million to RM600 million during a normal year. That was close to 100x its market cap today. Again, to highlight no Malaysian company has enjoyed before such profits in a single year except for Petronas the parent company.

It is hard to predict whether how fast it will become normal again. What is known is this. Gloves used to be a 3D (dirty, dangerous and difficult) business where Malaysian workers would not want to be into. Some of the quarters as shown are outright not livable. Malaysia has been using foreigners for the business. 

Today, because of the cashflows that they are generating the guys are doing it differently. They are investing huge amount on automation, improving living quarters etc. Those were not so possible in the past. Hence, these are the changes that we will see in the near future.

Despite having so much funds, it seems that the world because of the pandemic just do not produce enough gloves for consumption. For this period, it seems that it is hard to replicate the factories and move on to produce more just to meet demand. At the same time, the glove makers are generating so much cashflow - an amount they have not seen before.

Top Glove is expected to bring in net free cashflow of about RM10 billion in the next 12 months. These are funds they may not need in the near term. So what should they do about it. I know that people have been critical of them when in just a few days they have spend some RM220 million just to do buybacks.

I think given the funds that they have this is just what they should do. Glove makers do not need funds like the highway or O&G guys. All the gloves makers - large ones especially - should just do all the 3 - i.e. cash dividends, buybacks and share dividends or even cancelling out their shares.

They can be done variably. When they think the share price is cheap, do buybacks. When it is not so cheap, then as what Top Glove has announced, do a aggressive dividend disbursement. Imagine, if they make RM12 billion PAT, 70% is just RM8.4 billion. There is still so much funds as compared to the past for them to use it for operations.

I am not sure how long this kind of cashflow numbers will continue to be enjoyed but by doing the dividends and buybacks they are bringing the right value to its shareholders as well as cashflow into the system.