Ken Griffin on Unfettered Conversations with A and Z

The content here is for informational purposes only, should not be taken as legal, business, tax, or investment advice, or be used to evaluate any investment or security, and is not directed at any investors or potential investors in any a16z fund. For more details, please see a16z.com/disclosures.

So let's start with GameStop, because GameStop was a little while ago, so I'm going to just do it quick. There's a little blurb here on Wikipedia. And I'll just start by saying I don't represent—by no means do I represent what's on Wikipedia as the truth, but rather just sort of as an expression of kind of the gestalt of the commentary, especially around that time, and just to kind of refresh people who haven't kind of fuzzed out on the details. So January 25th, it was announced that Griffin's Citadel would invest $2 billion into Melvin Capital, which was the hedge fund that had suffered losses more than 30% on its short positions, particularly on GameStop. On January 28th, Robinhood, an electronic trading platform favored by many traders involved in buying GameStop stocks and options, which, by the way, my firm's involved in, abruptly announced that it would halt all purchases of GameStop securities except to cover shorts and would only allow those securities to be sold if already held, but not sold short.

So, in other words, Robinhood cut off basically the ability for the retail traders who were torturing GameStop and Melvin Capital at the time from being able to trade. The price of GameStop stock declined steeply shortly thereafter. Because Robinhood receives a substantial portion of its revenue through a payment-for-order-flow relationship with Citadel Securities LLC, many commentators criticize the potential for a conflict of interest where the same entity plays the role of market maker and also participates in the market that it makes—and, of course, in this case, also was a major investor in the hedge fund on the other side of the GameStop situation. So, you know, just more generally, I would love to hear, and I know everybody would, you know, kind of from your perspective, like, what happened?

Like, what is the true story of what happened during that period?

So, in broad strokes, Melvin Capital was short a variety of stocks that became of interest to rather savvy and sophisticated retail investors who realized that the amount of stock short was just disproportionately large relative to average daily trading. And these retail investors, realizing that there were these unduly sized short positions in the marketplace, started to buy these stocks, that caused the hedge funds that were short these stocks to start to incur losses. And when firms are losing money, they almost reflexively start to cut their own risk. So, in this case, they start to cover their shorts, and you end up in this reflexive pattern that as retail buys the stock, pushing it higher, the hedge funds that are short are covering their shorts, pushing the same stock price higher.

And this vicious circle becomes incredibly painful for the hedge fund managers that are short the securities of interest. And we saw this playing out in the marketplace. And on the day that we invested in Melvin, we thought that this had run its course. In fact, it was very clear on the morning of the day that we made the investment that this short squeeze was apparently dying down. And we invested money into Melvin to take advantage of the fact that a number of their shorts had become very inflated in price, and we expected those prices to revert in due course, and we'd have made a successful investment. At that moment, the world changed. We had the social media landscape with some very important influencers really lit up on the story of GameStop as being a stock to get long and to ride to the moon.

Melvin continued to cover their short very aggressively over probably the next 48 hours, give or take. I can't remember the exact timing of this. Now, ironically, I'm almost certain that Melvin had covered their entire short before the 28th. In fact, they put out a press release. The press release would give the exact timing of it. I don't recall that off the top of my head. But I'm pretty certain that by the time that Robinhood stopped trading on the 28th, Melvin had already covered their short and moved on. And basically just taking the losses would be the way to think about that, right? Yeah, they'd taken their loss and they moved on. I mean, part of what good risk managers do is when they're wrong and they can't understand what's taking place in the marketplace, they take it on the chin, they take their loss, and they move on.

Now, Robinhood had a distinctly different problem than Melvin had. They had a problem of too much success. Robinhood had opened accounts with millions of retail investors and who, seeing this price dynamic playing out in GameStop, seeing some of the really important influencers in financial markets advocating the purchase of GameStop, we saw an absolute deluge of retail buyers of GameStop, unlike anything, I think, the markets have ever seen before. The problem that's created for Robinhood is this very concentrated position of buying required them to post good faith margin with the clearinghouse that everybody on Wall Street uses. And I believe that that good faith collateral requirement was order of magnitude $3 billion of cash.

And Robinhood simply didn't have $3 billion of shareholders' equity to draw on to post that margin. And so because of their incredible success, they needed to restrict trading at that very moment in time where I'm certain they would have wanted to continue to trade, to gather the revenues associated with trading, but they couldn't because they had to let some of those purchases work their way through the settlement cycle to release the demands for cash collateral. And of course, as you know, Robinhood was out trying to raise capital at that moment in time to generate more cash to give them the flexibility to make the margin calls that they had to make.

There's a couple of claims that went viral around that time that I think probably are still circulating around. This idea that on the one hand, you've got this relationship with Melvin Capital, where you're now a big investor. On the other hand, you've got this relationship with Robinhood, where they get a lot of their revenue for payment for order flow through your market maker. There's this perception developed that you're sitting in the middle of this web and kind of pulling strings, and then there's this kind of shadowy consortium or whatever they call it in the background, and they're issuing this overnight demand for money, and that's presumably somehow rigged up by Wall Street. So what was your reaction to kind of finding yourself in the spotlight on that kind of thing, and how do you kind of process through trying to explain to people what the reality of the situation was?

Well, I have to say that processing conspiracy theories is not one of our core competencies. So we were a bit slow out of the gate to dispute this, this ridiculous set of claims, just given like, we don't find ourselves in the middle of conspiracy theories very often. So as a, as a large market maker, in fact, the largest market maker in the market in late January, in GameStop, in AMC, in the other meme stocks, we were very interested in seeing the continuation of trading, both buys and sells. One-way flow is a really difficult proposition for a market maker. So if people keep selling you stock, you keep accumulating inventory, what are you going to do? You make your money as a market maker from the bid-ask spread of buying and selling, getting into and out of a security over the course of a day.

So we, as a market maker, We're the largest market maker in this period in late January because of our operational capacity to take on the operational risk and capital demands that were inherent in this incredible increase in participation by retail investors. So in contrast to Robinhood, we had the financial strength to meet our collateral calls. We had the operational bandwidth to meet the demands of the marketplace on our business. And then with respect to Melvin, their shortened GameStop was, to the best of my knowledge, already gone or virtually gone. It wasn't even in our minds on the day of the 28th. So the fact that people made that connection ex post was certainly not a connection that I'd made a prior.

So you weren't sitting there thinking, 'We have to optimize the value of this investment we just made in Melvin Capital?' No. And then two things that are just something I knew intellectually, but didn't realize kind of emotionally or viscerally until I saw it happen, which is: if you are short a stock, if you're a fund and you're short a stock, you cannot—and, Ken, correct me if this is wrong—you can't close out that short without delivering that stock. Which is to say, like, I can't, if I'm short and I offer you $100 to close out the position, $500 to close the position, $1,000 to close the position, $10,000 to close out the position, I can't close out the position without the actual share of stock because basically there's, in theory, potentially unlimited downside if the stock keeps rising.

Is that technically true? For 99.99% of situations, of which this was one of that 99.99, you had to buy the actual shares back if you were short and trying to cover your short. So for all intents and purposes, one should view if somebody's short a stock, they're going to have to one day buy those shares back in the marketplace as a regular way trade.

You know, sometimes professionals over the years, I've seen people willing to settle a short for cash in lieu, but that's almost always the context of things like tender offers for a company. Okay. So if a company's being bought for cash, let's call it, you know, General Electric's going to buy a company, they're going to pay $24 a share. Once the tender closes, if you were short that stock, you're—since the tender's closed, the company's been bought, you can, under those circumstances, settle your liability for cash. Yeah, but what you're describing is a particular kind of bounded situation with presumably minimal risk. Yes, the shares are gone, the company's been bought, and how do you wrap up that contractual situation amongst the parties?

But if there's unlimited potential future downside, you can't get a counterparty who will settle you out for anything short of the actual stock.

One of the challenges you have as a short seller is your risk is unbounded. That's why when people are constructing portfolios of longs and shorts, their short positions tend to be much smaller than their long positions on a relative basis because the risk on the short side is unbounded in comparison to the risk on the long-side positions.

And then that leads to the second thing, which is the GameStop stock price. You know, we're sitting here now, what, almost a year later, and it's still—the market cap—the stock price is still $179 a share, which is, you know, is up 1,000% from a year ago. And the market cap of the company is almost $14 billion. And if you just look, if you look at the chart, it's not quite, you know, it's not at the all-time high that it got during the truly crazy period, but like, it's not that far off. It kind of peaked out at over $300 and it's still at $179. It certainly hasn't fallen back to where it started. The suggestion I think that that price might be telling us is there are still funds out there that are short that haven't been able to buy back.

And the Reddit horde is still torturing them. Or maybe the company is, by the way, much better, is the other possibility. But are you surprised that that stock has held up? Because I think a lot of the commentary at the time was obviously this thing is going back to near zero.

Well, I think it's an incredibly complicated situation. First of all, the management team of the company did a great job of buying back its own stock ballpark two years ago at much, much lower prices. The company bet on its own future and bought back a fair number of shares. I think it was the single digits per share back roughly two years ago. And that's in rough strokes. I'm not a GameStop expert per se. But my memory serves me right. That's what they did about two years ago. And then there's been the rise of a significant new investor, the founder of Chewy. And he has an incredible reputation as being an entrepreneur and really understanding how to connect with the consumer in a profound way in an e-commerce environment.

And if somebody is going to figure out how to turn GameStop into a successful e-commerce-based platform, he's high on the list of people to do it. That's the question. Can they pivot from a huge footprint of stores around the world with a relatively high cost of distribution to an e-commerce-led company with a broader mandate that's able to engage the consumer in a profoundly different way? And the market price today reflects people's views on that very same question. The current short position in the stock is actually quite trivial compared to what it was just a year and change ago. Virtually all the short players are long since gone from this name. They've given up trying to understand how to price GameStop with the founder of Chewy at the helm.

If you look at, by the way, if you look at the five-year chart, it looks, pardon the metaphor, it literally looks like a corpse that suddenly came back to life. It's just this flatline for like four years. And then there's this crazy spike, you know, during the Reddit drama. And then there's this kind of choppy, but like fundamentally, as you said, kind of, you know, this kind of new normal, at least for the last like whatever, nine months. Yeah.

The question here is I play my Xbox. I just got Call of Duty: Vanguard. I downloaded it. I didn't walk into a store.

Well, I mean, that was the presumption prior to the Reddit guys figuring out the short situation, right? That was the presumption, right?

That was the presumption. The presumption was the world was going to go to digital downloads so fast that GameStop would not be able to change its cost structure quickly enough to adapt to that brave new world, and they were going to meet the same fate as Blockbuster. And so the question is, will the management team at GameStop find ways to connect with the consumer that are different than what they were doing three or four years ago that create value for consumers for which they get paid to do?

Well, the reason I brought this up, the five-year chart, it goes to the point you made. I just want to explore one more level, which is this is a situation, like you can tell a very different story here. And the story basically is they had this, you know, they were in trouble. Then they had this exogenous event caused by, you know, the mechanics of the stock market. And then to your point, they have seized, in the best-case scenario, they've seized on the exogenous event to now construct a better future for themselves.

Oh, no doubt. No doubt. And they raised a tremendous amount of capital to create a war chest that gives them the flexibility to pursue a variety of different business strategies.

And so it's like speculation creating reality, like potentially in a really positive way.

So that, well, the markets will judge that in retrospect. Were the people that bought GameStop stock from the company over the course of the last year brilliant or not? And we'll find out based upon the success, the failures or success, the merits of where GameStop takes their business. By the way, that's what makes America's capital markets work. Differences of opinion drive our capital markets. Just remember, a few months ago, Hertz was left for dead in the middle of the pandemic. They were in bankruptcy, and they went to raise money in the stock market, and the SEC said, 'You can't do an offering, you're bankrupt,' right? And now Hertz is this incredible success story. So I think we all have some level of humility about our ability to forecast how any given company is going to progress, prosper, or fail.

Well, I think that's one of the great things here is that it turns out retail is very smart. Sometimes it's called retail 'dumb money,' but actually—and I mean, smart on Tesla, smart, paradoxically, on something like Hertz, which was bankrupt, and potentially smart on many of these others. One of my favorite things is if you Google 'Apple IPO Massachusetts,' there's an article in The Wall Street Journal about how the state of Massachusetts, to protect the general public, banned their participation in the Apple IPO, which is, of course, now the biggest company in the entire world. So it turns out sometimes retail investors are smart. And I would argue that right now it's a better time to be a retail investor than ever before.

I think it's always important to remember that a number of your retail investors, they're intrinsically optimists. And when they see a great product and a company run by an inspired CEO, they're willing to put their money on that. They're willing to believe in the future of America. They're willing to believe in the Tesla story.

Okay, look, I would love to keep going. We could go for hours on this, but we're coming close again to the end of your time. So I wanted to also, I wanted to ask you about the other thing you've been in the headlines for recently in our world, as well as more generally, which is your purchase of the US Constitution and your competition—your just very narrow, I think, trouncing, but your trouncing of the ConstitutionDAO Web3 project that got a lot of attention, a consortium of Web3 crypto people that were trying to buy the same Constitution. So maybe tell us a little bit about that. How did that go down from your perspective?

I actually saw it several weeks before the auction. And it's one of those moments I walked out of Sotheby's and told a friend, I'm like, 'I'm going to buy that.' Because to own such an important part of the history of America and really just the profound wisdom of the words transcribed on that paper by the thought leaders of our nation, that was truly important to me. And then nothing like seeing the ConstitutionDAO raise just a mind-blowing amount of money in a few days in front of the auction. What a statement about community. I mean, I am blown away by the passion of the community to come together to share this document with our country. And just as I will share this document with our country, I was really impressed to see so many Americans willing to put up money to make that happen as a reality.

And so, the night of the auction, what I've learned over the years in auctions: simply, the person willing to pay the most wins. There's no grandeur in being the winner at the auction. You're just willing to pay more. I was fortunate enough to have the financial resources to acquire the Constitution. And as you're well aware, I've already committed to lending it to Crystal Bridges, where it will be shared with, hopefully over the next few years, millions of Americans. And Crystal Bridges is a really special place. It touches the Midwest in a profound way. It touches the South in a profound way. A huge number of the people that go to Crystal Bridges have never set foot into an art or history museum before in their lives.

And to really share the American vision with so many people, I hope, is an inspiration to our youth about the greatness of our country, about the greatness of our Founding Fathers. And we didn't get everything right, but we changed the world and will inspire people to pursue both public service and to pursue how can they make America better. That's fantastic. That's great.

So I can't think of a better way to end the conversation, and we're right at six. So, Ken, I want to thank you for your time and for getting into these exciting topics with us. And we really enjoyed having you.

What a pleasure. Great to be with both of you tonight. And thank you, everybody in the audience, for joining us, and we will be back soon.