The First Casualty Of The Big Short Squeeze: Melvin Capital Gets $2.75BN Bailout From Citadel, Point72 After Its Shorts Explode

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by Tyler Durden
Monday, Jan 25, 2021 - 09:45 PM

With dozens of heavily shorted (by hedge funds) stocks exploding higher in recent days, it was only a matter of time before the first casualty of said bull raid emerged, and thanks to the WSJ we now have the first name.

Melvin Capital, which we learned last week had suffered massive losses on its shorts, is set to receive a $2.75 billion capital injection from hedge fund giants Citadel and Point72 and investors (in what appears to be a bailout so Mevlin Capital founder Gabe Plotkin, a former star portfolio manager for Steven Cohen, could pay his margin call). The bailout loan investments are for non-controlling revenue shares in the hedge fund, although it wasn't immediately clear how much of Melvin's revenue the two funds would get.

Melvin Capital's Gabe Plotkin

According to the WSJ, the influx of cash is expected to help stabilize Melvin, which lost a staggering 30% in just the first three weeks of 2021. While Melvin started the year with $12.5 billion, and had been one of the best performing hedge funds on Wall Street in recent years, it saw huge losses (and margin calls) as a result of numerous short bets against companies and have stunned clients and other traders.

In other words, 16-year-old Robinhood traders 1 - "star" hedge fund portfolio manager 0. In yet other words, hedge funds are now bailing out other hedge funds (in which they have invested money), who have been steamrolled by the Robinhood Gen-Z "buy everything" juggernaut.

The $2.75 bailout is effectively a rights offering for Citadel and SAC, as they had more than $1 billion invested in Melvin as of 2019. Melvin founder Gabe Plotkin was a top portfolio manager at Point72’s predecessor firm, SAC Capital Management, before he left to start Melvin.

An interesting question here is how it is legal that Citadel, which buys the bulk of retail orderflow and is intimately aware of which institution will get crushed as a result of historic short squeeze bull raids, is also allowed to bailed out its investment in Melvin, which got hammered precisely because of said orderflow. The answer, sadly, is beyond our pay grade.

As the WSJ reported last week, "Melvin is known for running an expansive and aggressive short book that has sometimes made up the bulk of the fund’s gains, an uncommon dynamic in the industry. The firm has returned an average 30% a year since it started in 2014, despite charging performance fees that range up to 30% on investment gains."

The gains came to a jarring end once teenage traders realized that with the Fed at their back, they could steamroll any bearish hedge fund in their way.

Not surprisingly, one stock that crushed Melvin is GameStop. We all know what happened there. Some of the recent Reddit posts on Gamespot specifically call out Melvin, which disclosed in its most recent quarterly regulatory filing that it held put options on GameStop. Put options are contracts that give investors the right to sell stock at a specific price by a certain date and limit an investor’s potential losses (the WSJ cites a person familiar with Melvin who said its GameStop puts expired last week).

In recent days, Plotkin had been calling clients with chief operating officer David Kurd to inform them of and explain the losses thus far. One client said Melvin’s message was that the fund still liked its portfolio and that it had rebounded from past losses.

We wonder if he feels the same way just days later, and if he will boldly go back to shorting the same stocks that nearly put it out of business.

Finally, since this is merely the start, we remind readers of the post we published in November, when we laid out the Top 50 shorts by the hedge fund community...

... when we said that "our advice is to go long the most hated names and short the most popular ones - a strategy that has generated alpha without fail for the past 7 years, ever since we first recommended it back in 2013."