2mm, Companies
Jan 9, 2012
Richard Beddard
12 Comments

Games Workshop in two minutes

A two minute monologue

What it does: model soldiers

Games Workshop designs, manufactures, wholesales and retails war gaming miniatures, scenarios, craft materials, books and magazines for its Warhammer, Warhammer 40,000 and Lord of the Rings games set in fantasy worlds.

Category: stalwart

Although profits collapsed twice in two decades, most recently in 2007 when the company made a loss, Games Workshop is capable of steady growth and high profitability, while distributing surplus cash to shareholders.

The recent crisis was self-inflicted as the company expanded aggressively incurring unwarranted costs. But it has recovered and in the last two years returned over 20% on equity in-line with the 10 year average. Recent half year results reported growth in sales, profits, and profitability for the war gaming business and a large royalty payment from THQ, which makes Space Marine, a video game set in the Warhammer 40,000 universe.  

More speculative aspects of the story include US expansion, more digital products, and more Lord of the Rings products to coincide with the release of The Hobbit film this year.

What needs to happen: cautious expansion

The company got into trouble using windfall profits from the Lord of the Rings game to open new hobby centres around the world, but many new customers were transient, attracted by the films. Now Games Workshop is expanding cautiously, focusing on increasing sales and profits in existing stores by giving customers what they want: a stream of novel miniatures at increasingly high levels of detail and intricacy and centres in which to play, model and learn. By nurturing committed gamers it’s growing by word of mouth (and facebook).

What could go wrong:

competition
There isn’t much. Rival role playing games put the player in the shoes of an individual not a whole army. Warhammer’s scale means the modelling component is much greater, with battlefields to be constructed and painted.

Video games continue to be touted as competition. They are probably as much an opportunity as a threat although I’m watching Skylanders with interest and a little trepidation as an example of how miniatures and figurines and video might cross-over.

management
Tom Kirby, who masterminded Games Workshop’s rise and fall, is still chairman although he has ceded the chief executive’s chair to Mark Wells. Kirby is guardian of ‘The Hobby’ and his self-flagellation in the annual reports indicates he has learned from the mid-2000’s. Wells also wears a hair shirt. Both men have big shareholdings and prefer to focus on the business than City analysts, which is a good omen for long-term shareholders.

company finances
The company has no debt and modest lease commitments. Shareholders’ equity is 59% of total assets, including leases.

other: Lord of the Rings license
The six year license was extended in February last year and Games Workshop is uniquely able to produce and market the game, so I see little risk of the license being removed.

valuation
The share price is the biggest risk. At 515p, the ten year earnings yield is about 7.5%. There is a danger investors are paying too much for a modest return,  but I expect Games Workshop to grow, so it remains in the Thrifty 30.

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More on Games Workshop.

12 Comments

  • Trident January 9, 2012 at 6:39 pm

    Happy new year Richard,

    I’d add two comments. Firstly, it’s declared dividends of 49p in the last 12 months and following the recent price surge that equates to a near 10% yield. And the dividend policy clearly marks the company’s working capital needs – making valuation a little easier and demonstrating management commitment to their shareholders.

    Secondly, on competition – I think this is one where it’s worth considering how a competitor can come in and take market share. Very, very difficult given the years spent building up the IP and customer loyalty. Operating in it’s niche there are growth limits but also a very deep moat.

    Reply
    • Richard Beddard January 9, 2012 at 7:08 pm

      Happy New Year Trident, and good to hear from you.

      I remember you are a fan.

      I’m wondering what you mean regarding the dividend (which is paid according to the company’s needs and not according to a schedule) making valuation easier?

      I like the idea of the, shall we call it, flexible dividend as I’m ambivalent towards dividends and agree companies should only pay them if they don’t require the money for profitable investment.

      I also agree its a prime candidate for having a sustainable competitive advantage (aka moat) though I’m always shy of claiming to have identified one. As Buffett himself says, you only get 10 in an investing career (and that’s a career like his)!

      Reply
      • Ed Croft January 11, 2012 at 2:12 pm

        Regarding Economic Moats. I know you’ve done plenty reading on the subject, but a really excellent primer for newbies is The Little Book that Builds Wealth by Pat Dorsey http://j.mp/AfyVCI – it is fantastically well written, short and concise.

        I have struggled to find UK small caps with exciting durable economic moats. One of the most outstanding models I discovered was explained to me in person by Jonathan Milner CEO of Abcam… Abcam has a tremendous business model that is only going to strengthen. Every antibody on the website is unique to Abcam, and as the number of antibody reviews for each grow, the antibody becomes more valuable. Their oldest antibodies in their catalogue are the most highly priced ! There’s an extraordinary correlation of price and age in their catalogue which is the complete inverse of most online retailers. Of course, many in the city know this and ABC is priced v. punchily accordingly – but that’s the growth/moat premium eh!

        Reply
        • Richard Beddard January 11, 2012 at 11:12 pm

          Thanks for the book suggestion Ed, I’ve added it to my wishlist…

          And please don’t remind me about Abcam. I looked at in 2008, spoke to the management, and still didn’t have the guts to back the business despite the even then punchy valuation: http://blog.iii.co.uk/explosive-growth-as-easy-as-abc/

          I could have been a hero!

          Reply
          • Ed Croft January 12, 2012 at 9:06 am

            Maybe still could? I remember Domino’s in 2004-05. It fell back to a PE of about 17-18 times if I remember correctly which was as low as it got. It then picked up serious institutional backing. Abcam is already heavily owned and highly prized (PE 25 or something), but if it did get down to those valuation levels again… which is either 2 years away at this price or 30% below this price today… I think it could be a real bargain. [I don't own but have watched it's amazing numbers and it's climb since 2007 before I really understood it]

        • Richard Beddard January 12, 2012 at 10:35 am

          Actually, it’s interesting what you say about price and age of antibodies in the Abcam catalogue. I didn’t know that. So their products just keep getting more valuable. It’s a great story.

          But it doesn’t really change things for me I think, and it’s why it’s so hard for me to invest in any high growth situation: I have no idea how big the market could grow.

          To get an understanding of the market sufficient to believe it can continue growing as rapidly as it has is the work of a sector specialist, whereas your average investing joe is a generalist.

          It’s just not the kind of analysis I do, because I just don’t have time to be expert at everything (anything!).

          Reply
  • Trident January 9, 2012 at 7:22 pm

    Hi Richard

    I didn’t know Buffett reckoned on identifying 10 moats in a lifetime – I know he advocated limiting yourself to 20 investments in a lifetime.

    What I meant about GW’s dividend policy of paying out surplus cash and being disciplined about it is that you then know what their working capital is and can work out the true ROCE. I don’t always believe that the balance sheet working capital is truly indicative of the company’s working capital requirement especially in seasonal businesses, it’s quite often what the company just ends up with at year end. GW is also looking to expand in the US and clearly is not looking to invest vast sums to do so (with a such a high paying dividend policy)which again puts a lid on the amount of risk and provides some clarity on valuation.

    I know Tom Kirby is a Buffett fan from reading earlier company reports.

    I like the 2 minute approach, and have adopted a similar approach myself in trying to write out on a single sheet of A4 the reasons for making an investment and then explaining it to someone who has no investment experience – it forces you into thinking about the key issues.

    Reply
    • Richard Beddard January 9, 2012 at 7:50 pm

      Not being a Buffetologist I don’t have the precise quote at hand but coincidentally I saw it alluded to in a report from Tweedy Browne dug up by Mark Carter. There’s a summary and a link on his site: http://alt-mcarter.blogspot.com/2012/01/great-10-year-record-great-future-right.html

      The report basically demonstrates that highly profitable companies rarely remain so and concludes, apologies for the long quote:

      “In recent years, Warren Buffett has said that you shouldn’t consider buying an interest in a
      business unless you are willing to own it for at least ten years. He and Charles Munger have also mentioned that the futures (and future growth) of very, very few businesses are predictable with certainty. As a corollary, they believe that the competitive landscape in ten years can only be predicted with certainty for a few businesses. They like a business that they can “understand”, and they don’t like a lot of change in a business. Warren Buffett and Charles Munger classify Coca-Cola as an “inevitable” that they believe is certain to grow. As a corollary, they must believe that Pepsi Cola, Cott, Virgin Cola and other competitors’ future actions and responses over the next ten years will not impair Coca-Cola’s future profitability or dent its 15%+ growth prospects, and that customers’ choices among many competing beverages will continue to favor Coca-Cola’s offerings. Similarly, in emphasizing the rareness of businesses that are “certain” to grow at 15%+ rates over a long period of time, Warren Buffett and Charles Munger describe having an opportunity ticket that may only be punched ten or fewer times in a lifetime. Because there are so few businesses that are certain to grow at high rates that are also available at an attractive price, Warren Buffett and Charles Munger believe that you should load up and concentrate your portfolio on that “opportunity of a lifetime” when you find it. How many businesses are you certain about ten years from now?”

      - I am very sceptical of my own ability to spot such companies but I would say Games Workshop is as close as I’ve come – hence I’m prepared to remain a holder even though the surge in the price has taken it well out of ‘obviously cheap’ territory.

      Glad you like the 2min approach. I see Expecting Value is going one stage further and adopting a 1 min approach! http://expectingvalue.com/shares/twelve-for-2012

      Reply
  • Ed Croft January 11, 2012 at 2:08 pm

    I think this is a very good addition to your investment process Richard. It’s so important to formulate a thesis for every trade before you invest, and it shouldn’t be done retroactively.

    The ‘What might go Wrong’ section reminded me of an excellent James Montier piece on Risk that he wrote when at Soc Gen which might help structure your template. He talks about three forms of risk, valuation risk, earnings risk and financial risk. http://designs.valueinvestorinsight.com/bonus/bonuscontent/docs/Risk_Montier.pdf

    We tried to contact Games Workshop for an interview last year when the stock was much cheaper – and they said “No we don’t do media” – its certainly a tick in the box for management imo.

    Reply
    • Richard Beddard January 11, 2012 at 11:19 pm

      Thanks for the link Ed, that paper by Montier is already part of my collection but I’ll re-read it again for sure. I too have tried to talk to Games Workshop’s management on the record for an article, and failed! Fortunately I find their store managers effusive!

      Reply
  • Ethereal May 9, 2012 at 10:16 am

    this is a great post
    i’m an avid hobbyist and a loyal customer of Games Workshop and preparing a business report as an assignment on GW. i find your assessments of their financial situation and history as well as market share assessment found in the comments to be incredible helpful.
    just liked to say thankyou :)

    Reply
    • Richard Beddard May 9, 2012 at 10:28 am

      Thanks Ethereal

      Reply

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