Pembridgecap

A Wealth Creation Journal

Live Portfolio Update – 2021 – #3 (Tencent)

Buy Tencent as a 8% position @ HKD 645 per share.

Tencent is a company that I have actually spent the most time researching for the past 3 years because of work. While I cannot invest it in personally due to compliance reasons, I want to include it in the portfolio here.

Expect a full blog on Tencent soon!

Games Workshop – 1H 2021 Results Update

What a joy to it is to be a business owner of Games Workshop!

Despite the closure of retail stores, GW reported excellent 1H 2021 results with revenue up 26% and gross margin expanding to 75% on the back of the higher volume. Net income reached an all-time high of GBP 73.9m and net margin improved from 39.5% to 49%.

The margin expansion has driven by operating leverage.

GW CEO, Kevin, reported that “operating profit – pre-royalties receivable – both value (up £35 million to £83 million) and profit to sales ratio (up 12% to 45%) have improved in the period. Our high margins are delivering incremental profit compared to last year at 91% (2019: 55%).

91% incremental margin!

In the long run, the margin should shrink a little as they reinvest into their business especially as they have so many avenues of investment to drive future growth. It is not reasonable to expect GW’s margin to expand at its current rate, and I would rather them aggressively reinvest back into its core businesses.

China got a special mention from Kevin:

“An extended range of core products have now been certified for China Compulsory Certification (CCC) and have been available in the country. With Space Marines proving to be more popular than ever, we have enjoyed success in stocking and selling selected complementary licensed products within our own sales channels, key amongst which have been some action figures. These are also stocked in mass-market locations, helping us with brand awareness. We are expanding our translation team to ensure our customers in China and other overseas countries can enjoy the official Warhammer experience.”

I have been in close contact with the Chinese Warhammer community and translation quality is atrociously bad! I have no doubt that when they finally fix their China operations, it will provide the next leg of revenue growth. China is a huge market and I know Warhammer IP appeals to Chinese fans as much as it does in the UK and US.

A slight disappointment is to see the royalty income decline from GBP 10.7m to GBP 8.7m. But royalty income is going to be chunky. With the Warhammer IP is going from strength to strength (TV series, animation and comic), it would ultimately be reflected in the royalty income at some point. Not to mention a strong pipeline of Warhammer game in 2021 and going forward.

In the long run, GW’s intrinsic value is driven by 1) the number of fans and 2) revenue per fan.

GW is a vertically integrated entertainment franchise that has historically monetised through miniatures. In the last few years, it expanded its fan base through better marketing on social media and better product campaign. Going forward, it is also exploring new ways to grow fan base through TV series, animation and comic. Not only is the fan base growing, it is also increasingly able to sell its fans more products such as mobile games.

So we are seeing both the fan base and revenue per fan growing for GW. In the next few years, this will prove to be a very potent combination!

Investment action: Adding 1% @ current market price

Jet2 (previously Dart Group) – a mistake of inaction!

After evaluating the financial resulting ending Sep 2020, it seems clear that I was probably being too conservative for not adding to Jet2 during the period of time where they raised new equity and sold logistics business. At that point, the risk of ruin is extremely remote and I have always believed in the normalised earnings of GBP 150m which means I could easily justify a market cap of GBP 1.5bn.

So I could have made a purchase around GBP 1bn market knowing full well that the risk of ruin is minimal. But I didn’t. And I don’t really have any good justification. So this is a mistake of inaction.

However, we are where we are now at a market cap of GBP 2bn. What to do next?

Jet2’s lack of a long growth runway concerns me quite a bit as it already commands a 40-50% market share within the UK’s package holiday sector. Hence Jet2 is unlikely to be a multi-bagger from here. But it could grow its market share to 60-70% as it comes out of this pandemic. I estimate its package holiday business could grow to 5 million customers within the next 3-5 years up from its current 3.2 million customers (pre-pandemic).

On the pricing side, I continue to be worried about ticket pricing due to a glut of plane capacity. But Jet2’s route network overlap with the major airlines is minimal and expect to shrink coming out this pandemic as Ryanair and easyJet retreat from the regional airports.

Finally, Jet2 gained incredible customer goodwill which could improve the sustainability of its franchise.

So on balance, it is a better business now versus 9 months ago. It is set to recover in 2021 and beyond.

I think I am in a better position to take advantage of any price correction now!

Nintendo entering the Cloud Gaming era

I played Control on Nintendo Switch today and it felt surprisingly good. Control was first released on PS4 and was previously thought impossible to port to the lower-powered Switch. But game streaming technology makes it possible.

The unique thing about a cloud game is that it requires an Internet connection to play and the gamer doesn’t own the game outright. Similar to the way that Spotify subscription users don’t own the music on Spotify.

Currently, Nintendo is working with a third-party company – Ubitus, a Taiwan cloud technology company to provide the cloud gaming solution. This is very different to Playstation and Xbox which both have gone down the path of developing their 1P cloud solution.

This could be a good thing for Nintendo as it allows Switch players to access AAA games which were previously unavailable on Switch. I wonder if the next Switch upgrade will come with 5G and introduce the possibilities of cloud gaming anywhere!

On the other hand, it also revealed the weakness in Nintendo’s cloud gaming strategy. They need to develop a proper company-wide strategy to adapt to the gaming era. I suspect at some point, they need to decide if they want to develop a cloud solution for Switch platform. The risk with a third party solution is that gamers would lose access to Control if Ubitus for whatever reason decide not to stream it any more.

With Xbox fully embracing the clouding game and cross-device future, the competitive pressure is heating up. It is possible that 5G smartphones + streaming could commoditise Switch’s superior gaming experience.

My next research project is to closely follow the technological evolution of cloud gaming.

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