Games Workshop – An Investment Fantasy

Games Workshop (GW) is the largest investment (20%) within my portfolio as it is the cheapest and simplest idea that I can find. When GW ownership was first acquired in April 2018, I only committed 5% of total investment funds because I did not fully appreciate GW’s outstanding business quality. Despite the share price increasing from GBP 22.75 to GBP 61 since then, I further increased the investment in GW as my understanding and conviction in the business developed positively. I may be a slow learner, but it is better to be late than never.

GW is the UK-based creator of Warhammer Hobby which makes fantasy miniatures set in endless, imaginary worlds called Warhammer Universe. The Warhammer Hobby involves painting and collecting Warhammer miniatures with rich backstories developed over 500+ Warhammer novels in the last two decades. Fans can form armies with the miniatures to participate in the tabletop wargaming with the rules developed by GW. All miniatures are designed and manufactured in the company’s headquarter in Nottingham. The story writers collaborate with miniature designers and game makers to weave new characters, games and stories seamlessly together. GW generates revenue through the sales of miniature and the royalty income from licensing its intellectual properties (IP) for PC and mobile games.

I think of Warhammer fan base in three categories – Collectors, Gamers and IP fans. The Collectors preoccupy themselves with collecting and painting miniatures because of their design and beauty. The Gamers are passionate about the wargames and strategically acquire miniatures based on their roles and powers in the game. IP fans, fascinated by the Warhammer Universe, mostly enjoy the Warhammer novels. In reality, the fans have one main preference but also participate in other aspects of the hobby in varying degrees. Interestingly, the Collectors make up for 30-40% of GW’s revenue.

While not everyone is a natural fan of the Warhammer, those who carry the Hobby Gene have an innate tendency to become a fan. This love affair between fans and GW was under trial during the period from 2010 to 2015. Under the leadership of previous Games Workshop management, the company had minimal communication with the fan community, shun social medial (because they did not want to deal with criticism from the fans), closed down popular product lines and increased prices excessively to offset a shrinking fan base. During this 5-year period from 2010 to 2015, the revenue shrunk from GBP 126.5m to GBP 119.1m while the net profit declined from GBP 15.1m to GBP 12.3m.

Just when it seems like GW is set on an inevitable slow decline, Kevin Roundtree took over as the new CEO of Games Workshop in 2016. The first thing he did was to reconnect with the Warhammer fan base through the Internet. Then, he reintroduced the popular Warhammer games that fans loved. Most importantly, he makes it easier for fans to get into the hobby by offering lower price point starter sets and simplified the game rules. The fans are elated and came back into the hobby in droves. One fan even commented that “it is like Games Workshop was taken over by someone who actually knows about sales and marketing in the twenty-first century.” Its revenue doubled to GBP 256.6m while its net profit jumped five-fold from GBP 12.3m in 2015 to GBP 65.8m in 2019. This is a testament of the fans’ loyalty towards Warhammer. Few companies can not only keep their customers after years of mistreatment but also win them back with one big gesture.

So why are fans so loyal to Warhammer? Warhammer has a differentiated customer experience that few can match – beautifully designed miniatures with great details, a strong physical network of players, and cleverly crafted fantasy worlds that fans can immerse themselves into. Even as fans complained about GW during 2010 – 2015, they acknowledged GW’s miniature as best in the industry. GW has the unique competence to mass-produce high-quality miniatures in a cost-effective manner because it has years of accumulated manufacturing know-how and the scale to internalise its entire manufacturing process. As the largest fantasy miniature producer, they can cover the fixed cost of investing in customised tools and mouldings. The design team can work closely together with the manufacturing team to push the limits on manufacturing the next best miniatures.

Gamers are going to play the games that have a decent chance of finding another Gamer to play against in the local community; thus it is critical to have a minimum player population size locally. Hence, GW uses its fleet of 500+ physical retail stores to provide physical space for local fans to meet and recruit new blood into local Warhammer communities. Local Warhammer clubs are formed as the fan base grew. It took GW over 30 years to build this physical network of Gamers globally which new competitors will find it hard to replicate.

Put in another way, GW’s moat lies in its physical social network of Gamers. Warhammer – the game – is the equivalent of Facebook – the digital platform – that binds these players together. Each new player joining Warhammer strengthens the social network because it increases the existing players’ probability of finding a good game quickly. Physical social networks are of course inferior to virtual social networks because 1) Gamers cannot have a game whenever and wherever they want, 2) Gamers’ social relationships are not digitalised and hence not accessible to GW, and 3) Gamers’ interactions cannot be stored in a useful format. Nonetheless, the physical social network is still a powerful moat for the business.

Finally, GW’s IP elevates Warhammer above other board games and tabletop games. Most board / tabletop games are hit-driven businesses where new gameplays are easily copied by competitors. Unlike most board / tabletop games, Warhammer fans immerse themselves in the narratives as they collect and play the miniatures. It is a common scene to see Warhammers fans tries re-enact plots from the narratives through the games. Ask any Warhammer fan what they like most about their favourite miniatures, and the reasons usually are the characters’ personalities and their struggles and victories in the narratives. The progress in the narratives will introduce new characters which then is made into new miniatures. The stories give meanings to the lifeless miniatures and emotional bonds are formed when fans project themselves into the characters. This emotional bond with Warhammer drives repeat purchase. Or in the modern business parlance, Warhammer fans have high lifetime value. This strategy is common among other successful media franchises such as Pokémon and Star Wars.

I believe GW’s moat is likely to grow stronger with its unique corporate culture and first-rate management team. GW’s culture is formed by employees who are themselves biggest fans of Warhammer and they come to work here because they love what they do. GW also has a very strong creative culture where people have the creative freedom to try new things. After spending two decades at GW, Kevin, the CEO, is the right steward of company culture. I have come to know him better over the last year. He cares deeply about Games Workshop and he understands the full potential of Warhammer IP. Kevin set up a new media business unit to bring the Warhammer IP into mainstream media. If this is done successfully, the acquisition cost of new fans is going to decrease significantly. One of the biggest investment risks is Kevin’s departure due to some unforeseen reasons.

I value GW in two parts – core earnings from the sale of miniatures and royalty income from IP licensing. Through acquiring new fans and growing spend by existing fans, GW can grow its core earnings by 10-15% annually. I do not need to know precisely the size of the total market to believe that GW has a very long growth runway ahead. Another popular card game called Magic the Gathering has ~ USD 500m in revenue double that of Games Workshop’s revenue. GW has a sizable fan base in China but negligible revenue. I think China can be at least as big as the US which is GBP 100+m (50% of total revenue). On the royalty income side, GW is significantly underearning relative to the strength of its Warhammer IP. It is currently generating GBP 11.4m which is only 5% of its miniature sales. The top media franchises, such as Pokemon and Dragon Ball, make the majority of their income from licensing rather than merchandise sales. Despite paying a hefty multiple of 24x 2020 earnings, I believe we are getting a fantastic bargain because this is a very high-quality franchise with strong growth prospects, under-appreciated IP monetisation potential and strong corporate culture that reinforces its moat with time.