Games Workshop – just another product cycle?

I’ve discussed and developed various aspects of my strategy a lot since I started writing this blog in February. There are diminishing returns to tinkering with my strategy and at some point too much attention becomes a negative. I am relatively happy with it now and think I need to give it some time to do its thing.

So next year I plan to write relatively fewer strategy posts, but instead take some deeper looks at some of the shares in my portfolio and watchlist. I’m going to try and focus on the more high level, qualitative and idiosyncratic issues rather than simply what can be seen from the numbers.

The first issue I’m going to explore is Games Workshop: is the current growth sustainable or just another product cycle?

Firing on all cylinders

Games Workshop has grown to be my largest holding – it is currently over 15% of my portfolio and has become my most profitable investment ever (in absolute terms). I’ve explained my reasons for buying it previously here.

It has had an astounding run this year, with the share price near quadrupling. This hasn’t necessarily left it looking overvalued, as the increase has been supported by rapidly growing sales. Profits have al been growing at an even faster rate, due to operational gearing (most costs are fixed so increasing revenues also means increasing margins). These are shown below.



The increase in profits and revenues is the result of some successful restructuring of the business and particularly this year from some well-handled and very successful new product launches – in particular the launch of the 8th edition of Warhammer 40k.

Games Workshop is now on a forward PE ratio of about 18. It is much cheaper on this basis than a lot of other shares I own, even after its recent run. Surely this is not that expensive for a business firing on all cylinders?

The bear case

The bear case is that Games Workshop is cyclical – not in relation to a wider economic cycle but rather to the releases of its own new products. Once the excitement over its current new products has died down, Games Workshop may struggle to continue to grow or may even shrink from the temporarily high sales. Analysts are correspondingly predicting a decline in profits and revenues in 2019, as can be seen in the charts above. The possibility that profits will fluctuate in the future makes it hard to tell if the valuation is fair.

We’ve seen Games Workshop go through good and bad patches before. It boomed from 2001 on the back of a Lord of the Rings game, capitalising on popularity of the the film franchise. It then crashed again as interest in this game died down, compounding this with over-expansion.

You can see its history of boom and bust from its long term share price chart below. The current explosion in the share price really stands out!


The crucial question for me is whether something has changed that means Games Workshop can continue to deliver growth from this higher level.

Has something changed?

The horse’s mouth

There is not much in the way of reassurance that Games Workshop can continue to deliver sustainable growth in its annual reports. Tom Kirby, the outgoing Chairman, has often flagged the lack of consistent underlying growth as an inherent weakness of the business (while its profitability and a rock solid moat are its strengths). Games Workshop has been pretty coy about the growth coming from individual product launches. This is quite unlike most of the other businesses I follow, who spend a lot of their time talking about their growth prospects. Instead, the focus of the narrative Games Workshop puts forward has been much more on improving the operational side of the business and ensuring it is robust. This seems a sensible way for the business to be managed, but it doesn’t provide much indication one way or the other of whether further growth is likely from this point.

With fewer clues than I hoped for in Games Workshop’s annual reports, I’ve tried to have a more detailed look into the factors that might drive further growth (and trawled the internet for evidence of them). As a caveat, a lot of what I’ve written below is just conjecture – but even so I think there is value in thinking through the issues.

Changes to the operating model

The main way in which Games Workshop has sought to make its business model more robust is to only operate single-man stores and quickly close any that aren’t profitable. This restructuring has taken a few years and now seems to have increased profitability. It should also make Games Workshop more resilient to any downturn in trading. However, while greater operational resilience is definitely a positive for the long term holder, I’m also interested in the scope for continued growth in sales from this point.

Changes to the products

I’ve done a bit of digging online to try to find out whether there is something about the latest new products that is making them so successful. The main change appears to have been a fairly drastic simplification of the rules to its two cornerstone games (Warhammer 40k and Age of Sigmar). This seems to have gone down very well, according to most of the reviews I have read. I came across several reviews written by lapsed players, who are more willing to re-engage with ‘The Hobby’ now the rules are less fiddly.

It seems likely to me that the positive impact that improving the gameplay of The Hobby has on sales will endure for at least a few years. Greater playability should improve the overall immersiveness of the cornerstone games, benefiting future sales of models as well as current sales. Better gameplay may also be important for getting younger players interested in the first place, following which they may continue to collect models for many years to come. I’m not really sure exactly how long this will last, but I am encouraged that the product changes appear fairly fundamental rather than transitory.

Network effects and marketing

Another possible reason for optimism is that Games Workshop is likely to benefit from network effects – the more people playing the more attractive the game for everyone. Again, this may suggest that sales could continue to grow for some time.

I’ve discovered that Games Workshop has been making some fairly significant changes to its marketing strategy, as described enthusiastically in this video from the end of 2016. The changes in marketing may well be more significant in driving the recent boom in sales as the product changes described above. These marketing changes, including increased use of social media, should also mean the impact of network effects is greater. Well probably for a while…

I’m a little sceptical about how sustainable the impact will be as I think the addressable market has some limits. It doesn’t take a genius to work out that Warhammer appeals to quite a specific type of person. I’m someone geeky, male and interested in sci-fi and fantasy, so should fit the target market, but even I find it a bit too niche. I worry that there is limited scope for expanding the addressable market, as the kind of person that could get into Games Workshop is highly likely to already be aware of it.

IP licensing

Many investors seem to get quite excited about the prospects for Games Workshop to license its IP for films and video games. Might this generate the sustainable growth I’m looking for? The short answer is no. While royalty income is growing it is still a relatively small fraction of profits (about 20% in 2016/17). This proportion will shrink considerably this year, as most of the growth has come from the main part of the business: sales of models. While this may be an interesting additional growth driver for the future, it’s not really moving the dial very much at the moment.

What to do?

My musings above haven’t led me to a very clear conclusion. While the improvements to the products and marketing seem permanent rather than temporary, I’m sceptical that there are strong enough reasons to believe that growth will continue at anything like the current rate. This may mean that Games Workshop is overvalued relative to other opportunities out there. According to my Graham rule of thumb estimate, the current valuation implies average growth of around 7% over the next few years. This could be a bit optimistic, given analysts are projecting a 15% fall next year.

On the plus side, the current share price momentum is great and imminent earnings upgrades for next year seem highly likely – this suggests more rise in the share price is possible.

Overall, I think it is probably about time for me to take profits and bail from this position. I might give a bit of flexibility for the current momentum to continue, but I’ll be selling out if the price starts to show any signs of weakness.





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