Games Workshop Analysis

Big profits from miniature figures

Metrics (as of September 21)

• Market Cap = £3.64 billion

• EV = £3.51 bil

• FCF = £102 mil

• Price / Sales = 11.05

• P/FCF = 35.69

• FCF Yield = 2.8%

• Debt / Equity = 23.94%

• EBIT = £152 mil

• EV/EBIT = 23.09

Introduction 

Games Workshop is a stock that is somewhat paradoxical. Games Workshop and Warhammer are largely viewed as a geeky, slightly embarrassing hobby. However, Games Workshop as a stock, is one of the hottest, most loved equities on Fintwit by UK investors. 

I purchased my first Warhammer paint set back in the early 2000s. Unfortunately, it was only a pre-teen fad that I quickly moved on from. 

As a stock, I initially looked at Games Workshop back in 2017, with a price of £16, but considered it too expensive. Ever since, I have looked longingly in from the outside as the share price has increased sevenfold to highs of £120. 

The Business

Games Workshop manufactures Warhammer, Warhammer 40,000 and licenses Lord of the Rings / Hobbit miniature figurines. Customers paint the figurines which are then used in wargames. 

Games Workshop has built a community around devoted hobbyists. The unique worlds and stories that they have created has ensured they have developed an almost impenetrable moat. 

Although headquartered in the UK, 70% of sales come from abroad. With over 500 international retail shops and a further 4,000 stockists, Games Workshop is a truly global business. Games Workshop retains control over every aspect of design, manufacture and distribution of our models and rulebooks.

History 

Founded in 1975 by John Peake, Ian Livingstone, and Steve Jackson, Games Workshop originally started out as a manufacturer of wooden board games and importer of 

They went on to develop a chain of games shops. In 1981 Games Workshop helped to found Citadel Miniatures Limited, a manufacturer of metal miniatures based in Nottinghamshire. 

The company later moved closer to Nottingham and began to develop and expand, producing a wealth of miniatures, kits and books under the Games Workshop name.

In 1991 Tom Kirby undertook a management buyout and floated the company on the LSE in 1994. 

Management 

The management ethos at Games Workshop appears to be ‘under promise and over deliver’. 

The CEO, Kevin Rountree, became the company’s CFO in 2008 and the CEO in 2015. With a company turnaround manifesting in 2017, Mr Rountree appears to be the driving force behind the last several years of growth. Under Kevin’s watch the share priced has grown from £5 to over £120.  Aged only 51, it’s likely he will be around for many years to come. 

One management red flag is Kevin’s Ownership/Compensation ratio of 0.79. Since 2018 he has sold a cumulative £1.23m of shares. The entire board only own a paltry 0.0595% of the company. This is a red flag, despite their excellent stewardship. 

Notwithstanding their small ownership, the board looks after their staff. This year the board rewarded 2,600 ordinary workers with a £10.6m special bonus on top of a £2.6m profit share, to reward their hard work during the pandemic. This £5,000 pandemic bonus per employee was more than notable employee windfalls from Microsoft, Facebook or Walmart. 

Not All Revenue Is Created Equal

Look at those margins! They are ridiculous for a bricks and mortar business that sells physical goods. Games Workshop is not a software business, but the profit margins almost make it appear so. 

Games Workshop’s gross margins have averaged 70%, whilst operating profits have averaged 30%, in the past 5 years. The mark-up comes from the fact they are selling resin and moulds that dedicated customers are willing to pay a premium for. 

Licensing and Opportunities 

In 2021, 12% of operating profits came from royalties, with no associated costs, this goes straight to the bottom line. The business owns a wealth of IP. In a world where NFT’s and the Metaverse appear to be two of the most popular phrases on Fintwit, there’s no doubt Warhammer can tap into these opportunities. 

On the 25th of August, Games Workshop launched Warhammer+, with a cost of £4.99 per month. Warhammer+ is an attempt to tap into low cost, recurring revenue whilst continuing to grow and engage their fanbase. Warhammer+ offers some of the following :-

• Warhammer animations and hobby shows

• Access to digital vault of Warhammer publications and White Dwarf issues

• A free exclusive Citadel miniature worth £25 every year

At £4.99 per month Warhammer+ is a pay-and-forget monthly cost for diehard fans, tying together the physical and digital aspects to the Games Workshop model. Warhammer+ has introduced two initial animated series, Hammer and Bolter and Angels of Death along with game commentary plus Citadel Color Painting Masterclass

Early feedback has highlighted that Warhammer+ is laser focused on diehards but will not necessarily appeal to new fans. However, it’s important to remember how the likes of Disney+, with a multi-billion dollar budget, was poorly received when it launched. Warhammer+ is in its infancy. It’s one revenue stream to watch that could take Games Workshop’s revenue and fanbase to new levels, if done right. 

2022 also brings with it one big reason to be optimistic, the release of Amazon Prime’s Lord of the Rings series. Amazon Prime has spent a whopping $495 million (the highest ever) to produce the new LotR TV series. With such an exorbitant budget, it’s possible this series could introduce a new generation to the world of Tolkein, and in turn the Games Workshop tie in. Based on the series success, I am confident it won’t be long before we see new heroes and villains introduced in miniature format. 

Bull Case 

1. Wealth of IP -  further unlocking of IP. A Warhammer TV series has been reported for a number of years, with the Eisenhorn apparently still in production. Is a Warhammer theme park too far of a reach? 

2. Growth in revenue through recurring, high margin streams, particularly from Warhammer+. 

3. Launch of Amazon Prime Lord of the Rings creates a new generation of fans. 

Bear Case 

1. Stagnation of revenues. - Prior to 2017 Games Workshop’s revenue was flatlining, even decreasing. 2019-20 revenue growth was only 5%. However, this improved considerably to 30%, as customers found themselves stuck at home in the midst of a global pandemic. How will the world reopening affect revenue growth? With the most recent company update, it appears to be inline with expectations.

2. Reduction of engagement. - It feels unlikely that Games Workshop could lose engagement. However, as younger consumer attention is directed to online and gaming, it will be imperative that they keep up. 

3. Managements low stock holdings. - The largest red flag, in my opinion, is the low ownership held by the board. Kevin Rountree has undoubtedly done an incredible job but in what scenario does he prioritise short term at the detriment to long term shareholders? The real concern would be if he stepped down as CEO, made more likely, with less skin in the game. 

Valuation

Games Workshop is a 20 bagger in the past 5 years. It’s excellent track record means that high expectations are baked into the stock price. Using a DCF model, I’ve modelled two scenarios to provide an indicative DCF price. Each used a Risk Free Rate of 2%

Bear case - £23 

• Sales slow to 5% per year

• COGS/Sales return to around 33% mark 

Bull Case - £75 

• Sales continue growing at 15% per year 

• COGS / Revenue (%) reduces to 27% as margins increase 

There is a considerable difference between the two scenarios. I find it difficult to envisage a world in which the share price decreases by 80%, but stranger things have happened. 

Conclusion 

The pandemic may have been a blessing in disguise for Games Workshop. With revenue growth slowing in 2020 , the pandemic reinvigorated growth and profits. 

Short term, Games Workshop may be in for a bumpy ride, with lofty expectations, a foot wrong could see a significant pull back.

However, in my opinion, shareholders have no reason to be fearful, there’s a lot to be optimistic about. With the ridiculous margins, a devoted fanbase, opportunities with Warhammer+ and the potential of a new generation discovering Lord of the Rings, I have no doubt that Games Workshop will be around for a long time to come. 

At an EV/EBIT of 23.09, Games Workshop may not be as overpriced as the PE initially makes it appear. 

My entry price target is closer to the £70 mark. However, a 40% price drop may be too much to ask for. I am sure I could be looking longingly in from the outside for a long time to come.