2023-05-09 06:23:55 ET
Summary
- Games Workshop Group is a company that creates and distributes miniature figures and games across the globe.
- Revenue has grown at a CAGR of 12%, driven by an improved interest in Warhammer and product development.
- GAW has an EBITDA-M of 39% and NIM of 29%, representing its monopolistic position.
- GAW signed a deal with Amazon to develop Warhammer movies/TV shows. This could fundamentally change this business.
- GAW's valuation is rich for a toy retailer but for a small company with Amazon movie on the horizon. Maybe not.
Investment thesis
Our current investment thesis is:
- GAW is an incredible niche business. Its financial profile is impressive, with interest in Warhammer remaining positive, which is key.
- A movie/TV deal with Amazon represents a gaming-changing deal if it plays out.
- GAW's valuation is rich for the current business alone but reflects investors speculating on the Amazon deal.
Company description
Games Workshop Group PLC ( OTCPK:GMWKF ) is a company that creates and distributes miniature figures and games across the globe. The company operates in two segments, Core and Licensing, and offers various games, including Warhammer: Age of Sigmar, Warhammer 40,000, and Horus Heresy. Additionally, Games Workshop Group publishes books and develops digital content for animation and TV.
Share price
GAW's share price has generated monumental gains over the last decade, with a 1000%+ return in a short period of time. This has been driven by a change in market sentiment around the business and what it is capable of, with impressive growth given the products sold.
Financial analysis
Presented above is GAW's financial performance for the last decade.
Revenue
GAW's revenue has grown at an impressive 12% CAGR, with increased interest in its product in recent years.
There has been much doubt around GAW's earnings potential. The company is essentially "all-in" on the Warhammer universe, for which it owns the intellectual property. The rapid increase in share price is a reflection of the transition in sentiment, from the belief that this is a niche that is potentially dying, to a sustainable growth segment.
The tabletop gaming industry has experienced strong growth in recent years, driven by exhaustion from the existing gaming offering and the nostalgia effect. Warhammer is not the only miniature figure product that has seen increasing interest, but it is one of the more popular ones. This is a critical development in the industry as interest was slowing, with the primary demographic aging and the new generation interested in digital products.
Despite the resilience, we note that interest has trended down over time. As per Google Trends, Warhammer 40k peaked around 2011, declining ever since.
This is not a major issue as the business will most likely remain a niche. The key is for the business to continue to make compelling products to upsell its existing base and generate continued recurring sales. Further, it should invest in attracting the younger generation to the hobby and keeping the existing base interested. We believe the company has been doing both well, which is why it has reinvigorated growth. Regarding the former, the company continues to launch products regularly and has expanded into the Lord Of The Rings Universe. Regarding the latter, the company has continued to invest in animated TV shows, building the lore around its cinematic universe.
GAW recently announced an agreement with Amazon to develop Warhammer into both a film and television production , with the scope for merchandising. This is truly a game-changing development. At a minimum, GAW will see a significant increase in revenue from the value of the rights, as well as increased merchandising income. The potential upside, however, is limitless. If the series & movies are successful, Warhammer could be propelled into the mainstream, fundamentally changing the business. This could allow the business to expand into other IPs or enter related industries such as Merchandising.
Creating movies/TV shows are notoriously difficult and so there continues to be a near-term execution risk, but if filming begins, the company begins its transformation.
There are many "ifs" and "buts" with this analysis, but success here would make GAW a fantastic takeover target. What likely stops companies like Disney ( DIS ) is GAW's size. A large conglomerate coming in would likely lose the key expertise which keeps GAW improving Y/Y, the risk is too high. However, if we see this move closer to the mainstream, Disney (or another party) could be interested in replicating this with their IP.
The increased interest in miniature figures has become increasingly competitive in recent years given the uptick in interest, with a growing number of companies entering the market. GAW does not have the best reputation, as the business is highly litigious and protective over its key asset. This has put pressure on GAW to differentiate itself through innovation and pricing.
A key concern for us with GAW is the development of 3D printing. In theory, consumers could print an army for a fraction of the price. This is not a disruptive issue currently but could be with continued technological development. The threat is not consumers selling the products, as the products can already be sold for less if manufactured in a low-cost country. The concern is that enthusiasts, who are the big-ticket customer, could invest in a printer and replace GAW.
Economic considerations
We are currently experiencing a period of economic weakness and uncertainty, driven by heightened inflation and rate hikes. This has led to a slowdown in discretionary spending across many sectors as consumers see their cost of living rapidly rising.
GAW is currently being impacted by this, with growth in the most recent quarter declining to 4%. Our view is that soft growth is likely to continue into 2024, as inflation remains stubborn.
Margin
GAW's monopolistic position allows the business to earn fantastic margins. It currently has an EBITDA-M of 39%, up 19ppts. in the decade. Further, it has a NIM of 29%, up 17ppts.
Margin expansion has been driven by aggressive pricing by the business, as well as tight operational spending. Due to the niche products offered and its monopolistic position, consumers are coming to GAW rather than GAW selling to the market. The key to the business has always been growth.
Balance sheet
With the business being highly profitable, it is unsurprising to see its balance sheet is of equal quality.
The company's inventory turnover is at an impressive level for a retailer and has increased in the most recent period, suggesting Management is active in adjusting inventory levels for changes in demand.
Further, the company has little debt relative to its earnings potential (ND/EBITDA ratio of -0.2x), which means there is no solvency risk.
Management's policy so far has been distributing to shareholders via dividends, with a current yield of 3%. Given the company's trajectory, this looks sustainable.
Outlook
Presented above is Wall St. consensus forecast for the coming 5 years.
Analysts are not currently pricing any impact from the Amazon announcement, which is in line with Management. Growth is expected to slow slightly but remains at an attractive level.
Margins are expected to slip, which seems reasonable given the increased level of competition and the desire to maintain a strong growth trajectory.
Valuation
GAW is currently trading at 19x its LTM EBITDA and 26x earnings. This is noticeably above its 10-year average, reflecting its impressive improvement in margins and continued growth.
The current valuation is a reflection of markets expecting growth to continue. A 20x+ multiple is a premium reserved for high profitability and growth.
In order to imply a valuation, we have conducted a DCF valuation of the business. Our key assumptions are:
- Revenue growth of 3-6%.
- FCF conversion in line with historically achieved.
- A discount rate of 8%
- An exit multiple of 15x, reflecting lower growth but impressive margins.
Based on this, our target price is £81, a downside of 17%.
The key nuance is of course the Amazon deal, which we have not priced in (The share price jumped 15% on the news alone). Investors willing to speculate could easily realize value here just from filming commencing, especially if a star actor is attached (Henry Cavill is rumored and passionate about the game). What the upside could be is impossible to quantify but it would likely yield double-digit revenue growth for much of the initial years in the mainstream. However, we should be clear that the fundamentals of the current business suggest it is overvalued.
Final thoughts
GAW is a textbook example of dominating a niche. Its margins are fantastic and the growth achieved in the last few years is unbelievable based on facts alone. Long term, we believe the company can achieve inflationary revenue growth, c.3%, while maintaining its current margins. It will experience periods of decline and require short-term margin dilution as it invests in customer acquisition but the company has shown it can return to the green.
The interesting part of this business is the deviation from the above paragraph's "long term". The Amazon deal, and everything that could come from this avenue, as well as expanding into other genres, represent game-changing value. Despite the downside implied, this business cannot be rated a sell when a successful movie could double revenue in a matter of years.
Current investors, or those interested, would do well to keep a keen eye on what Amazon does with this. Following Henry Cavill on social media would also be a good idea.
For further details see:
Games Workshop Group: Hollywood Deal With Amazon