Business Breakdowns
· Todd Wenning
[00:00:00] S1: For sure. If you look at the chart, you can see where it falls apart. What happened was they got the license, the agreement to manufacture the Lord of the Rings miniatures, those games. It was such a bonanza. I'm sure you can remember in the 2000s how big Lord of the Rings was, and they had three movies and everyone got really excited about it. What happened to Games Workshop was they kind of took their eye off the ball when it came to investing in their own IP. They were just making so much money working with Lord of the Rings that they weren't keeping their IP fresh. When Lord of the Rings movies stopped coming out, that traffic stopped. Now they didn't have fresh IP. They got in some real challenges. In 2008, there was a real scare that they might go under. That was an important moment. And I think a lot of great companies, if you look back at their history, there was probably a moment somewhere along the line where they had a near-death experience. Great companies say, we're never doing that again. We will not take on debt. We won't do whatever got us in trouble the first time. We're going to fix that. And that's certainly what Games Workshop has done. And so again, it's just super critical that they continue to invest in their IP. They release new editions, and so that keeps the IP fresh. Some people might say, oh, I didn't like this edition or whatever, but they'll buy the next one. The idea is just keep it fresh, keep it going, investing in the business, staying relevant. That's the key to Games Workshop's business.
· Matt Reustle, Todd Wenning
[00:00:00] S0: Is there a creative director that sits on top of managing that IP? I think a lot of the success of Marvel and those movies should be attributed to Kevin Feige, who was a diehard fan and made sure that evolution into the theater was done with thoughtfulness around the most enthusiast Marvel fans, but could also be consumable by normies like myself. How does Games Workshop approach that? Do they disclose who looks over it? What's the storyline there? [00:00:00] S1: They have a very unique organization as well. So, it's a flat organization. It's not a strict hierarchy. They actually have it set up where there's two groups. One group is focused on core retail. So, dealing with the stores, dealing with manufacturing, and there's another group that's focused entirely on IP. They take that IP part of their business extremely seriously, as they should. That's, I think, a key to Games Workshop's success. This modern success post-2008 is that they've realized we really need to build up this IP again, make a deep connection with the users and the game players. [00:00:00] S0: Back a bit to the financial model or the spreadsheet-oriented questions. In terms of capital allocation, I assume with EBITDA margins at 40%, a decent amount of that flows into free cash flow. What do they invest in if they do have to reinvest CapEx? And how would you just describe the overall capital allocation framework for the business? [00:00:00] S1: They have a very unique approach to returning capital to shareholders. I think their average dividend payout ratio is about 80%.
· Todd Wenning, Matt Reustle
[00:00:00] S1: They have a very unique approach to returning capital to shareholders. I think their average dividend payout ratio is about 80%. [00:00:00] S0: Very UK of them. [00:00:00] S1: It is very dividend focused. There's another company in the UK called Admiral Group, which is a car insurance company. They have a very similar process where they figure out, here's all the cash that came in. We're going to keep a buffer, make sure that we are able to be secure in case there's COVID or something different comes up, an emergency. And whatever's left over, we give it to our shareholders. It's very simple. I believe they have authorization to buy back stock, but I don't believe they've done it before. They haven't really had a 2008-type period where the stock was super cheap either. Their approach is, “Hey, we're just going to give you whatever is left over.” I think it's a very shareholder-friendly approach, especially for their type of business. Because you can imagine, being as cash-rich as they are, they could easily fall into the empire-building trap, where they just start buying up studios and all these sorts of things. And they are just relentlessly focused on what they do. I think that is the right capital allocation process for them. [00:00:00] S0: And you mentioned a bit about this stock not getting overly cheap. Do they have a way of thinking about valuation? Or do you have a way of thinking about – whether it's PE or anything else, just to frame the valuation framework that you would use for a business like this?
· Matt Reustle, Todd Wenning
[00:00:00] S0: And you mentioned a bit about this stock not getting overly cheap. Do they have a way of thinking about valuation? Or do you have a way of thinking about – whether it's PE or anything else, just to frame the valuation framework that you would use for a business like this? [00:00:00] S1: For this type of business, I think because it pays such high dividends, really cashflow oriented, a discounted cashflow model is what I use. I forecast what I think is going to happen with the margins and figure out what that turns into cash, and then discount that cash back to the present. And that's how I model the business. You might look at the stock today, I think it's trading for about 30 times earnings, which is not optically cheap. But if you think about the potential for margin increase and this network effect acceleration, we might look back and say, that wasn't too bad to pay. [00:00:00] S0: You had a very nice write-up recently where 40 times earnings, I think, was the actual headline – is actually cheap. I often think that there are some impressive businesses out there that are like that and you need to look for characteristics. And I can see your angle here, certainly. And 30 times, not 40 times. More reason. On the risk side of the equation, I think we've kind of alluded to several throughout, or what you would keep your eye on the most. Is there anything else that you would add to it, or one in particular that you would highlight as the risk that you think most about for the business?
· Todd Wenning
[00:00:00] S1: In terms of the risk, there's a couple of things. Kevin Rountree, who we haven't mentioned yet, who is the CEO and writes, in my opinion, some of the best annual reports out there. I mean, if you're an annual report fan, you have to check out Games Workshop. You can imagine, if you were the CEO of a business with this sort of fantasy IP, you would be inclined to create these 200-page glossy annual reports with all the IP you have, to kind of show off what you've done. It's like a Word document. It's a simple Word document. And he's got some great lines that he puts in those reports. And he says, "we believe shareholder value is created primarily by not destroying it." So he has these great one-liners that any sort of Buffett fan would just love, and I do too. And he repeats them every annual report. So he kind of drives it home. He's been CEO since 2015, and has been extremely successful. And he's 55 years old, so still pretty young. Could go on for a long time. But there's always the risk that Kevin decides, “I've done a great job, I've got other plans in life, I want to move on.” One of the concerns is, what does the post-Kevin Rountree Games Workshop look like? Seems like they have a blueprint for success to execute on, but you just never know. There's always the risk of a management transition not going well. Someone who doesn't connect with the fans. So there's always that risk. The key risk, however, is just avoiding irrelevance. If you go on online and you go to Warhammer chats and things, people will be upset about prices, or this edition. But that's okay. When you're looking at IP, what you care about are people who are passionate, one way or the other. The worst thing that can happen is just a yawn. Indifference. So if they care, that means that they will buy when they are happy, but they still really love the IP. And so as long as Games Workshop continues to harness that, it'll be great. AI is a potential concern or a potential benefit. It's unclear at this point. Management has come out and said that we don't want our IP creators to use AI because they're afraid that it'll get mangled in the AI world, or stolen or something like that. What's interesting is that part of the backstory to the Warhammer 40,000 is that humans used AI and it turned everything bad. They had to fight against AI robots.
· Todd Wenning, Matt Reustle
This is all coming kind of full circle in a weird way. Hopefully that's not our future. But they are naturally concerned about their IP getting stolen and misused and diluted somehow. And so I think that's another risk. That's probably three risks right there to keep an eye on. [00:00:00] S0: I think the point on Kevin highlights the importance of the people that oversee IP are so incredibly important. And some of those other points are noteworthy as well. Maybe Warhammer 40,000 will become some type of Nostradamus-like tale and you add even more lore to the story. This has been fascinating. I mentioned before, I absolutely love businesses built around IP and particularly when they find ways to really nurture it while building a nice business around it. What are the key lessons that stand out to you from analyzing this business that you would potentially think about looking for elsewhere or applying elsewhere as an investor?