Qualiport

[ March 29, 2000 ]

Toying with Games Workshop

By Maynard Paton (TMFMayn)

Carburton Street, London -- Oh, my. After Monday's feature on Games Workshop (LSE: GAW), the Qualiport discussion board became a sudden flurry of activity. Grown men, with a tear in their eye, started to reminisce over their wargaming experiences. Oh, those were such happy days...

Anyway, moving quickly to the here and now. And back to investment. I mentioned on Monday that I would cover the subjects of valuation and the recent financial restructuring of Games Workshop. However, such was the feedback on the Qualiport board, that I'm going to address some other aspects of the Games Workshop decision first.

Investing in toys

Firstly, the thorny subject of other "related" companies. Names such as Electronics Boutique (LSE: EBQ), Hamleys (LSE: HYL), Character Group (LSE: CCT) and Eidos (LSE: EID) were all mentioned on the Qualiport board. And all these "toy" companies have recently experienced trading difficulties of one sort or another, casting doubt on the suitability of Games Workshop.

Let me put the record straight with these comparisons. Firstly, Electronics Boutique and Hamleys. The similarity with these two retailers and Games Workshop here is that all three have retail outlets. And that's it.

If you've read my sector review of General Retailers within the Motley Fool Industry Focus 2000 (covering 14 sectors, each with a great stock idea, priced at a very reasonable £17.50, folks!) you'll know how incredibly wary I am of this particular sector. Put simply, there just isn't such a thing as long-term buy and hold within the General Retail sector.

The problem with any general retailer is just that. They're general. Take Electronics Boutique. The computer games that the company retails can be bought by any consumer in stores such as @jakarta, Woolworths or WH Smith (LSE: SMWH). And that means there is just no sustainable competitive advantage with the Electronics Boutique business model. General retail is a commodity business. If a rival retailer can sell identical or similar goods to you, then price is your only weapon. And constantly fighting on price isn't a recipe for long-term investment success.

And the same applies with Hamleys. The company may have a well-recognised premium brand, and that works well with tourists. But the goods I can buy at Hamleys, I can buy cheaper elsewhere.

Compare all this with Games Workshop. If I'm on the look out for wargaming products, then I have two choices. Firstly, if I know that Games Workshop is the overpowering force in this niche industry, I head off to one of their stores. Alternatively, I may head off to a general toy store, and find that Games Workshop products dominate the store's wargaming offerings. Either way, Games Workshop will almost certainly receive my money.

And there's the difference. If I want to get involved in wargaming, then Games Workshop is very likely to benefit because of its all-pervasive presence in this particular market. If I want to buy a computer game, or a yo-yo, then Electronics Boutique or Hamleys just do not have that same "certainty" of receiving my money. There are too many retail alternatives for computer games and yo-yos.

In short, Games Workshop just isn't your typical general retailer.

On to Character Group. Oh dear. Character Group, bizzarely given its name, owns no significant toy character licence. The company is mainly a distributor and manufacturer of toys. Every year, it has to jostle with many others to predict and then scramble to become a licensee for the much coveted "must-have Christmas toy". There's not much predictability in this business. With the fickle nature of kiddies toys, Character walk a tightrope every year. If they make one bad decision, then a large profit-depleting stock write-off could be on the cards.

Compare Character's predicament to Games Workshop. Games Workshop own all the licences for the games, and more importantly, its niche products have shown a proven and durable demand. Games Workshop has well over ten years of demonstrated growth in the bag, pushing its products into the US, Europe and the Far East.

That's enough to satisfy me of the smooth and sustainable appetite for Warhammer.

Now Eidos. Just this week, I've had a discussion with Bruce Jackson (TMFGoogly) about the recently troubled computer games producer over on the Eidos discussion board. Rather than repeat my views here, you may wish to read our thoughts over on the Eidos board, or indeed this rather well-timed Duelling Fools feature.

Suffice to say, a troubled Eidos, without any proven dominance in its marketplace, is not an attractive buy-for-a-turnaround-then-long-term-hold proposition for me. Unlike Games Workshop, perhaps.

All in all, none of the aforementioned companies holds a candle to Games Workshop. None of them govern their particular market place, none of them appear to have the self-reliant creativity needed for future profits and none of them have an established long-term sales growth history.

Computer games

The threat of indirect competition, mainly computer games, was mentioned as a possible hazard for Games Workshop. The danger is that kids won't be interested in painting model soldiers anymore with the delights of Lara Croft and her ilk on offer. On the Qualiport discussion board, opinion seemed to be divided on this matter.

There's no hard and fast data that I can supply to suggest whether or not the electronic threat is justified. On a purely subjective and personal basis, I suspect the threat is overplayed. All I can offer in my defence is the fact that computer games have been around for over 15 years, and Games Workshop have grown substantially in that time. If there was ever going to be big switch towards computer games to impact Games Workshop, surely it would happened by now.

Management -- who needs 'em?

Within the ideal Qualiport company criteria, Bruce states "A well-managed company. This is the most important factor in a company."

I disagree.

I think the most important factor within a company is the overall "moat" to protect future profits. If you've got huge barriers to entry, then the certainty of future profits and the predictability of future profits lead to a comfortable long-term buy and hold proposition. Typical moats are patents, copyrights, brands or reputations that completely overshadow the competition.

Take Tesco (LSE: TSCO). Most regard the company as being the best-managed supermarket operator in the country. Compare Tesco's recent profit performances with J Sainsbury (LSE: SBRY), and you'll see Tesco running rings around their underperforming rival.

I wouldn't invest in Tesco solely on its great management. Loyalty cards and other management-induced gimmicks may have given Tesco the edge, but management talents can't change the fundamentally poor characteristics of the mature and commodity-based food retailing sector.

In fact, Sainsbury's have now brought on board management muscle in the form of Sir Peter Davis to help its fortunes. And that's the point. Poor management can be replaced overnight by good management. But the fundamental attributes towards a business or industry cannot be changed as quickly, if at all.

Would you bet on the great business with an average manager, or an average business with a great manager? I'd go for the great business every time.

This leads back to Games Workshop, and the question mark over the management. If, as I suggested on Monday, Games Workshop does have a definable moat in the wargaming industry and still has significant avenues for revenue growth, then I could declare the company "a great business".

The main charge against the management has been weak financial control. Large and increasing amounts of cash have regularly been sucked into working capital over the last year or two.

Just as things seemed to be getting back to normal, and before the latest restructuring programme, last June saw the replacement of the financial director. Possibly a warning sign in itself of further trouble to come, FD Dick Hosie made way for Michael Sherwin. So I guess it was Mr Sherwin, after his initial look at the books and financial systems, who bit the bullet and initiated the November restructure.

So here's the current quandry. Putting valuation and threats of computer games aside, is it advisable to jump aboard the strong Games Workshop horse with an unknown financial jockey at the reins? Or do we wait until the qualities of Mr Sherwin are proven, by which time we may be paying a higher price for the managerial "certainty"?

All that's needed is proper financial discipline at Games Workshop. That's not too much of a demand. Certainly when the company has already done all the hard work, establishing a niche and dominant market position for its products. After laying all the groundwork for the future, I feel getting somebody to look after the purse strings properly should be a relatively minor task.

Related Links
• Games Workshop for the Qualiport?
• Industry Focus 2000

Note
The Qualiport was launched on December 19th 1997 with an initial investment of £4040.63, all in Rentokil Initial. Further cash was added as holdings in Emap, Marks & Spencer and Unilever were bought during 1998. The vagaries of the value per share accounting method caused percentage return calculations for calendar 1998 to be somewhat distorted. To avoid confusion and somewhat misleading figures, the Qualiport's returns are being measured from 1/1/99, at which point the total portfolio value, including cash, stood at £16,809.60. An additional £2000 cash is added to the portfolio on April 1st and October 1st each year. The total cash investment in the portfolio to date has been £20,184.62. To access the Qualiport's total trade history, click here.