QUALIPORT
Qualiport Meets Games Workshop

By Maynard Paton (TMFMayn)
February 24, 2003

Games Workshop (LSE: GAW) is not the most obvious of 'quality companies'. Indeed, the world's largest tabletop battle games firm is probably as 'niche' a business as you'll find. Designing, manufacturing and retailing a vast array of miniature figures and gaming rulebooks may sound faddish or 'geeky', but investors should put any prejudices aside: the company's record and prospects tell a different story.

Supported by new products and extra stores, Games Workshop's pre-tax profits following its 1994 flotation have jumped from £6.0m to £13.5m. What's more, the company continues to thrive during what's proving to be a difficult time for most other businesses. Last month's half-year figures showed profits up 10%.

On February 14th, I met with Tom Kirby, Games Workshop chief executive, and Michael Sherwin, Games Workshop finance director, to learn more about its business and the long-term potential.

(For those wanting a primer on Games Workshop, the company's website outlines in detail what the company does and its history, while this article reviews the company's financial history.)

The company

The obvious question: At a time when PlayStations and other forms of entertainment are flourishing, why have tabletop battle games remained so popular?

"Some people are just hot-wired to love toy soldiers" was Kirby's simple answer, who estimated about 8%-10% of males had some sort of interest in the activity. "Our job is not to persuade those people who are reluctant to play [tabletop battle games]. But we know some people inherently love it. Our job is to find them."

Kirby drew a parallel with fishing. "Some lads go out all day fishing. That doesn't appeal to most people, yet they go fishing of their own free will and they love it. And you'll find every town has its own fishing tackle shop, where the owner is probably on first name terms with his customers. We're a bit like that."

Sherwin added: "If we go to an institutional meeting, there's bound to be somebody at the table who plays golf. That's another example. Again, it's a niche. Only a minority play, but those who do often get deeply involved."

So how does Games Workshop stand in relation to its rivals?

Kirby outlined his views on the company's status: "The difference in scale between Games Workshop and other makers of fantasy miniatures creates no meaningful comparisons. No one would ever seek to compare Ford with Morgan or Honda with Harley-Davidson. In our world, when compared to other entertainments, we are the Morgan or the Harley-Davidson -- the niche player. When compared to other miniatures companies, we are the Ford. None of the others have a turnover within 10% of ours."

Kirby also reviewed the company's strengths: "Reputation, which has a genuine value" was number one. Having effectively created its own market from scratch in the 1970s, Games Workshop prides itself on the quality of its games and miniatures, which in turn attracts the loyalty of most customers. The company's long-term commitment to service is another operational edge. A monthly magazine and the company's 274 stores -- which provide knowledgeable and enthusiastic staff to encourage novice players -- add to the competitive barriers.

Games Workshop's financial clout also helps to stave off rivals. "We're the only people who can afford the good designers" Kirby noted. With Games Workshop spending £3m a year on its particular R&D, prospective newcomers require "deep pockets" and a considerable "pay back time". Sherwin believed there were "no big, fast answers" for firms starting out in the battle games arena.

Management

Although the dominant force in its niche, Games Workshop hasn't been without its problems. During 2000, profits fell as growing pains emerged.

"In the early years, Games Workshop was a one man band", Sherwin recounted, referring to Kirby's leadership during the 1990s. Kirby headed a management buy-out in 1991 and during the following seven years, oversaw a near quintupling of revenues (to £65m).

But in 1998, a "lack of skill set" prompted Kirby to step down from his executive duties. Chris Prentice took up the reins, whose task was to lead Games Workshop through its next growth phase and in particular, ensure the company's infrastructure would cater for the rapid expansion.

Kirby, who'd remained chairman throughout Prentice's tenure, was reappointed chief executive in September 2000: "Coming back involved a big lifestyle change. It required a big incentive to come back for three years." That 'big incentive' is a significant cash bonus, payable to Kirby later this year if various earnings and share price targets are met.

But will Kirby take the money and run? No. Kirby reassured he was staying on for the long term: "My commitment will remain beyond the bonus payment. I think the fact that I came back shows my commitment never went away."

A notable factor in Kirby's decision to return and stay put was the different role he now plays. No getting stuck into the operational nitty-gritty anymore, but more of a 'mentor' to his loyal staff. Following the recruitment of a stronger all-round operations team, Sherwin joked: "We don't have the what-will-happen-if-Tom-gets-knocked-down-by-a-bus syndrome anymore".

Potential

So what can shareholders expect from Games Workshop in the future?  "We're after organic, measured, manageable growth" was how Sherwin described the outlook.

It's worth noting that Games Workshop is one of the few UK businesses to have successfully transported its domestic accomplishments overseas. Over 70% of revenues are now generated outside the UK, with Europe and the US prime areas for expansion.

Even so, the UK market was said to be still some way off saturation. The interim results showed home sales growth of 7%, almost all of which was volume driven. With the possibility of enhancing and adding to the 120-store domestic retail chain, the potential for the UK over the next five years was described as "single digit growth ahead of inflation". Kirby pointed out the company had just nine outlets within the M25.

January's half-year results also showed European sales surging 70%. The reason? "None of them dropped the ball" was Sherwin's clear-cut response. Spain for example has done very well of late, its success being down to a great, and importantly, stable, management team. In terms of expansion, Europe should do a "bit better" than the UK. The possibility of double-digit annual growth over the next few years is not out of the question.

The US hasn't performed so well recently, though it remains a "very promising" territory. The cause of flat interim revenues Stateside was the independent stores that sell Games Workshop products, which proved "hard work".

According to Sherwin, one of the issues concerned the reluctance of independent storeowners to hold game playing activities in-store (a key promotional feature of the company-owned shops). To counter this, additional investment in 'support teams' is being undertaken, which will help the independents run introductory games and "paint clinics". More company-owned US stores are on their way, too.

Figures from Games Workshop's recent results presentation suggest group sales could triple (to around £330m) if the spend per population within the overseas markets match that currently seen in the UK. But just how long would it take for the rest of the world to catch up? No definitive timescales were given, with Kirby simply remarking: "It'll take a long time... We're the tortoise." 

Summary

Like all company directors, Tom Kirby and Michael Sherwin gave an upbeat appraisal of their company. However, they've probably got more right than most at the moment. Positive results and obvious expansion potential supports their optimism.

While battle games may be an obscure activity to most people, long-term investors should not be put off. Games Workshop is a unique company and its games, content and reputation have taken a long time to develop and provide a tangible business 'moat'.

On the face of it, it would take something special to prompt Games Workshop customers to jump ship to another company's games. Most have already devoted plenty of time, money and energy to learning the rules, building the armies and painting the figures, and writing off all of that won't come easy.

There's arguably a 'network effect' in place, too. With battle gaming a social activity, new entrants to the industry require a critical mass of players to succeed. If a Games Workshop customer wants to switch to a rival game, but his friends remain content with Warhammer, he faces a dilemma. All in all, rivals setting out to challenge Games Workshop don't face an easy task.

Certainly in the UK at least, Games Workshop has no visible alternative on the high street. If you're 'hot-wired to toy soldiers', you'll almost certainly end up visiting one of the company's stores. Another factor that particularly impresses is the international progress. UK companies traditionally falter overseas, yet foreign sales at Games Workshop have increased 82% over the past four years. No business achieves that sort of performance without having a robust competitive strength.

On the management front, talk of keeping things simple, sure and steady progress and sensible supervision of the European hyper-growth should reassure prospective shareholders. And the news that Kirby, for so long the driving force behind the firm, is keen to stay on is also uplifting. Needless to say, Games Workshop remains firmly on the Qualiport's watch list.

More: Games Workshop discussion board

The author owns shares in Games Workshop.