A Warren Buffett Small Cap You May Have Missed: Games Workshop Group PLC

Warren Buffett has achieved a 20% annual rate of return for nearly 50 years by investing in quality companies sporting economic moats, pricing power and established brands.

At first glance, Warhammer manufacturer Games Workshop (LSE: GAW) seems to be the perfect Buffett-style share, so today I’m going to take a closer look at the business and see if the great man would ever consider rolling the dice on this table-top gaming company.

Market Leader In A Niche Market

Games Workshop designs and produces miniature soldiers, which hobbyists assemble, paint and use in table-top gaming systems. An individual hobbyist can easily spend hundreds of pounds on models, paints, rule books and even novels.

Significant investment into their design and printing capabilities has resulted in a very high quality and range of figures not matched by competitors. When you spend hours building figures, the quality of detail is central to the experience and Games Workshop has an advantage here over other model makers.

But the real jewel in the Games Workshop crown is its rich fictional universes. Have you ever seen the raw passion of serious Star Trek fan? The enthusiasm shown for the Warhammer universe is certainly comparable. To give you an idea of how successful and loved the fiction is, the Games-Workshop novel A Thousand Suns made it to the no.22 spot on the New York Times Bestseller List. This lore has been developed over 40 years, and its depth keeps customers coming back for more.  

Games Workshop is also the only table-top gaming company to have a high-street presence. If you live in the UK I’m sure you’ve walked past one of their 142 bold stores, with hordes of well painted figures in the windows. The company boasts 414 stores worldwide. This network is key to their business – the hobby is certainly niche, and I’m sure most customers begin by being drawn into to one of these incredible stores. Staff are on hand to play a demo game and the customer can paint a test figure for free. Without this unique experience I doubt many people would find the hobby, let alone commit to it.

So to summarise, GW is a near-unopposed leader in a niche market, with high quality products and a loyal customer base.

But what’s the catch?

There is one Warren Buffet principle that leaves the investment thesis in Games Workshop crumbling… Buffett once said: “I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will”

Games Workshop’s great product offering meant success was its to lose, and unfortunately management seem to be doing their best to destroy these fantastic qualities from the inside.

Prices have been sky-rocketing, with customers claiming box sets sell for 50-100% more than a few years ago. Worryingly, revenue fell 8% last year, so the number of boxes sold must have dropped off rapidly. The company doesn’t mention volumes in its annual report, which could be telling.

The company has also taken the decision to turnthe majority of their stores into one-man operations. This will save millions, but who is going to recruit the next generation of gamers if there is not enough staff to play demo games?

While I love the business and its strengths, it is losing customers that have been fiercely loyal for years. I’m not expecting a change of strategy from new CEO Kevin Rowntree because he has been part of these changes as COO for years.

Removing restructuring costs, the shares trade on a PE of 12, which seems slightly overpriced given falling sales. So for me, Games Workshop remains one to watch until management change direction on their attitude towards customers.