Hi everyone,
This is Graham Neary, bringing you the inaugural edition of Monopoly Investor.
In this edition, I want to talk you through one or two of my core ideas when it comes to monopolies and pricing power.
Let’s start with a personal anecdote.
If you’re like me, you found that lockdown in 2020 forced you to take up some new hobbies. We were forced to come up with new ways to pass the time.
Initially, I started off with bridge. It’s Warren Buffett’s favourite game, so it must be good!
However, the rules were a lot to take in. I could understand them, with some effort, but I also needed three victims to play with me.
Explaining the rules of bridge to other beginners is not so easy. Maybe if Buffett, Gates and another bridge player lived next door, it would have worked out.
I needed something more accessible, but also something that I could get my strategic teeth into.
That’s when I discovered Catan.
Ironically, given the title of this newsletter, Catan has more than a few things in common with Monopoly (whose rights are owned by Hasbro - $HAS).
But Catan is far superior. Its trading strategies are deeper, there are multiple routes to victory, and the winner usually wants to conceal how they are going to win (until the very last minute).
It’s fair to say that I’m a fan of this game…
What’s the relevance of this to investing?
Well, Catan happens to be an example of a company with immense pricing power.
Let’s suppose that you’re like me, and sometimes you hang out with more than three friends at a time.
Well, in that case, the base game is insufficient. You also need the 5-6 player expansion pack (pictured above).
No problem! That will be an extra $30, plus significant shipping costs and taxes.
In exchange for this princely sum, you get some playing cards and some painted cardboard. Think of what the margins on this must be!
Don’t get me wrong: this expansion pack is definitely worth it, if you want to organise a six-player game. The materials are of a nice quality, and everything works as it should. But at the end of the day, they are just playing cards and painted cardboard.
Now suppose that after a few months, you are finding that all the little wooden game pieces are becoming quite chaotic on your kitchen table, and you want a neat way to store them.
Catan has a solution for that: little wooden holders. They are a snip at $25 for four of them, or an extra $15 if you want to complete the set of six. That’s $40 for six small and unsophisticated pieces of wood. (I’m proud to say that I’ve resisted the urge to buy these yet).
If you look at the entire Catan shop, it’s an amazing illustration of how a brand can be monetised to the maximum.
And for fans of the game like me, we are often willing to pay a premium for the official kit, instead of risking disappointment with an imitation.
It’s true that there are beautiful offerings from independent craftsmen on sites like Etsy ($ETSY), and we will sometimes buy from them, too.
But even with that competition, the margins earned by the official manufacturer - especially on accessories and merchandise - must be extraordinary.
All of which brings me back to the theme of this newsletter.
Creating monopolies
A powerful and unique brand is one example of a quasi-monopoly, and it can generate serious amounts of cash.
Unfortunately, we can’t buy shares in Catan (or I would have done it already).
Originally designed by Klaus Teuber in Germany, Catan is now owned by the French games publisher Asmodee, which in turn is owned by the illustrious French private equity firm PAI Partners.
The 2018 acquisition by PAI saw an enterprise value of €1.2 billion for the publisher. Not bad for a few board games! The portfolio does include other favourites such as Diplomacy, Carcassonne, Pandemic and Ticket to Ride.
These would be highly investable, if they ever reached the public markets!
Until then, we will have to make do with the likes of Hasbro ($HAS) - home of Monopoly, Play-Doh and My Little Pony - which currently trades at a forward P/E ratio of 21x.
Or, if you prefer games for slightly bigger kids, there is always the UK-listed Games Workshop ($GAW.L).
I’ll focus on this one now, as an example of one type of business that I love to own shares in. It’s also quite topical, since it released its annual results a few days ago!
The Mighty Warhammer
Disclosure: Graham Neary owns shares in Games Workshop.
Share price: £113.70
Market cap: £3.7 billion
This trades at a P/E multiple of around 30x, so it’s not for the faint-hearted value investors among us.
The core thesis is that, as the owner of the Warhammer franchise, Games Workshop has an incredibly strong competitive position.
In the words of one gaming website, Warhammer has “a terminator’s iron grip on the mainstream perception of miniatures games”, and compares it to the niche that Dungeons and Dragons (another Hasbro property) controls in role-playing games.
Think about the switching costs. If your friends already play Warhammer, how are you going to convince them to abandon their Warhammer investment and learn the rules for a completely new game?
I’ve been a shareholder here since November 2019, when I bought a few shares at £52.60.
I had been commenting on its results for a few years, and always said something similar - a very nice company, possibly on the expensive side, and its results seemed unpredictable, due to the product release cycle.
At some point, I decided that I was sick of saying what a nice company it was, and decided to just shut up and buy a few shares in it!
Fast forward 20 months, and my return including dividends is around 125%. A remarkably easy “bagger”!
Signs of quality
The Games Workshop results were fabulous, although the shares did retreat by 6% on the news. That’s the price of a high rating - you get volatility if the picture is not quite up with expectations.
(It’s often unclear what these expectations are, as the analyst forecasts are so inaccurate, but I digress…)
Even those who have never looked at GAW before might see signs of quality from the very moment they start reviewing these results.
Before we even start talking about growth, just take a look at those margins.
By my sums, the operating profit margin is a mighty 38%.
That’s a sign of some serious pricing power.
Remember that the models are made from plastic and resin. No precious metals are involved here!
And like Tom Sawyer, who convinced his friends to whitewash the fence for him, Games Workshop has convinced its fans that painting figurines is fun.
I don’t doubt that the satisfaction felt by fans is real - I’m tempted to have a go at it myself - but it’s incredibly convenient for the company!
We have margins of 38% before getting into the pure-profit, zero-cost royalty stream.
Those royalties - running at c. £16 million - have a lot of work to do, if they’re going to help justify a £3.7 billion valuation.
But when you combine them with the core operations, you get the best part of £100 million in cash generation this year alone. It is this cash generation which has enabled a healthy and growing stream of dividends.
What’s exciting is that the growth opportunities are open-ended, as Warhammer extends its reach both in the real world of tabletop gaming and in the digital world.
Wikipedia has assembled a helpful list of Games Workshop video game titles, and you’ll notice that there’s a promising pipeline of upcoming games.
Indeed, there is no indication whatsoever of video game activity slowing down.
An excerpt from this week’s results:
Several large franchise games were announced as launching in the next 12 months including Warhammer 40,000: Darktide, Total War: Warhammer 3 and Total War Battles: Warhammer. There are currently 15 video games in development across all platforms ranging from AAA PC/console titles to mobile projects, which will be released over the next few years. Further out, more large scale projects are in the early stages as well.
There is also an explanation as to why licensing income - which includes both video games and “entertainment” products more broadly - was down slightly this year:
Whilst recognised income is down due to lower levels of deals with high minimum guarantees compared to the prior year, actual sales of licensed products at retail value was the highest ever this year. In other words more customers bought more Warhammer licensed products than ever - in excess of £133 million worth. In the recent 'Top 150 Global Licensors 2020' list we placed at 66th.
A word on management
CEO Kevin Rountree knows how to write commentary which appeals to me as an investor.
Not every CEO makes a point of highlighting return on capital, but he does.
He also has the habit of helping the company to achieve an enormous return:
During the year our return on capital improved from 94% to 184%. This is an exceptional result, driven by the growth in operating profit before royalties on a reduced average capital base, a result of the volume growth in the year and the impact of COVID-19 in the prior year.
The company mission is repeated every single year, and is reassuringly simple:
Our ambitions remain clear: to make the best fantasy miniatures in the world, to engage and inspire our customers, and to sell our products globally at a profit. We intend to do this forever. Our decisions are focused on long-term success, not short-term gains.
Isn’t there something delightful about having a clear plan?
I need to be careful not to fall in love with this company, but it might be too late. I think I already have!
Perhaps in the comments you could let me know: what is the bear case? What do I need to worry about? What have I missed?
Because as things stand, I’m struggling to find reasons to worry about this one!
Next Wednesday: our first “exclusive”
Next Wednesday at 11:00 (British Summer Time) or 06:00 (Eastern Daylight Time), I’ll publish our first exclusive article for premium readers, with my current favourite Buy idea.
I’ll be publishing two of these every month. So if you want my very best investment ideas delivered straight to your inbox, please consider subscribing.
That’s all for now - I hope you have a great weekend. And if it’s raining, maybe consider investing in some board games!
Best regards,
Graham
On pricing power and board games
Hi Graham. I discovered Catan recently too and it's completely addictive. £GAW is now my largest holding and it's difficult to find a bear case. I suppose from my own point of view, I don't use the product and I have no interest in it so it's difficult for me to have a finger on the pulse of the hobby or the changing fashions of this sort of gaming. I guess a secular shift in the popularity of the hobby would be a concern but the geographic diversification may offer protection from this to some extent. The price is indeed punchy and has been for a long time but I can only see this business growing for years ahead. Execution risk might be another concern as the latest results did highlight some customer service issues and perhaps the scale of the business is making it harder to manage whilst maintaining high levels of service. IT/ERP issues seem to be a recurring theme in results narratives too
Actually my single biggest concern is the lack of management skin in the game. Directors appear to have been consistent sellers and none are major shareholders. This is at odds with Kevin Roundtree's commentaries which always sound like the words of a passionate founder / owner (I do realise he is neither).