344. UK Mid-Cap Opportunities: Books, games and big returns

23 January 2025 (pre-recorded 22 January 2025)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION]

Staci West (SW): Welcome back to the Investing on the go podcast brought to you by FundCalibre. We’re focusing on the appeal of UK mid-cap investing and why, despite the turbulence, opportunities are abound for those willing to do the work. I’m Staci West and today I’m delighted to be talking to Alexandra Jackson, manager of the Rathbone UK Opportunities fund. Alexandra, thank you very much for joining me today.

Alexandra Jackson (AJ): Thank you for having me, Staci.

[INTERVIEW]

SW: First episode of the new year, so I want to start with something close to my heart. Books. And whist we could talk about specific books, this is an investing podcast with I want to focus on a specific holding of yours — Bloomsbury Publishing. Myself excluded, I thought people were reading less, all this news about spending too much time on your phone. It’s also not a growth industry. But Bloomsbury Publishing is different, so what is it about them that makes it so appealing?

AJ: Great question. I know you’re a voracious reader, Staci, so I love that you’re interested in Bloomsbury and you are right, the competition for eyeballs is very intense at the moment. The competition for people’s attention when they’re, as you rightly point out, there’s so much media that you could possibly consume, but actually that very competition, you know, from TV and social media, that’s actually playing quite a crucial part in bolstering book sales. And that is partly why we love Bloomsbury.

So adaptations of books into movies or TV shows something called BookTok, which we’ve talked about before. Maybe we’ll touch on that later. They’ve actually led to a surge in sales of the original works. So think Harry Potter. What happens to the Harry Potter book sales when the films come out?

So actually books are continuing to rise in popularity. We saw a record number of physical books sold in the UK during 2022, which I think people thought was a sort of post covid or a covid bounce when we all, you know, had less to do during Covid. People took sort of solace and entertainment, I think from reading a lot, but actually it’s stuck. And publishers have seen quite strong sales, but Bloomsbury is quite unusual. There aren’t many listed publishers left out there. And I think this conception that actually, you know, reading is in sort of terminal decline is what’s contributed to quite a low valuation in Bloomsbury. And that was quite appealing to us when we first bought the shares.

It’s more diversified as well, and people appreciate they have exposure to different geographies. So this isn’t just a UK business by any stretch. Different genres, different formats. So actually they’ve been able to deliver really consistent and what I think is really decent growth, they’ve averaged 12% a year over the last 10 years in terms of revenue growth. And that from what people tell you is an industry and structural decline. I think, you know, the numbers really prove out that it isn’t. So it’s great to see that. But even better is that in that timeframe they’ve also managed to grow their margins as they transition from physical to digital books, which are much more sort of cost effective. And they’ve also driven returns as well. We love that they hand back the cash that they generate to shareholders and they’ve now had 20 years of unbroken dividend growth. So it’s a really good stock from a kind of shareholder return point of view as well.

They’ve got one of the books that we’ve discussed before. One of your favourite authors, Sarah J. Maas, she is in the romance fantasy genre. She has, I think you’ll be pleased to know Staci, she’s got a new book coming out, hopefully later this year, a new book in the ACOTAR franchise. Once you’ve got an acronym, that stands for of course, A Court of Thorns and Roses. [SW: Yeah.] Once you’ve got an acronym, you know, you’ve really arrived in terms of social media, so a new book from her later this year.

SW: And it also takes up an entire shelf because her books are no small feat. They’re chunks of work. I think the last one’s like 800 pages or something. [AJ: Yes] She has an entire shelf dedicated, I think of you every time I see it. My husband calls the bookcase the trophy shelf because there’s nothing better than a physical book.

And you mentioned it briefly, which is BookTok and the surge of talking about books and the teasers from social media. I get 90% of the books that are on my to be read list probably from BookTok and social media in general. And it is obviously a driving force. It’s so easy to get stuff out to people, especially more indie authors that you wouldn’t see anywhere else. And on just TikTok and that do, is there any concerns over what is going to happen with TikTok in the US?

AJ: Hmm. I think that’s a really good question. Not one that I’ve heard lots of people ask. Actually I’m not that worried about TikTok sort of staying around anymore now that President Trump is so heavily involved in this saga. I think actually the risk of it being finally banned after the extension that he’s given is really quite low. He’s been actively touting for buyers so that the platform will be 50% US owned and will will be able to kind of continue to operate in the US. But it is, you know a little corner of TikTok that generates an extraordinary number of views, millions, billions of views of, as you say, people kind of previewing their favourite novels and particularly the more independent novelists. And actually that romance fantasy genre does really, really well there and has become hugely popular. I always see people reading them on the tube, and as you say, they’re very thick books, so they take a while and more importantly, they drive a nice margin for Bloomsbury.

SW: So before I get carried away with books, I wanted to talk about another holding, which is another hobby actually. And this is Games Workshop, so we probably, people listening know about Games Workshop, but they manufacture the Warhammer miniatures, again, a big hobby for a lot of people. But what makes the company so attractive, again, in a niche area.

AJ: Yeah, it is quite niche again and actually it shares quite a few things with Bloomsbury. Again, that theme of digital media starting to drive sales for a more physical hobby. It was also another business that was overlooked I think for a while by fund managers in the market. Slightly quirky nichey hobby, as you say. But I think recently investors have been able to kind of start to appreciate its numerous qualities, a bit more the financial qualities and, you know, maybe get over some of that snootiness. We’ve been in this one for many years, and I think on the surface, you know, it can look a bit boring and a bit quirky, but unassuming. But once you start peeling away the outer layers of this company, you find the most incredibly well run business.

They are well aware of their strengths and that market position they had have, but also the complexities of having to operate in such a niche market, but one where your customers are incredibly passionate and incredibly protective about the whole community. It really, really is a community. And that’s a really, I think that’s what a unique starting point for running a business and certainly for being an investor in a business. So the management of the business is hugely important to us, and I actually thoroughly recommend anyone you know, any investor or anyone interested in this company to read the Games Workshop annual report. It’s very short, it’s to the point. It doesn’t read like most other companies reports. They call out mistakes that they’ve made during the year, and they talk about the rationale for decisions that they’ve taken. So delaying ERP system implementation, for example, it’s just so clear and it’s very honest and it’s incredibly humble.

I’m gonna read you a little quote from it because it’s just so unusual. So the CEO says: “This 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.”

You just never hear CEOs talking like that. And let alone FTSE 100 CEOs, they’ve just gone into the FTSE 100, which is probably why lots of people have heard of it more recently. So we love that it’s run for the long term. I mean, sure, having basically no competition in your field does make that a little bit easier. You know, if you want Warhammer models, there’s only one place to go. But we also love the very rich IP that’s in there. That’s a great starting point for an investment, a a long-term investment.

They’ve got, you know, three decades of these fantastical characters, all these narratives, this sort of sci-fi universe that they’ve built up. And their customers have, as we said, have hugely loyal and they’re a bit less price sensitive than the general public. It’s a global business as well, 80% of sales now come from outside the UK and these guys control nearly every aspect of the production so they can respond quite quickly to changes in demand. All their products are designed and made in Nottingham near their HQ, and then they distribute them out to their network of independent stores. So it’s a really kind of, you know, vertically integrated business.

And then the kicker on top, which is helping to drive the shares at the moment is the royalty income that they are getting, where video games companies, for example, are licensing the Warhammer IP to include in their own games. So last year Activision confirmed that there will be a Call of Duty game with Warhammer embedded. This is a huge step forward for what people describe as a niche a niche hobby or the game that your listeners kids probably spent Christmas playing. It’s called Space Marine Two, that’s got Warhammer IP in it as well. And then they’ve also announced a Warhammer TV series with Amazon, and it’s gonna star Henry Caval, who is a huge Warhammer fan. And the way we think about this is a bit like the transition that Disney went through when they started along that kind of film and merchandising pathway and the impact that had on the financials of that business back in the midst of time.

So we think there’s, you know, a really interesting story here again, a bit like Bloomsbury, these guys are dividend royalty. They generate tons and tons of cash and they know exactly how to allocate it sensibly in the long-term interests of shareholders and the community.

SW: Also, interestingly, that both of them have a crossover with being developed into tv and movies with books and also Warhammer, you say we really can’t get away from our screens.

AJ: We can’t be allowed to.

SW: The irony of recording this virtually. You mentioned that it was a recent addition to the FTSE 100. You have been in Games Workshop since FRSE 250 days which is kind of the, well, I would say the meat of the portfolio is the FTSE 250, but you can obviously go to FTSE 100. What are you looking for when you’re going outside of the kind of mid-cap range and how far down the market cap spectrum can you go with this fund?

AJ: Hmm. I’m glad you asked that actually. It’s Games Workshop was kind of a good example of how the process is meant to work. So the whole point of this fund is to try and find those, you know, FTSE 100 players, but get in on the ground floor and give our clients exposure to the kind of higher growth that you can get a bit earlier on in the journey. But again, with those companies that are able to earn their place in the FTSE 100, so Games Workshop has sort of demonstrated that.

And then I guess other funds would then be forced to sell a stock like that when it hits the FTSE 100. We have retained kind of the most flexibility that we can do in the fund. So we’re not forced to sell any businesses, no matter where they are listed, as long as they’re listed in the UK.

So we don’t mind whether it’s FTSE 100, even small-cap or or AIM as well. We’ve got some AIM stocks maybe, we’ll come onto that is slightly different. So we don’t want to sell, we don’t want to have to sell businesses just because they hit this sort of arbitrary 5 billion or whatever hurdle. You know, some of the best returns in the portfolio have come from businesses that we’ve owned and have transitioned into FTSE 100 names.

The majority of the fund, as you say, the meat is always in FTSE 250, it’s about 50% at the moment. We’ve got more FTSE 100 exposure than we’ve had in a while. It’s about 35%. Partly because we’ve had that success, you know, companies like Games Workshop, like Diploma, Intermediate Capital have done what we hope they would do, and they’ve transitioned from the FTSE 250 and we haven’t had to sell them. But normally what would happen in the kind of usual life cycle of the fund is they would enter the FTSE 100, we would start trimming and then you recycle that capital into smaller names again, or new issues or new opportunities and so you kind of get this refresh of the portfolio.

As everyone knows, there haven’t been many IPOs and there’s delists and de-equalisation happening in the UK. So we haven’t had the chance to recycle a portfolio in quite the same way. We are not nervous about that because, you know, for the portfolio we’re not nervous about that because the names that we have that are in the FTSE, they’re so high quality names like Games Workshop. Diploma, as I said, they’re brilliant growers. They’ve got lots to recommend them. It’s just a slightly more unusual asset allocation than we used to, I guess.

AIM has historically been a really decent chunk of the portfolio because it’s where we often find the tech names in the UK. They’ll often start their life listed on AIM because they can raise capital, maybe have a bit more flexibility there. So we’ve never kind of shied away from AIM but at the moment our waiting is kind of 10%, a little bit below 10%, which is, you know, lower than it’s ever been probably because there are just some more painful structural issues there. We are in conversation with lots of our holdings about relisting. Whereas before they might say, you, you know, no, it’s management destruction, it costs a couple of million pounds. We don’t need to.

Actually, a lot of the companies now say, yeah, we’ll we’ll do it, we’ll think about it. It’s on the board’s list of priorities. So I think we’ll continue to see that AIM waiting come down. Probably only, you know, largely again, because the companies will move to the main list. And the bar I think is just, you know, incrementally higher for us to consider other AIM names. But, you know, I saw a AIM business yesterday, which was you know, tech business really defensive financials are phenomenal you know, fantastic business that I think will do incredibly well. And I’m glad that we have the flexibility to buy that. If we you know, if it gets through the process.

SW: Let’s just quickly then stick with technology because we talked a lot about hobbies, but obviously technology is such a big area and such an important area for many investors. And you have one name in particular, Bytes Technology that I wanted to to mention.

AJ: Yeah, so they’re a software reseller, which didn’t mean a lot to me when I first heard about this industry, but basically that means they take software so products like Microsoft and they will help a small or medium sized business to roll out that software across their business. So if you were a medium sized business and you didn’t have a huge IT department, or even if you had a decent sized IT department, you would need some advice and support from these software providers to help you get started with yours with the right level of provision for cybersecurity, for cloud, for even for AI maybe. But the Microsofts of this world are not doing that. They are not customer facing for small businesses for sure. So they need a middleman, and that’s where resellers like Bytes come in.

We own another one in the portfolio, which is a little bit different, but a sort of similar story, which is called Softcat. And it’s a really nice cycle in terms of the sort of the drivers for the business and the customer. So Microsoft – and their peers – need resellers to sit in the middle and offer them access to this kind of small, medium sized part of the market where it’s not worth their while to go direct. So Microsoft will offer Bytes incentives, they’ll offer them trainings support and then Bytes offers that on to their clients. So then that’s a great offer for the client. So around we go in this kind of virtuous cycle in terms of the stock, the investment case, it’s a really capital like model. They’re just passing through this software. It’s a great way to play Microsoft in the UK. And generally that kind of burgeoning IT requirements in that we all have in this digital world.

Particularly cyber AI, I don’t know many even medium-sized business owners who feel totally confident in their approach to cyber, cloud, AI, all of those things and would love some advice. We also think it’s a bit more defensive than other parts of the software market because most of the spend that runs through Bytes is about sort of business as usual stuff. It’s run rate, it’s normal course of business. It’s not those large digital transformation projects, which they can be very profitable when you’re at the peak of doing those. But they’re much more cyclical, they’re much more macro dominated, and when they fall away you’ve got a big cost base to try and cover somehow. So we like that it’s more run rate type business. It’s a bit smoother.

The stock has de-rated recently though, due to they’ve had some management issues, management changes and, you know, whisper it possibly a little bit of overhyping around the speed at which all our jobs are gonna be taken over by AI. So while we wait for that to happen Bytes gives you double digit growth in a structurally supported environment. They’ve got net cash in the balance sheet, so that gives them opportunities for M&A or probably more likely to be shareholder returns.

SW: Well, you alluded to it earlier, which is it’s no secret that the UK has been a difficult place to be for the better part of what, seven, eight years now. So how do you go, how do you approach that? Does it make coming to work just really difficult some days? Or actually, are you finding, as you mentioned earlier, that it’s creating more opportunities for you and that makes it exciting, if not kind of depressed sentiment, how does that impact you?

AJ: Gosh, this really is like a therapy session. I love it. I think if you are still running money in UK SMID-caps right now, after, as you say the last you know, almost decade or so, then you are you are very resilient by now. And you’ve probably got a very supportive you know, boss and kind of team environment around you that still believes in UK equities. So, and I think if you like, you know, if you like a challenge, if you thrive on kind of, oh, this is a bit tough, but I think I can make this work.

And if you’re, if you are still passionate about the UK and you know, like one fund manager said to me yesterday, if you still got the fire, then you know, a difficult market is definitely not something that would depress you.

It’s something that hopefully kind of fires you up and allows you to, I don’t to to show what you can do, you know, if you really lean into this the UK market is almost like less than the sum of its parts. I would say at the moment. What we see is bottom up some really, really good companies. We’ve talked about a couple of them, but you know, the portfolio is chock full of them and I’ve got, you know, a long watch list as well.

So it sort of feels like if you can, you know, duck and dive a bit and be a bit nimble then there’s, you know, there’s quite a lot to prove. I find that exciting still. I’ve definitely still got the fire. I’ve been out on the road seeing companies. I was in Bath and Bristol last week seeing industrial companies and going on site visits, going around factories, putting on my hard hat and my steel steel toed boots. Seeing the incredible technology and IP and in kind of engineering know-how that is on an offer in the UK market is absolutely, it is absolutely incredible what these little businesses do that most global investors have never heard of. And when you look at the rating compared to the well-known US version you can see that there’s so much value that we can capture.

SW: So do you think things are looking up?

AJ: Looking up? Okay. Are things looking up? I don’t know. I don’t know in the short term about that because, you know, you’ve got quite a contrast at the moment between a US president who is, you know, go-go growth very pro his own domestic economy, putting America first, as we know, deregulating cutting taxes and all of those things are very, very good for the stock market. That’s the kind of thing investors love to talk about.

Whereas in the UK we have a government that is so far been kind of following almost the opposite tack of higher taxes, more burden on companies, whether they mean it on, whether they meant to or not, the result is, it’s harder to operate in this domestic economy. So from that point of view, the US does look kind of more appealing when you look at it like that.

But actually the positioning is now so crowded in the US everyone is so overweight US equities and valuations look very lofty trumped up – I call them – in some parts and it just leaves so little room for error, it leaves very little cushion in case of any kind of macro slowdown or as we saw kind of stickier inflation. And if rates in the US can’t come down as quickly as the market’s expecting, you get this yield rising and that’s very difficult for stocks when they trade on, you know, kind of over 20 times.

So in the short term, maybe, you know, that kind of case for US exceptionalism continues a little bit, but there are clients who are increasingly saying to us, what if it doesn’t work out perfectly in the US? What if Trump, you know, overplays his hand or says something stupid or, and, you know, I don’t know what the chances of that are. But the UK is kind of sitting here waiting with some of these global world class businesses on a massive discount. And actually I just saw that M&A has reached a five year high in the UK market incoming. So people are definitely spotting this opportunity.

SW: And then just finally, what would be your parting words to investors then who are looking at the UK considering adding it to their portfolio? What’s the case for it today?

AJ: If we don’t buy these names, someone else will.

SW: There you go. Done <laugh>.

AJ: That’s it.

SW: That’s the bottom line. If I’ve ever heard one.

AJ: Short and simple, I’m gonna learn from Games Workshop.

SW: Love it. On that note I will end it there. So thank you very much for joining me and talking through a lot of examples in the fund but also the market and where you’re seeing opportunities.

AJ: Thank you so much, Staci.

SW: Rathbone UK Opportunities is a flexible fund targeting quality growth businesses, looking to take advantage of cheap UK valuations. The fund combines structural winners with a strong core of high-quality compounders with a final portfolio of around 50 to 60 holdings, with a bias to mid-cap stocks.