Leapfrog
Enterprises Inc.
November 20, 2014
Yuan Chen, Chen Liang, Yiqi (Delia) Ye
Agenda








Current Holdings
Company Overview
Macroeconomic Review
Industry Review
Business Strategy & Corporate Governance
Financial Analysis
Valuation
Recommendation
Current Position

2,000 shares bought on April 5th, 2013 @ $8.19

Current Price: $5.45 (11/19/2014)

Total Loss: -33.49%

Portfolio Shares (MV): 5.80%
LF 5.80%
Source: Yahoo! Finance RCMP Portfolio (https://finance.yahoo.com/portfolio/pf_1)
ABBV
ABT
AEO
AL
COF
JKHY
LF
NHC
PETM
SNA
UNP
WAG
ZIXI
Relevant Stock Performance
Source: Bloomberg Finance: LF & Russell 2000 Index Spread
Company Overview

Traded on the NYSE with ticker symbol LF

Founded in 1995 by Micheal Wood and Robert Lally and headquartered
in Emeryville, California USA

GICS Sector: Leisure Products

Sub-Industry: Toys & Games

Focus: Educational entertainment toys

579 full-time employees as of December 31, 2013
Source: LeapFrog 10K 2013, Bloomberg Finance
Business Segments
& Distribution Channel
Global Revenue Breakdown:
Other Countries,
19%
Three main retailers:

Wal-Mart

Toys R Us

Target
United Kingdom,
11%
United States,
70%
Wal-Mart,
25%
Others,
49.00%
Toys "R" Us,
15%
Target,
11%
Source: LeapFrog 10K 2013: Page 67,69
Major Products & Services

Products:


Multimedia learning platforms

LeapPad Family of Learning Tablets (3-9 yrs.)

Leapster Family of Handheld Learning Game System (4-9 yrs.)

LeapReader Reading System (1-8 yrs.)

LeapTV (3-8 yrs.)
Learning toys


Dozens of Product Lines (0-6 yrs.)
Services:

LeapFrog Learning Path

Over 1,200 downloadable Apps in Online Application Center
Source: LeapFrog Website http://www.leapfrog.com/en-us/store/
Major Products & Services
LeapPad 2
LeapPad Ultra
LeapPad 3
LeapTV
Release Date
June 2012
June 2013
June 2014
October 2014
Price
$ 79.99
$ 129.99
$ 99.99
$ 149.99
Age Range
3-9 years
3-9 years
3-9 years
3-8 years
Apps
100+ Games
& Videos
Over 1,200 Apps
Peer-to-peer
play
×
✓
✓
✓
Amazon Rating
4.5/5.0
(860)
3.5/5.0
(754)
4.5/5.0
(143)
4.5/5.0
(58)
Source: Amazon, LeapFrog Website http://www.leapfrog.com/en-us/store/
Macroeconomics Overview
Consumer confidence
Per Capita Disposable income
Source: Federal Reserve Bank of St. Louis (http://research.stlouisfed.org/fred2/series/A229RX0)
Macroeconomics Overview
Toy spending per child worldwide
Child population distribution
United Kingdom
United States
France
Billions
Population (Age<15)
1.40
1.20
1.00
0.80
0.60
0.40
0.20
-
Source: Population Reference Bureau (http://www.prb.org/DataFinder/Topic/Bars.aspx?ind=14&loc=246,310,341,355,412,463,241),
Statista (http://www.statista.com/statistics/194424/amount-spent-on-toys-per-child-by-country-since-2009/)
2014 Population
2030 Population Projection
Porter 5 Forces Analysis
― Toys and Games Industry
Barrier to entry:
Moderate & Decreasing
· High-cost and long-term nature of
brand reputation
· Declining life-cycle
· Targeting niche markets
Threat of Substitutes:
Moderate & Increasing
Competition:
High & Steady
· Psychographic shifts
· Numerous players
· Digital games, education and
entertainment
· Low switching costs
Porter 5 Forces
· Peer affect
· Low profit margin
· Short-lived and/or seasonal
· Technology
· Other leisure activities
Bargaining Power of Suppliers:
Moderate & Steady
Bargaining Power of Buyers:
Moderate & Decreasing
· Licensing rights on popular brands
· Players being retailers
· Less substitute products
· Low individual profitability and
prevalence of available end customers
· Forward integration
· Government regulation
Competitors Analysis

Multimedia learning products
Vtech Holding Ltd.
Fuhu, Inc.

Learning toy category
Vtech Holdings Ltd.
Mattel, Inc.: Fisher-Price brand
Hasbro, Inc.: Playskool division

General tablet computers and eBook readers: Apple, Amazon and Samsung,
and the Sony and Nintendo handheld gaming systems
SWOT Analysis
Strength
•
•
•
•
•
•
Higher quality educational products
Age-appropriate and personalized education
curricula
Award-winning learning solutions
Online learning world for children
Easy-to-use parent resource center
No interest-bearing long-term debt
Opportunities
•
•
•
•
Demographic and psychographic shifts
International expansion
New platform
Downloadable content library
Weakness
•
•
•
•
Price premium
All products under single brand
Seasonal
High fixed costs
Threats
•
•
•
•
•
Safety standard
Competitors
Loss skilled workers
Industry declining
Highly changeable consumer preferences
Source: Q2 2015 LeapFrog Enterprises Inc. Earnings Call, LeapFrog Enterprises Inc. 10-K
Weakness and Risks

Price Premium

High Fixed costs

Overly Concentrated Distribution Channel


Highly Seasonal and Fluctuating Sales


Three biggest retailers accounts for more than 50% of net sales
More than 70% of sales is made during holiday season each year
Highly Changeable Consumer Preference and Product Trend

Sales is highly depend on new product
Source: LeapFrog 10K 2013, Page 10-17
Risk Factors – A Special Concern

Suspicious Earnings of 2012 and 2013

Changes in Valuation Allowance account for 50% and 75% of Net Income in
2012 and 2013, respectively
Net Income after Valuation Allowance Adjustment
Taxable Income
Net Income
Adjusted Net Income
86
84
62
43
34
19
21
20
13
2011
Source: LeapFrog 10K 2013, Page 42, 56-58
2012
2013
Business Strategy

Build an operational foundation to support future



Invest heavily in new platform and content library development
Looking into international market

Increase international revenue to 50% of total revenue

New Chief International Officer, Antony Hicks
Leverage content assets across many platforms

1200+ apps for tablets & 100+ games and videos for LeapTV
Source: LeapFrog Website, Earnings Call Transcript Q2 2015: Page 3-5, 10
Corporate Governance


Aged Management Team & Board Directors:

Average Executives And Board Mambers Age: 57+

Management team’s capability is questioned
High Level of Executive Compensation:

11.18 million, 2% of net sales

Competitors’ compensation/net sales ratio is under 1%
(Hasbro 0.8%; Mattel 0.4%)

ISS Governance QuickScore is 8, as of Nov 1, 2014.

Audit: 5; Board: 8; Shareholder Rights: 7; Compensation: 8
Source: LeapFrog 10K 2013, Morningstar Company Report: Page 13-18, Yahoo Finance: Corporate Governance
Technical Analysis
Source: Bloomberg as of 11/19/2014
Ratio analysis
Liquidity ratio
Operating efficiency
6.0
Dupont analysis
50%
40%
30%
20%
10%
0%
-10%
-20%
5.0
4.0
3.0
2.0
1.0
0.0
2009
2010
2011
Current Ratio
2012
2013
3
2.5
2
2009
2014E
2010
2011
Gross margin
Quick Ratio
Greenblatt ratio
2012
2013 2014E
Net margin
1
Return ratio
0.6
30%
0.4
20%
0.2
10%
0.0
0%
-0.2
-10%
1.5
0.5
0
-0.5
2009
-20%
-0.4
2009
2010
2011
2012
2013 2014E
Greenblatt ratio 1 (EBIT/Tangible Assets)
Greenblatt ratio 2 (EBIT/EV)
Source: LeapFrog 10K 2013
2009
2010
2011
Return on equity
2012
2013 2014E
Return on asset
2010
2011
2012
2013
2014E
Return on Equity
Tax burden
Other expense burden
Operating margin
Asset turnover
Leverage
Trading comparable analysis
Comparables
(USD'000)
Company Name
LeapFrog (NYSE:LF)
Mattel (NasdaqGS:MAT)
Hasbro (NasdaqGS:HAS)
Vtech Holdings (SEHK:303)
High
Low
Median
Mean
LeapFrog Financials
EV
+ Cash
Equity Value
Shares outstanding
Implied share price
Source: Capital IQ as of 2014/11/17
MarCap
($mn)
P/E
P/BV
EV/
EBITDA
EV/
EBIT
EV/
Revenue
EV/Forward
Revenue
EV/Forward
EBITDA
354.3
10,500.2
6,789.3
3,439.3
4.80x
14.90x
18.90x
16.30x
0.90x
11.40x
12.00x
6.70x
7.20x
10.60x
9.80x
12.50x
11.70x
13.20x
12.70x
14.20x
0.50x
2.00x
1.90x
1.70x
0.51x
1.95x
1.81x
1.68x
8.79x
10.45x
9.31x
11.70x
18.90x
4.80x
14.90x
12.87x
12.00x
0.90x
11.40x
8.10x
10.60x
7.20x
9.80x
9.20x
13.20x
11.70x
12.70x
12.53x
2.00x
0.50x
1.90x
1.47x
1.95x
0.51x
1.81x
1.42x
10.45x
8.79x
9.31x
9.52x
14E
Revenue
435,016
638,023
150,868
788,892
70052
11.26
15E
Revenue
479,407
682,357
150,868
833,225
70052
11.89
15E
EBITDA
20,831
198,237
150,868
349,105
70052
4.98
DCF Assumptions & Three scenarios
SCENARIO
REVENUE
2011
Segment
Multimedia learning platforms
% of total
Growth
Learning toys
% of total
Growth
All other
% of total
Growth
Total net sales
Growth
2012
2013
2014E
315,300
69%
463,100
80%
47%
441,200
80%
-5%
351,572
81%
-20%
132,000
29%
113,500
20%
-14%
109,500
20%
-4%
80,849
19%
-26%
7,800
2%
4,700
1%
-40%
2,900
1%
-38%
2,595
1%
-11%
581,300
28%
553,600
-5%
435,016
-21%
455,100
COSTS
Cost of sales
% of sales
268,988
59%
336,344
58%
337,565
61%
283,639
61%
Seasonality
4th quarter net sales as % of total sales
46%
Source: LeapFrog 10K 2013
42%
34%
2015
2016
2017
2018
Multimedia Growth
Optimistic
Base case
Pessimistic
20%
15%
12%
15%
12%
10%
12%
12%
10%
12%
10%
5%
Learning toys Growth
Optimistic
Base case
Pessimistic
-5%
-5%
-8%
0%
-5%
-8%
0%
0%
-5%
0%
0%
-5%
All others Growth
Optimistic
Base case
Pessimistic
-5%
-5%
-8%
0%
-5%
-8%
0%
0%
-5%
0%
0%
-5%
Cost of sales Assumtions
Optimistic
60%
Base case
60%
Pessimistic
60%
59%
59%
60%
58%
58%
59%
57%
57%
58%
2014 4th quarter as % of total sales
Optimistic
54.0%
Base case
50.0%
Pessimistic
46.0%
FCF, WACC and Terminal Value
Step 1: FCF calculation
(USD'000)
EBIT
- Tax
= EBIAT or NOPAT
+ Depreciation & amortization
- CAPEX
- Capitalization of goods
- Increase in NWC
= FCF
2014
2015
2016
2017
2018
(37,407)
0
(37,407)
11,044
(34,908)
(8,801)
38,451
(31,621)
11,047
695
10,352
10,784
(33,403)
(7,518)
(5,008)
(24,794)
22,095
1,412
20,684
11,484
(27,110)
(6,523)
(5,369)
(6,833)
36,146
2,323
33,822
12,919
(21,999)
(7,071)
(10,332)
7,340
50,513
16,277
34,235
14,502
(14,068)
(7,554)
(8,493)
18,623
Step 2: WACC calculation
Risk free rate
Market risk premium
Equity beta
Cost of equity (CAPM)
5-year annualized return
Average
Business risk premium
Step 3: Terminal value calculation
2.5%
6.5%
1.19
10.27%
11.76%
11.01%
2.00%
S&P regression
5 year
4 year
3 year
Average Beta
Beta
1.49
1.07
1.03
1.19
Growing perpetuity method
Normalized FCF (last yr of projections)
Assumed perpetual growth rate
Implied terminal value (at 2018)
Debt to Asset ratio
WACC
Source: LeapFrog 10K 2013
0
13.01%
18,623.4
3.0%
191,610
DCF and Sensitivity Analysis
Step 4: Discounted cash flows
(USD'000)
FCF
Counter (present = end of 2014)
Discount factor
Discounted CFs
Sum of PV of CFs
PV of terminal value
Implied EV
+ Cash
Equity Value
Diluted shares outstanding (‘000)
Implied share price (USD)
(31,621.0)
0.0
100.0%
(31,621.0)
(42,407)
117,473
75,065
127,467
202,532.5
70,052.0
2.89
(24,793.5)
1.0
88.5%
(21,939.1)
(6,833.3)
2.0
78.3%
(5,350.4)
7,340.1
3.0
69.3%
5,085.6
18,623.4
4.0
61.3%
11,417.6
Implied share price (USD)
2.89
Current share price (USD)
5.45
% premium / (discount) to current
(46.95%)
Step 5: Sensitivity analysis
Implied share price (USD)
WACC vs. perpetual growth rate
WACC
Implied share price (USD)
Beta vs. perpetual growth rate
Source: LeapFrog 10K 2013
14.01%
13.51%
13.01%
12.51%
12.01%
2.50%
2.61
2.70
2.80
2.91
3.04
Perpetual growth rate
2.75%
3.00%
2.65
2.68
2.74
2.78
2.85
2.89
2.96
3.01
3.09
3.15
3.25%
2.72
2.82
2.94
3.07
3.21
3.50%
2.76
2.87
2.99
3.12
3.27
1.49
1.39
1.29
1.19
1.09
2.50%
2.62
2.67
2.74
2.80
2.87
Perpetual growth rate
2.75%
3.00%
2.65
2.69
2.71
2.75
2.78
2.82
2.85
2.89
2.92
2.97
3.25%
2.73
2.79
2.86
2.94
3.02
3.50%
2.77
2.83
2.91
2.99
3.07
2.89
2.89
Beta
Recommendation
Weighted stock price valuation
Case
Implied share price
Weighting
Optimistic
5.81
30%
Base
2.89
60%
Pessimistic
0.06
10%
Weighted share price
$ 3.48
Current price
$ 5.45
% premium / (discount) to current
(36.1%)
Recommendation
 Sell
2000 shares @ mkt