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Leapfrog Enterprises Inc. November 20, 2014 Yuan Chen, Chen Liang, Yiqi (Delia) Ye
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Agenda Current Holdings Company Overview Macroeconomic Review Industry Review Business Strategy & Corporate Governance Financial Analysis Valuation Recommendation
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Current Position 2,000 shares bought on April 5th, 2013 @ $8.19 Current Price: $5.45 (11/19/2014) Total Loss: -33.49% Portfolio Shares (MV): 5.80% Source: Yahoo! Finance RCMP Portfolio (https://finance.yahoo.com/portfolio/pf_1)https://finance.yahoo.com/portfolio/pf_1
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Relevant Stock Performance Source: Bloomberg Finance: LF & Russell 2000 Index Spread
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Company Overview Traded on the NYSE with ticker symbol LF Founded in 1995 by Micheal Wood and Robert Lally and headquartered in Emeryville, California USA GICS Sector: Leisure Products Sub-Industry: Toys & Games Focus: Educational entertainment toys 579 full-time employees as of December 31, 2013 Source: LeapFrog 10K 2013, Bloomberg Finance
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Business Segments & Distribution Channel Three main retailers: Wal-Mart Toys R Us Target Global Revenue Breakdown: Source: LeapFrog 10K 2013: Page 67,69
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Major Products & Services Products: Multimedia learning platforms LeapPad Family of Learning Tablets (3-9 yrs.) Leapster Family of Handheld Learning Game System (4-9 yrs.) LeapReader Reading System (1-8 yrs.) LeapTV (3-8 yrs.) Learning toys Dozens of Product Lines (0-6 yrs.) Services: LeapFrog Learning Path Over 1,200 downloadable Apps in Online Application Center Source: LeapFrog Website http://www.leapfrog.com/en-us/store/http://www.leapfrog.com/en-us/store/
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Major Products & Services LeapPad 2LeapPad UltraLeapPad 3LeapTV Release DateJune 2012June 2013June 2014October 2014 Price$ 79.99$ 129.99$ 99.99$ 149.99 Age Range3-9 years 3-8 years AppsOver 1,200 Apps 100+ Games & Videos 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/http://www.leapfrog.com/en-us/store/
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Macroeconomics Overview Source: Federal Reserve Bank of St. Louis (http://research.stlouisfed.org/fred2/series/A229RX0)http://research.stlouisfed.org/fred2/series/A229RX0 Consumer confidencePer Capita Disposable income
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Macroeconomics Overview Source: Population Reference Bureau (http://www.prb.org/DataFinder/Topic/Bars.aspx?ind=14&loc=246,310,341,355,412,463,241),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/)http://www.statista.com/statistics/194424/amount-spent-on-toys-per-child-by-country-since-2009/ United Kingdom United States France Toy spending per child worldwideChild population distribution
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Porter 5 Forces Analysis ― Toys and Games Industry Porter 5 Forces Barrier to entry: Moderate & Decreasing · High-cost and long-term nature of brand reputation · Declining life-cycle · Targeting niche markets Competition: High & Steady · Numerous players · Low profit margin · Short-lived and/or seasonal · Technology · Other leisure activities Bargaining Power of Buyers: Moderate & Decreasing · Players being retailers · Low individual profitability and prevalence of available end customers Bargaining Power of Suppliers: Moderate & Steady · Licensing rights on popular brands · Less substitute products · Forward integration · Government regulation Threat of Substitutes: Moderate & Increasing · Psychographic shifts · Digital games, education and entertainment · Low switching costs · Peer affect
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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
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SWOT Analysis StrengthWeakness 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 Price premium All products under single brand Seasonal High fixed costs OpportunitiesThreats Demographic and psychographic shifts International expansion New platform Downloadable content library 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
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Weakness and Risks Price Premium High Fixed costs Overly Concentrated Distribution Channel Three biggest retailers accounts for more than 50% of net sales Highly Seasonal and Fluctuating 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
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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 Source: LeapFrog 10K 2013, Page 42, 56-58
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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
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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
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Technical Analysis Source: Bloomberg as of 11/19/2014
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Ratio analysis Liquidity ratioOperating efficiency Greenblatt ratioReturn ratio Dupont analysis Source: LeapFrog 10K 2013
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Trading comparable analysis Comparables (USD'000) Company Name MarCap ($mn)P/EP/BV EV/ EBITDA EV/ EBIT EV/ Revenue EV/Forward Revenue EV/Forward EBITDA LeapFrog (NYSE:LF)354.34.80x0.90x7.20x11.70x0.50x0.51x8.79x Mattel (NasdaqGS:MAT)10,500.214.90x11.40x10.60x13.20x2.00x1.95x10.45x Hasbro (NasdaqGS:HAS)6,789.318.90x12.00x9.80x12.70x1.90x1.81x9.31x Vtech Holdings (SEHK:303)3,439.316.30x6.70x12.50x14.20x1.70x1.68x11.70x High18.90x12.00x10.60x13.20x2.00x1.95x10.45x Low4.80x0.90x7.20x11.70x0.50x0.51x8.79x Median14.90x11.40x9.80x12.70x1.90x1.81x9.31x Mean12.87x8.10x9.20x12.53x1.47x1.42x9.52x 14E Revenue 15E Revenue 15E EBITDA LeapFrog Financials435,016479,40720,831 EV638,023682,357198,237 + Cash 150,868 Equity Value788,892833,225349,105 Shares outstanding70052 Implied share price 11.2611.894.98 Source: Capital IQ as of 2014/11/17
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SCENARIO 2015 201620172018 Multimedia Growth Optimistic 20%15%12% Base case15%12% 10% Pessimistic12%10% 5% Learning toys Growth Optimistic -5%0% Base case-5% 0% Pessimistic-8% -5% All others Growth Optimistic -5%0% Base case-5% 0% Pessimistic-8% -5% Cost of sales Assumtions Optimistic 60%59%58%57% Base case60%59%58%57% Pessimistic60% 59%58% 2014 4th quarter as % of total sales Optimistic 54.0% Base case50.0% Pessimistic46.0% REVENUE 2011201220132014E Segment Multimedia learning platforms 315,300 463,100 441,200 351,572 % of total69%80% 81% Growth 47%-5%-20% Learning toys 132,000 113,500 109,500 80,849 % of total29%20% 19% Growth -14%-4%-26% All other 7,800 4,700 2,900 2,595 % of total2%1% Growth -40%-38%-11% Total net sales 455,100 581,300 553,600 435,016 Growth 28%-5%-21% COSTS Cost of sales268,988336,344337,565283,639 % of sales59%58%61% DCF Assumptions & Three scenarios Seasonality 4th quarter net sales as % of total sales 46%42%34% Source: LeapFrog 10K 2013
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FCF, WACC and Terminal Value Step 1: FCF calculation 20142015201620172018 (USD'000) EBIT (37,407)11,04722,09536,14650,513 - Tax 06951,4122,32316,277 = EBIAT or NOPAT (37,407)10,35220,68433,82234,235 + Depreciation & amortization 11,04410,78411,48412,91914,502 - CAPEX (34,908)(33,403)(27,110)(21,999)(14,068) - Capitalization of goods (8,801)(7,518)(6,523)(7,071)(7,554) - Increase in NWC 38,451(5,008)(5,369)(10,332)(8,493) = FCF (31,621)(24,794)(6,833)7,34018,623 Step 2: WACC calculation Risk free rate2.5% S&P regressionBeta Market risk premium6.5% 5 year1.49 Equity beta 1.19 4 year1.07 Cost of equity (CAPM)10.27% 3 year1.03 5-year annualized return11.76% Average Beta1.19 Average11.01% Business risk premium2.00% Debt to Asset ratio0 WACC13.01% Step 3: Terminal value calculation Growing perpetuity method Normalized FCF (last yr of projections) 18,623.4 Assumed perpetual growth rate3.0% Implied terminal value (at 2018) 191,610 Source: LeapFrog 10K 2013
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DCF and Sensitivity Analysis Step 4: Discounted cash flows (USD'000) FCF (31,621.0) (24,793.5) (6,833.3) 7,340.1 18,623.4 Counter (present = end of 2014) 0.01.02.03.04.0 Discount factor 100.0%88.5%78.3%69.3%61.3% Discounted CFs (31,621.0) (21,939.1) (5,350.4) 5,085.6 11,417.6 Sum of PV of CFs (42,407) PV of terminal value 117,473 Implied EV 75,065 + Cash 127,467 Equity Value 202,532.5 Diluted shares outstanding (‘000) 70,052.0 Implied share price (USD) 2.89 Step 5: Sensitivity analysis Perpetual growth rate Implied share price (USD) 2.892.50%2.75%3.00%3.25%3.50% 14.01%2.612.652.682.722.76 13.51%2.702.742.782.822.87 WACC vs. perpetual growth rateWACC 13.01%2.802.852.892.942.99 12.51%2.912.963.013.073.12 12.01%3.043.093.153.213.27 Perpetual growth rate Implied share price (USD) 2.892.50%2.75%3.00%3.25%3.50% 1.492.622.652.692.732.77 1.392.672.712.752.792.83 Beta vs. perpetual growth rateBeta 1.292.742.782.822.862.91 1.192.802.852.892.942.99 1.092.872.922.973.023.07 Implied share price (USD) 2.89 Current share price (USD) 5.45 % premium / (discount) to current(46.95%) Source: LeapFrog 10K 2013
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Recommendation Weighted stock price valuation CaseImplied share priceWeighting Optimistic5.8130% Base2.8960% Pessimistic0.0610% Weighted share price$ 3.48 Current price$ 5.45 % premium / (discount) to current(36.1%) Sell 2000 shares @ mkt Recommendation
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