leapfrog enterprises inc. november 20, 2014 yuan chen, chen liang, yiqi (delia) ye
TRANSCRIPT
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
ABBVABTAEOALCOFJKHYLFNHCPETMSNAUNPWAGZIXI
LF 5.80%
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)
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
Three main retailers:
Wal-Mart
Toys R Us
Target
United States; 70%
United Kingdom; 11%
Other Countries; 19%
Wal-Mart; 25%
Toys "R" Us; 15%
Target; 11%
Others; 49%
Global Revenue Breakdown:
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 Over 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/
Macroeconomics Overview
Source: Federal Reserve Bank of St. Louis (http://research.stlouisfed.org/fred2/series/A229RX0)
Consumer confidence Per Capita Disposable income
Macroeconomics Overview
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/)
-
200,000,000.00
400,000,000.00
600,000,000.00
800,000,000.00
1,000,000,000.00
1,200,000,000.00
1,400,000,000.00
Population (Age<15)
2014 Population
2030 Population Projec-tion
United Kingdom
United States
France
Toy spending per child worldwide Child population distribution
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
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 AnalysisStrength Weakness
• 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
Opportunities Threats
• 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
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
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
2011 2012 2013
18,765
61,960
33,826
19,902
86,452 84,009
13,222
42,814
21,250
Net Income after Valuation Allowance Ad-justment
Taxable Income Net Income Adjusted Net Income
Source: LeapFrog 10K 2013, Page 42, 56-58
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
2009 2010 2011 2012 2013 2014E0.0
1.0
2.0
3.0
4.0
5.0
6.0
Current Ratio Quick Ratio
2009 2010 2011 2012 2013 2014E-20%-10%
0%10%20%30%40%50%
Gross margin Net margin
2009 2010 2011 2012 2013 2014E-0.5
0
0.5
1
1.5
2
2.5
3
Return on Equity Tax burden
Other expense burden Operating margin
Asset turnover Leverage
2009 2010 2011 2012 2013 2014E-0.4
-0.2
0.0
0.2
0.4
0.6
Greenblatt ratio 1 (EBIT/Tangible Assets)
2009 2010 2011 2012 2013 2014E-20%
-10%
0%
10%
20%
30%
Return on equityReturn on asset
Liquidity ratio Operating efficiency
Greenblatt ratio Return ratio
Dupont analysis
Source: LeapFrog 10K 2013
Trading comparable analysisComparables
(USD'000)
Company NameMarCap
($mn) P/E P/BVEV/
EBITDAEV/
EBITEV/
RevenueEV/Forward
RevenueEV/Forward
EBITDA
LeapFrog (NYSE:LF) 354.3 4.80x 0.90x 7.20x 11.70x 0.50x 0.51x 8.79xMattel (NasdaqGS:MAT) 10,500.2 14.90x 11.40x 10.60x 13.20x 2.00x 1.95x 10.45xHasbro (NasdaqGS:HAS) 6,789.3 18.90x 12.00x 9.80x 12.70x 1.90x 1.81x 9.31xVtech Holdings (SEHK:303) 3,439.3 16.30x 6.70x 12.50x 14.20x 1.70x 1.68x 11.70x
High 18.90x 12.00x 10.60x 13.20x 2.00x 1.95x 10.45xLow 4.80x 0.90x 7.20x 11.70x 0.50x 0.51x 8.79xMedian 14.90x 11.40x 9.80x 12.70x 1.90x 1.81x 9.31xMean 12.87x 8.10x 9.20x 12.53x 1.47x 1.42x 9.52x
14E
Revenue15E
Revenue15E
EBITDALeapFrog Financials 435,016 479,407 20,831 EV 638,023 682,357 198,237 + Cash 150,868 150,868 150,868 Equity Value 788,892 833,225 349,105 Shares outstanding 70052 70052 70052Implied share price 11.26 11.89 4.98
Source: Capital IQ as of 2014/11/17
SCENARIO
2015 2016 2017 2018Multimedia GrowthOptimistic 20% 15% 12% 12%Base case 15% 12% 12% 10%Pessimistic 12% 10% 10% 5%
Learning toys GrowthOptimistic -5% 0% 0% 0%Base case -5% -5% 0% 0%Pessimistic -8% -8% -5% -5%
All others GrowthOptimistic -5% 0% 0% 0%Base case -5% -5% 0% 0%Pessimistic -8% -8% -5% -5%
Cost of sales AssumtionsOptimistic 60% 59% 58% 57%Base case 60% 59% 58% 57%Pessimistic 60% 60% 59% 58%
2014 4th quarter as % of total salesOptimistic 54.0%Base case 50.0%Pessimistic 46.0%
REVENUE
2011 2012 2013 2014ESegment Multimedia learning platforms
315,300
463,100
441,200
351,572
% of total 69% 80% 80% 81% Growth 47% -5% -20%
Learning toys
132,000
113,500
109,500 80,849
% of total 29% 20% 20% 19% Growth -14% -4% -26%
All other
7,800
4,700
2,900
2,595 % of total 2% 1% 1% 1% Growth -40% -38% -11%
Total net sales
455,100
581,300
553,600
435,016 Growth 28% -5% -21%
COSTS
Cost of sales
268,988 336,344 337,565 283,639
% of sales
59% 58% 61% 61%
DCF Assumptions & Three scenarios
Seasonality
4th quarter net sales as % of total sales46% 42% 34%
Source: LeapFrog 10K 2013
FCF, WACC and Terminal ValueStep 1: FCF calculation
2014 2015 2016 2017 2018(USD'000)EBIT (37,407) 11,047 22,095 36,146 50,513- Tax 0 695 1,412 2,323 16,277= EBIAT or NOPAT (37,407) 10,352 20,684 33,822 34,235+ Depreciation & amortization 11,044 10,784 11,484 12,919 14,502- 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) 7,340 18,623
Step 2: WACC calculation
Risk free rate 2.5% S&P regression BetaMarket risk premium 6.5% 5 year 1.49
Equity beta 1.19
4 year 1.07
Cost of equity (CAPM) 10.27% 3 year 1.035-year annualized return 11.76% Average Beta 1.19Average 11.01%Business risk premium 2.00%
Debt to Asset ratio 0
WACC 13.01%
Step 3: Terminal value calculation
Growing perpetuity method
Normalized FCF (last yr of projections) 18,623.4
Assumed perpetual growth rate 3.0%
Implied terminal value (at 2018) 191,610
Source: LeapFrog 10K 2013
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) 0.0 1.0 2.0 3.0 4.0Discount 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 rateImplied share price (USD) 2.89 2.50% 2.75% 3.00% 3.25% 3.50%
14.01% 2.61 2.65 2.68 2.72 2.7613.51% 2.70 2.74 2.78 2.82 2.87
WACC vs. perpetual growth rate
WACC 13.01% 2.80 2.85 2.89 2.94 2.99
12.51% 2.91 2.96 3.01 3.07 3.1212.01% 3.04 3.09 3.15 3.21 3.27
Perpetual growth rateImplied share price (USD) 2.89 2.50% 2.75% 3.00% 3.25% 3.50%
1.49 2.62 2.65 2.69 2.73 2.771.39 2.67 2.71 2.75 2.79 2.83
Beta vs. perpetual growth rate Beta 1.29 2.74 2.78 2.82 2.86 2.911.19 2.80 2.85 2.89 2.94 2.991.09 2.87 2.92 2.97 3.02 3.07
Implied share price (USD) 2.89
Current share price (USD) 5.45
% premium / (discount) to current (46.95%)
Source: LeapFrog 10K 2013
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%)
Sell 2000 shares @ mkt
Recommendation