LF - Leapfrog

[yudeng2004]

I think what you're saying is LeapFrog will be the leading brand in this category, the Disney or Coke of child-hood entertainment. And I'm somewhat skeptical on whether that's a defendable position, and whether they can get the type of top-of-mind share that these other companies can have, particularly in this category. I mean, I would expect there to be a lot of competitors in the edu-tainment space that can easily get into this market and a lot of deeper pockets that can finance it..?

 

Obviously another worry is the sales around Christmas, etc, which makes it hard to distinguish from fad-ish toys that may be "hot" for one or two years and drop off subsequently.

 

Good analysis though. I'm more comfortable about the company now, than when we first started.

 

I eventually learned that "EDU-tainment(education through entertainment)" is different from "pure entertainment".  If it was all about childhood entertainment, parents could actually just get a Nintendo Gameboy - specifically made for that purpose and better than any tablet out there with the best games.

 

But LeapFrog's origin is in childhood EDU-tainment - they were the leading brand in this niche even before the LeapPad came out .  Their products are specifically designed to teach language, math, writing skills in an entertaining way.  You see the LeapPad has a Pen that comes with it, whereas the iPad mini or android are touch-screen based.  The reason is because LeapFrog offer apps designed by their education experts specifically for teaching writing skills.  Now how would you teach a kid writing skills with an iPad?

 

The apps on LeapFrog are made from their many years of experience in producing children education materials.  It has a lot of proficiency tracking system that tells the parent how much progress their kids are making in reading, writing, math, or foreign language skills.

 

From a usage perspective, you can view the LeapPad as "digital tutor".  You can put your kid in a room for 2 hours, and not worry about them breaking it or just wasting time playing Angry Birds.  You know this product frees you up by occupying their attention for 2 hours, but you also feel safe at heart knowing that the apps on there are made by education experts with years of experience, and is designed to help your kid learn.  You can keep track of their learning progress.  You also know that EVERYTHING on LeapPad is meant for EDU-tainment, and you will not need to scan through hundreds of apps from this over-bloated Apple or Android appstore just to find the few you trust your kids' education with.

 

On a recent Bloomberg interview, the first thing the CEO mentioned was the deteriorating quality of childhood education in developed countries.  He said LeapFrog's foremost focus is to improve childhood education in an entertainment way.

 

LeapFrog already dominated this niche even before LeapPad came out, but the tablet turned out to be the most ideal form factor for delivering EDU-tainment.  The LeapPad is really a continuation of what they have always done. They do not see themselves as a toy company, and is very clear about what their core values are. I don't think you will see them try to make dolls or action figures anytime soon.  They are a very very focused company sticking to their core value proposition.

 

I hope this clears more things up about the actual niche that they are in, and the commanding brand they already have in this niche. 

 

As for the faddish nature, it's totally understandable where you are coming from.  I think that's where one has to decide for oneself "is children tablet market itself a fad market".  If you think so, don't invest in anything related to kid tablets.  If you think this market is here to stay for the foreseeable future, I would say LeapFrog has a commanding position in this segment.

 

G/L investing.

[no_free_lunch]

yudeng2004,

 

You make some good points here.  I can't really buy into the story as I just haven't seen enough track record but yours is an interesting perspective.  I originally thought of how limited and yet expensive the app market is compared to android/ios but maybe it's the opposite.  The way you describe it, it is almost a feature that it is a locked down eco-system, with kids you want something simple like that.  At any rate, I will be monitoring it, best of luck.

[muscleman]

I did some rudimentary research.

Pros: They have an interesting ecosystem.

Cons: The leappad's quality is low compared with a kindle fire, and the price is not cheap at all. With $99, you can get the leappad, but battery is extra. In addition, most of the android/iphone apps are a few bucks, vs leap pad's apps' 25 buck app.

 

If they can make a product that has comparable quality to a kindle fire, then I think it will become a compelling buy for me.

[rockket]

http://www.cellular-news.com/story/61710.php

 

samsung just came out with a child tablet

[abitofvalue]

 

 

Obviously another worry is the sales around Christmas, etc, which makes it hard to distinguish from fad-ish toys that may be "hot" for one or two years and drop off subsequently.

 

Good analysis though. I'm more comfortable about the company now, than when we first started.

 

I can understand the worry about the company's product being a fad if the company had substantial sales for one christmas only.  However, in Leapfrog's case, you have multiple products - leappad, leapreader etc all doing pretty well over the last few years. The company is quite clearly the market leader in the childrens edutainment / children's tablet segment. The app store, installed base etc are very much barriers to entry for the competition. There is a reason Mattel, Hasbro and Disney are inking deals with leapfrog. Their own tablet development efforts have simply not been able to perform. 

 

Talk to a parent of a young child and its quite eye-opening the mindshare this company has. In speaking with relatives who have young kids, I have heard comments like -  "I felt so guilty I didnt get the new leappad for the kids last christmas, half his class had them when they got back from break" (note this is moving up to leappad 2 from leappad 1); "The Tagg is great, xxxx still uses it 2 years later. we just buy a couple of books"; "the kids love their leappad and it makes vacation so much easier"

 

Ofcourse, one might think that the entire segment is a fad, but to believe that the children's tablet segment is fad, one would need to believe that parents are going to let their children use ipads. I don't see how that is likely to happen in the near future.  As long as leapfrog can remain somewhat price competitive with the other childrens tablets, Leappad's competition is more likely to be the parent's tablet than another children's tablets.

 

I am not saying that Leapfrog's position is unbeatable or that no one can compete. Sure others can. But I think the company does enjoy significant advantages that the market seems to be undervaluing.

 

[Chris DeMuth Jr]

My 5- and 3-year olds are addicted to LF products.  For both health and financial reasons, I wish that they had taken up heroin instead.  This is truly perverse but they both know how to purchase games for it online.  They got their Leapfrog as a “present” but it is as much a present as a boat or plane – the upfront costs are just the beginning.  The only thing good about it from my perspective is that it means that the kids steal my iPad less frequently. 

 

As I am currently clearly on the losing end of this business arrangement, I can only assume that the LF shareholders are on the winning end of it.  LF’s common stock appears to cost significantly less than the shares are worth.  It is too small to be an independent company.  It would be an easy deal for a large toy company.  Either Mattel or Hasbro could take out essentially all of LF’s SG&A.  It is worth high teens to such a buyer and is even worth low teens to a financial buyer.

 

Maybe we get a takeout sometime in the next year and I’m able to claw back some of the money that I have sent to that company.  Incidentally, January puts look expensive to me.  You could consider writing $10 puts for $1.10 which I would submit is an attractive proposition.

 

My major concern is looking at how inexpensive iPads are getting – with late models on the market for under $200, that has to put pressure on GRMN and LF at some point. 

 

Would LF make sense for DIS to buy?

 

Would it make more sense to own this now or wait for one of its dramatic price corrections to set it up?

 

Does this board and management lead to LF deserving a discount to its private market value?

 

Does anyone think that its private market value is a single digit number?  Any way I look at this it appears cheap. 

 

Thanks.

 

[johnheiderscheit]

Anybody change their mind on LF at the current price point?  It looks like the word of mouth on some of the latest products might be "buggy" and the general down draft in toys seems to having a contagion impact.

[mcliu]

Space seems to be getting very competitive, even for this upcoming holiday season let alone the next. I guess that's capitalism, high margins attract competitors.

[abitofvalue]

Certainly seeing more competition but that wasn't unexpected and really should have no impact on the thesis.

 

The bulls have always said there will be more competition but (a) LF is best in class and has true "brand" or franchise value and (b) this is a growing segment as more parents care about early childhood education.

 

Skeptics have said (1) commodity product which was a fad and (2) not a real segment as better value in buying a kindle / ipad / android tablet

 

imo, the introduction of more competition actually discounts the bears second point and makes the bulls point. If this was a poor segment, it doesnt make sense for companies like Samsung to enter the market.  Their introduction will test the point (a) above as if LF has true franchise value it should still be able to perform at a high level.

 

What will be decisive is the comments about LF products being buggy. So far reviews have generally remained positive and Amazon lists it at 4-stars (similar to the leappad 2) with 90 reviews. This does bear monitoring and any slippage by LF will be a problem for the longs.

[constructive]

Anyone have a perspective on Leapfrog's chances this holiday season?

 

On Amazon, Leapfrog tablets and accessories make up most of the top products in Toys and Games / Electronic Systems & Accessories.

 

The LeapPad 2 Power is #183 in Toys and Games, LeapPad Ultra is #270, LeapPad 2 is #299 and LeapPad 1 is #3,146. That seems pretty solid, but maybe the higher margin LeapPad Ultra is not selling as well as hoped for?

 

The VTech Innotab series starting at #2,130 in Toys doesn't appear to be taking that many sales from them.

[writser]

Leapfrog just announced a pretty bad 4th quarter, with sales of $145m compared to $230m guidance. Stock is down 30% or something today. At this point the company is pretty much a net-net, market cap of ~$186m with $100m cash on the balance sheet and no debt.

 

I don't know anything about LeapFrog products but my guess is that they are expensive child that are being commoditized by other players and lose market share to tablets. Nevertheless the current valuation looks appealing. Has anybody been buying yet?

[philly value]

I know nothing, just looking at this for the first time. But seems to me like you are still solidly in territory where you are paying a positive value for the business. The press release states end of year cash as $94M, A/R as $101M, and inventory of $78M. The previous 10-Q has PPE at $36M. A/P and accrued liabilities total $84M, def rev $12M if you assume that covers ongoing support. Assume inventory is worthless, PPE 1/2 and you have a valuation of $117M or ~$1.67/share.

 

Not saying that "valuation" has any meaning, but given that back of the envelope calculations are more often than not optimistic for these types of situations, it seems you still have to take a view that the business can be turned around or sold in order to make this interesting.

[writser]

Sure, if you discount the inventory to zero they are not trading at net/net levels. And there is also the risk that they spend all cash trying to revive a dying business. But at this point I reckon they have ~$80m in excess cash so you pay $100m for an operating business that generated $180m in cash in the past five years and has ~$400m in annual revenue.

 

Which is extremely cheap imho so I am wondering what I am missing. Is their business really destined to fail?

 

Granted, the ability to miss guidance by 35% in a quarter doesn't really bode well for the quality of management .. Also they are burning their cash reserves at quite an impressive rate.

[CorpRaider]

Thanks for flagging writser.  I've looked at this before (years ago).  I'm intrigued. 

[GregS]

Sure, if you discount the inventory to zero they are not trading at net/net levels. And there is also the risk that they spend all cash trying to revive a dying business. But at this point I reckon they have ~$80m in excess cash so you pay $100m for an operating business that generated $180m in cash in the past five years and has ~$400m in annual revenue.

 

Which is extremely cheap imho so I am wondering what I am missing. Is their business really destined to fail?

 

Granted, the ability to miss guidance by 35% in a quarter doesn't really bode well for the quality of management .. Also they are burning their cash reserves at quite an impressive rate.

 

I dug up my notes from 18 months ago when I declined to invest.  Stock was in the $8s I think.  I wrote: "Key Question: staying power of the kids' tablet as a product category."  I feel like with their announcement we have our answer.

 

What I see is a declining business with inventory they will have to discount heavily and cash they will burn as they try to turnaround.  I doubt we've seen the bottom in the stock or their sales.  Fortunately they have no debt so that gives them some breathing room.  Your analysis seems awfully backward looking and I'd caution you on that.  I think the kids educational toy category is undergoing fundamental changes and their business has been disrupted by apps from mainstream tablets.  They sell overpriced hardware and even more overpriced software and I think their business model is toast.

 

They still have a good brand name in educational toys and content so that's worth something.  I can see a takeout by someone but that's awfully speculative.  Also, their brand can diminish quickly because most of their toys are designed for a small window (maybe birth to about 5 years) so they have to frequently capture new customers.

 

Ultimately, it seems like you have to discount inventory, have to figure on cash burn, and you don't really have a net-net anymore.  I won't touch it unless I see signs of a turnaround which are obviously at least a few quarters off.  Maybe I will miss it but it can also go a lot lower in the meantime.  I also think a turnaround would require remaking their entire business model focusing on educational software for iPhones/iPads and other platforms.  Can they pull that off?  I can see someone buying the name and doing exactly that but they aren't going to pay up for a lot of unsold inventory.  In the meantime the ice cube continues to melt.

 

Where I could be convinced I'm wrong is if there is a core part of their business in there that has been stable (baby and toddler?) and is reasonably valued at these prices.  The gadget business (tablets/TVs) is in real trouble.

[peter1234]

I think the kids educational toy category is undergoing fundamental changes and their business has been disrupted by apps from mainstream tablets.  They sell overpriced hardware and even more overpriced software and I think their business model is toast.

 

Agreed. Babies, toddlers and kids love iPads.

:)

[writser]

Thanks for chiming in all. I agree, it looks like bad management has to turn around a bad business that's bleeding money. Being cheap on a P/B basis isn't really relevant here.

 

However, it's still dirt cheap if they manage to turn the ship around so I'll keep following it for a while. The whole situation reminds me a little bit of JAKK a few years ago.

[muscleman]

Thanks for chiming in all. I agree, it looks like bad management has to turn around a bad business that's bleeding money. Being cheap on a P/B basis isn't really relevant here.

 

However, it's still dirt cheap if they manage to turn the ship around so I'll keep following it for a while. The whole situation reminds me a little bit of JAKK a few years ago.

 

Did they replace current management team? If not, there is no need to follow. The logic is that if the current team drags the co into this situation, it already proves that they are incapable.

[GregS]

Thanks for chiming in all. I agree, it looks like bad management has to turn around a bad business that's bleeding money. Being cheap on a P/B basis isn't really relevant here.

 

However, it's still dirt cheap if they manage to turn the ship around so I'll keep following it for a while. The whole situation reminds me a little bit of JAKK a few years ago.

 

Did they replace current management team? If not, there is no need to follow. The logic is that if the current team drags the co into this situation, it already proves that they are incapable.

 

JAKK is an interesting parallel. Will have to look into that a bit more.

 

Good point re management. Seems inevitable an activist gets involved here.

 

[HWWProject]

Agree with the recent negative sentiments on this stock, and I'm not a shareholder, but leaves a question - Here we have a company with a respected brand name, no debt, and stock selling below NCAV.  It would appear to be a great 'Ben Graham' net-net bargain.

 

If not now, any thoughts/advice on when you DO buy a net-net stock?

 

 

 

[GregS]

When it comes to retail and consumer products, the inventory isn't worth it's value on the balance sheet. 

[yadayada]

They make most of their profit in Q4 generally. But still think it should go to a much bigger discount. And you need to have a pretty good conviction in their products. Otherwhise your betting a net net that is barely a net net and will keep leaking money for years untill it isn't.

[JayGatsby]

New to the boards. This is my newest long position.  Thesis is basically:

1. Trades at a discount to net-net. Brand has additional off-balance sheet value (I think the customer is really the parent or gift giver giving them brand equity beyond the ages of their end user)

2. History of product development and profitability. Children's tablets, their cash cow, are clearly in decline although not dead. Legacy, low tech products seem to continue to perform ok

3. As legacy tablets decline management is adjusting the cost structure as evidenced by the 16% RIF

4. LeapTV seems to be performing ok, but can't be quantified. It's currently backordered on Amazon (although 3rd party sellers have it) for a few days. LeapBand also seems fairly popular although older launch and only $20

5. Earnings delay is just related to GAAP asset valuations. The press release was fairly specific in this regard. This has no impact on cash generating power, but has impacted the share price

6. Michael Milken controls the votes and can take steering power away from management in a downside scenario

 

Where am I wrong? How do I lose money here?

[jschembs]

I've only briefly looked at LF, but playing with my 18-month old son today, it struck me that many of LF's early-age products are relatively immune from technological disruption. Children need tactile feedback, which LF and others provide.

 

I have a feeling LF and RST will pan out quite well in the next few years.

[JayGatsby]

Well, misread this one! The earnings call was almost comical and the shareholder base doesn't seem to care. I guess the question is how much is a pile of cash and a nice brand worth if management plans to burn it?