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LeapFrog Enterprises: Leapfrogging Competitors in Educational Entertainment

November 23, 2012 | About:


LeapFrog Enterprises Inc. (LF) is the leader in educational entertainment for children. LeapFrog's award-winning product portfolio helps millions of children achieve their potential by delivering best-in-class curriculum through engaging content, fun multimedia learning platforms and toys. LeapFrog's products are available in more than 45 countries and have been used by teachers in more than 100,000 U.S. classrooms. LeapFrog is based in Emeryville, Cali., and was founded in 1995 by a father who revolutionized technology-based learning solutions to help his child learn how to read.

Valuation

LF is currently trading at a trailing twelve months P/E of 10.17 and a trailing twelve months EV/EBITDA of 7.53. LF's current P/B of 2.15 represents a 40% premium over its five year average P/B of 1.54. LF delivered a ROE of 24.6% over the past twelve months.

Financial And Business Risks

LF is debt free with cash and cash equivalents of $49.4 million representing 8% of its current market capitalization of $570.2 million. LF's business is highly seasonal with a significant portion of our revenue occurring in the second half of the year. LF's cash balance is at its lowest for the year in the first month of the fourth quarter, as accounts receivables collections taper off and LF builds up inventory levels in preparation for the fourth quarter holiday season.

LF's multimedia educational platform products compete with electronic learning aids and a variety of electronic products including tablet computers, eBook readers and mobile devices. Its multimedia platforms, such as its LeapPad learning tablet and Leapster Explorer platform, competes against handheld gaming platforms from Sony and Nintendo and against other smartphones and tablets. However, LF believes the LeapFrog brand is recognized for comparably higher quality educational products, despite premium pricing.

Consumer preferences can change drastically and even successful products have a relatively short period of high demand followed by a decrease in demand as the products mature. In 2006, LF's sales of the classic Leapster platform peaked, but it is no longer a significant portion of sales now.

Sales to Wal-Mart Stores, Toys “R” Us Inc. and Target Corp. (TGT), in total, accounted for approximately 64%, 65% and 65% of LF’s US sales in 2011, 2010 and 2009, respectively.

LF outsources substantially all of its manufacturing, using several Asia based manufacturers, most of which manufacture LF's products at facilities in the Guangdong province in the southeastern region of China. In 2010, a sole-source supplier of an ASIC for one of LF's reading systems had financial difficulties, which required LF to negotiate the purchase of certain intangible assets from the supplier in order to continue production of the ASIC. In 2011, LF had replace a chip in the LeapPad, because of the tsunami in Japan.

Business Quality and Capital Allocation

LF is a market leader in children’s educational entertainment, with a strong brand and a leading product portfolio. According to industry sources, LF had the best selling kids learning tablet, the best selling learning game system, the best selling learn to read system and the best selling electronic learning toy line in 2011 in the United States. It is also the winner of the Educational Toy of the Year award from the Toy Industry Association for 8 out of the last 12 years, including 2012. LeapFrog’s App Center also differentiates itself from other mass market app stores by providing content designed or curated to address specific learning needs and age groups.

LF has had significant change in management over the past year. William K. Campbell, President of Americas Sales, retired from LF in June 2012, following more than 12 years of service with LeapFrog. Greg Ahearn, formerly from Toys "R" Us, was appointed as the chief marketing officer in the same month. In July 2012, LF announced that chief financial officer Mark A. Etnyre has resigned from the company in order to spend more time with his family and pursue personal interests. Ray Arthur, former CFO at Toys "R" Us, took over from Mark as the new CFO. In the same month, Brad Rodrigues joined LF as senior vice president and general manager of digital and community development from Nike. There has been significant insider buying for the past three months, with five insiders buying 109,177 shares for $845,438.

LF does not pay a dividend.

Conclusion

LF's P/E of 10.17 looks attractive relative to its trailing twelve months ROE of 24.6%.

Disclosure

The author does not have a position in any of the stocks mentioned.

About the author:

Mark Lin
Mark is a private value investor and runs the Cheapskate Investing website which borrows from the wisdom of value investing giants, using a systematic quantitative screening approach to filter the global stock markets for cheap deep-value cigar-butts and wide-moat compounders. He is also a regular contributor to various value investing communities.

Visit Mark Lin's Website


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