Leapfrog: Growth At A Reasonable Price [View article]
WalkTheTalk,
One recent development as of a few days ago (from "The Street"):
"The most recent short interest data has been released by the NASDAQ for the 04/30/2013 settlement date, which shows a 1,807,919 share decrease in total short interest for Leapfrog Enterprises Inc (LF), to 12,709,956, a decrease of 12.45% since 04/15/2013."
Leapfrog: Growth At A Reasonable Price [View article]
Most of the concerns stem from issues surrounding increased competition, decreasing tablet prices, and rising consumer demand for lower-priced apps. LF is very small, has a volatile history, and is competing in a varied arena with not only typical kids tablet manufacturers or other children's-focused digital product makers, but also with entertainment companies focused on children (Nintendo, Sony) and mass-market tablets like the Kindle Fire and Nook, which parents may see as a general substitute for the LeapPad.
However, the LeapPad's appeal is not waning. Quite the contrary, the product continues to generate strong demand at lower prices than competitors' offerings (Kurio, Tabeo, Nabi). The Leapster, too, has remained a robust product offering. Further, multimedia sales--i.e. downloadable apps and games--are becoming a much larger part of sales growth and, by definition, earnings growth since they provide high operating leverage once marginal costs are eclipsed. As a result, the tie ratio of software sold per hardware unit is growing rapidly, further increasing customer lock-in and generating positive network effects. Finally, the economy is rebounding strongly and increased consumer demand will buoy the company throughout the year and should, with smart demand forecasting and deft inventory management, lead to a strong Q4 performance.
In terms of key variables, sustainable product / brand advantage in the face of diverse competition seems to be analysts' number 1 concern. However, analysts are near-term focused and often get impatient with a stock. History shows clearly that analysts are not good predictors and often lag their coverage area--i.e. downgrades are illustrative of past poor performance rather than expected future performance (this same sort of thing happened to credit agencies post-crash and, of course, stock pumpers like Henry Blodget during the TMT bust). Having said that, I agree the downward pressures on the stock are perplexing; hence my belief the market doesn't believe LF can withstand competitive pressures, which seems the most reasonable negative scenario.
Low pre-market volume on strong news. Investors could be waiting for a large trade either way, leading to an explosive open up or down. Traders and entry-point seekers, hold on for the bumpy intra-day ride!
Leapfrog: Growth At A Reasonable Price [View article]
relayer75,
Thanks for the correction. Perhaps it was a Freudian slip (as in, milked people out of money...). I also found it strange when I initially went through the company history that Milken and Ellison had formed an educational conglomerate to buy LF. And they say politics makes strange bedfellows.
Just released information shows 15% net sales increase Q1 y.o.y. and EPS beats by $0.02--solid news as expected. Pre-market sell-off mimicking recent trends. Look to buy cheap ~$8 and hold for the next year. Q4 is the big one given product seasonality, but trends point to a strong year. People still don't believe this company has staying power--let's see if they do.
15% net sales increase Q1 y.o.y. and EPS beats by $0.02--solid news as expected. Pre-market sell-off mimicking recent trends. Look to buy cheap ~$8 and hold for the next year. Q4 is the big one given product seasonality, but trends point to a strong year.
Apologies, I realized the first paragraph above may have come off the wrong way. I actually made the disclosure because, having met or seen the work of many exceptional young value investors over the last year (e.g. http://read.bi/10TVarV), I've become quite sure any competitive advantage I hold on the purely investment side of the industry is negligible--hence the mention of the consulting group's different focus. I cite Laven in particular because they just launched an office in NYC with great people, so they deserve a shout-out.
If you don't already follow him, Arne Alsin is one to watch. His articles generally don't go into much depth, but he apparently does great presentations at conferences and his track record is tremendous. Hard to call 10 coin flips in a row (but having seen mounds of data that suggest investor alpha is indeed very rare, I reserve some skepticism).
Thank you for the kind comments and glad I could help. Unfortunately I won't be publishing too many articles in the future, as I will be joining a hedge fund consulting group that focuses on operational due diligence and regulatory compliance (Laven Partners).
However, as a last "pick," let me suggest MWA. They have a bright future ahead and the stock will likely start to pick up by year end. Please also see my article on NCR from a few months ago. They just reported stellar results.
Thanks for the comments. You're right that the management angle is on the qualitative and speculative side. However, the history of management at the company has not been stellar. Michael Wood, the founder, had little previous business managerial experience. The previous CEO, William Chiasson (who is the current chairman), had experience in retail apparel and food and beverage. Moreover, he worked mostly in finance as a CFO (also at LF for almost 6 years). Admittedly, Thomas Kalinske, who took over after Michael Wood, was an experienced veteran, but the fact that he stayed on with the company for a long time and served as CEO at two different periods indicates strategy and direction were likely stale.
Current CEO Barbour has always been in the business (toy companies), having been a top management figure at Toys "R" Us, and having had high positions at Hasbro and Matchbox. He also was president at one point of toysrus.com, which gives him significant experience in children's online retail--exactly where the company wants to go in multimedia sales (downloadable content, apps, games, etc.). In fact, Barbour co-branded toysrus.com with Amazon.com in a successful online initiative. Overall, he led Toys "R" Us Japan to three years of record sales and earnings growth. He also grew sales at toysrus.com from $2 million in 1998 to $336 million in 2002.
Barbour additionally worked at the GameHouse division of Real Networks, which adds to his credibility given the importance of downloadable games for the LeapPad and Leapster. He is also inordinately passionate about children's toys and the industry--see article here: http://bit.ly/155losU.
"Why did John return to the toy industry?
John told me that he returned because he loves (I underlined 'loves' because when he said the word he almost shouted it), not likes but loves, the toy industry, its people and its consumers. "
Most important, Barbour and team have changed the strategy of the firm to "educationally fortified entertainment." They even see their competition as Apple, Amazon, and other multimedia firms. Previous strategy over the years had been more on education and less on the entertainment. Current management has figured out that locking-in kids with lots of fun games and apps that are "parent-approved" makes good business sense and jives with the times.
This focus flows through the kind of thinker Barbour is: “How about a $200 curricula pack - full of stuff- for grandparents? They’d buy that. Why can’t we be in videos, DVDs, online? Why can’t we sell 'on the road packs' to parents to keep their kids entertained while in the car: an educational video, a Leapster license plate game? How about MMOG games? What about TV? I mean, what’s the difference between us and Sesame Street?” This type of enthusiasm, product complementarity, and "we can be everywhere" mindset is very Jobs-like.
Also, as you and I both mentioned, operational measures (COGS and R&D expenses) as a percentage of sales have steadily gone down, providing increasing evidence of better, leaner management. Full-time employees, as you stated in your article, have also been reduced significantly from the 900 to 500 range over the last 7 years.
Finally, Barbour is the consummate insider and is known, according to a Global Toy News article, as "JB" in the toy industry. This type of familiarity suggests intimate knowledge of the industry, particularly of market trends, consumers, competition, suppliers, and distributors. It also suggests that he is the perfect guy for making a potential sale (which he has been open on the record about). (Fortunately) I won't go into histories of the Toys "R" Us alums, but I bet there is strong camaraderie and teamwork there as well.
In terms of revenue estimates, these were definitely difficult given a) the lack of consistent operating results and b) issues related to the recent recession and business cycles, to which LeapFrog is particularly sensitive. My argument has a few components.
First, there is the macroeconomic portion. Regardless of what people think may happen in 3 months, the economy is likely on a sustainable recovery for the next 1-5 years, and as consumer spending and aggregate demand increase, LeapFrog will benefit tremendously. In the same vein, the company's sales stagnated for several years a row from 2007-2011, so sales over the next year (and from last year) probably will show strong growth given they spring from depressed levels.
Second, the 6% growth is obviously an average figure, but LeapFrog's brand and products are far above average and thus should benefit more from the rising tide. To what extent they benefit is an open question, of course, but I used management's guidance of "high single digits" as a baseline. Seeing as the company exceeded expectations and guidance multiple times in recent quarters, I assumed they were being conservative and thus growth on the order of 12% might be more likely.
Finally, LF should benefit not only from the rising industry tide, but from stealing some market share as well. Hasbro and Mattel are doing great financially, but a booming industry makes it difficult to make necessary strategic changes including addressing the rising threat from children's tablet and digital / downloadable products.
Thank you for the response and kind words. You make an interesting point worth addressing, as I think it highlights just what makes LF special.
It would be difficult to make a case for an Apple acquisition. Given that LeapFrog is focused in the children's space, there would likely be better strategic and operating synergies with a large children's product maker looking to transition more forcefully into the tablet and digital revolution--e.g. a Mattel or Hasbro.
Moreover, LF's core strategy revolves not only around more innovative children's products, but also around ones that exhibit substantial competitive advantages related to children's pedagogy and development, areas which I don't believe Apple has any significant interest.
Finally, Apple's focus is more on innovating in game-changing technologies that change the way every-day users interact with the world in a (revenue-significant) way. LF is likely too specialized, too mature, and too small for them to worry about. Better targets for Apple would probably include newer, more scalable technologies that integrate (rather than diversity) its core focus.
Thanks for the comment and I apologize for the delay. The dividend payout should not affect the valuation. All that should matter are the discounted free cash flows, which is why a dividend discount model would not work for NCR. Also, technically one can look at overall capital appreciation at the stock sale date as a type of large "dividend."
As long as NCR can grow at a high enough pace beyond its cost of equity (and thus create value), then I'm fine with them not paying a dividend, as that value would be included in stock appreciation (since the money would stay in the company in the form of retained earnings and thus raise its stock value).
Leapfrog: Growth At A Reasonable Price [View article]
Scott,
Thanks for the kind comments. I definitely agree that comparing notes and research in a positive way is beneficial not only for analysis, but for cultivating positive relationships in a shared purpose. All the best to you and let's hope LF does indeed get up to the $12 level!
Leapfrog: Growth At A Reasonable Price [View article]
Christopher,
This is a great and timely article. Well done. Please check out my article on the topic as well ("LeapFrog: Strong Buy"). We both end up at around the $12 mark for a target price.
Thank you for the comment and your personal perspective on the company's history. I completely agree with buying on the "fall on good news" pattern that has emerged in the past year for the company. I bought in at an average cost of about $8.30, so if investors can get in at that or an even lower price, I'd by very happy for them.
I've heard news here and there (public, of course) that the quarter has been going very well. How the stock performs after a good earnings announcement, that's anyone's guess. I personally stay away from event-driven, earnings arbitrage strategies.
I did try to contact Investor Relations to ask about decreasing R&D as a percentage of sales (given an increasingly competitive environment) and if they could break out the unit economics of the business more clearly, but as noted in the previous conference call, they are not communicating with analysts or investors until the next earnings release.
Leapfrog: Growth At A Reasonable Price [View article]
One recent development as of a few days ago (from "The Street"):
"The most recent short interest data has been released by the NASDAQ for the 04/30/2013 settlement date, which shows a 1,807,919 share decrease in total short interest for Leapfrog Enterprises Inc (LF), to 12,709,956, a decrease of 12.45% since 04/15/2013."
http://bit.ly/12bvjqL
Leapfrog: Growth At A Reasonable Price [View article]
However, the LeapPad's appeal is not waning. Quite the contrary, the product continues to generate strong demand at lower prices than competitors' offerings (Kurio, Tabeo, Nabi). The Leapster, too, has remained a robust product offering. Further, multimedia sales--i.e. downloadable apps and games--are becoming a much larger part of sales growth and, by definition, earnings growth since they provide high operating leverage once marginal costs are eclipsed. As a result, the tie ratio of software sold per hardware unit is growing rapidly, further increasing customer lock-in and generating positive network effects. Finally, the economy is rebounding strongly and increased consumer demand will buoy the company throughout the year and should, with smart demand forecasting and deft inventory management, lead to a strong Q4 performance.
In terms of key variables, sustainable product / brand advantage in the face of diverse competition seems to be analysts' number 1 concern. However, analysts are near-term focused and often get impatient with a stock. History shows clearly that analysts are not good predictors and often lag their coverage area--i.e. downgrades are illustrative of past poor performance rather than expected future performance (this same sort of thing happened to credit agencies post-crash and, of course, stock pumpers like Henry Blodget during the TMT bust). Having said that, I agree the downward pressures on the stock are perplexing; hence my belief the market doesn't believe LF can withstand competitive pressures, which seems the most reasonable negative scenario.
LeapFrog: Strong Buy [View article]
Leapfrog: Growth At A Reasonable Price [View article]
Thanks for the correction. Perhaps it was a Freudian slip (as in, milked people out of money...). I also found it strange when I initially went through the company history that Milken and Ellison had formed an educational conglomerate to buy LF. And they say politics makes strange bedfellows.
Just released information shows 15% net sales increase Q1 y.o.y. and EPS beats by $0.02--solid news as expected. Pre-market sell-off mimicking recent trends. Look to buy cheap ~$8 and hold for the next year. Q4 is the big one given product seasonality, but trends point to a strong year. People still don't believe this company has staying power--let's see if they do.
LeapFrog: Strong Buy [View article]
LeapFrog: Strong Buy [View article]
LeapFrog: Strong Buy [View article]
If you don't already follow him, Arne Alsin is one to watch. His articles generally don't go into much depth, but he apparently does great presentations at conferences and his track record is tremendous. Hard to call 10 coin flips in a row (but having seen mounds of data that suggest investor alpha is indeed very rare, I reserve some skepticism).
LeapFrog: Strong Buy [View article]
Thank you for the kind comments and glad I could help. Unfortunately I won't be publishing too many articles in the future, as I will be joining a hedge fund consulting group that focuses on operational due diligence and regulatory compliance (Laven Partners).
However, as a last "pick," let me suggest MWA. They have a bright future ahead and the stock will likely start to pick up by year end. Please also see my article on NCR from a few months ago. They just reported stellar results.
Good luck investing and best wishes!
Rohan
LeapFrog: Strong Buy [View article]
Thanks for the comments. You're right that the management angle is on the qualitative and speculative side. However, the history of management at the company has not been stellar. Michael Wood, the founder, had little previous business managerial experience. The previous CEO, William Chiasson (who is the current chairman), had experience in retail apparel and food and beverage. Moreover, he worked mostly in finance as a CFO (also at LF for almost 6 years). Admittedly, Thomas Kalinske, who took over after Michael Wood, was an experienced veteran, but the fact that he stayed on with the company for a long time and served as CEO at two different periods indicates strategy and direction were likely stale.
Current CEO Barbour has always been in the business (toy companies), having been a top management figure at Toys "R" Us, and having had high positions at Hasbro and Matchbox. He also was president at one point of toysrus.com, which gives him significant experience in children's online retail--exactly where the company wants to go in multimedia sales (downloadable content, apps, games, etc.). In fact, Barbour co-branded toysrus.com with Amazon.com in a successful online initiative. Overall, he led Toys "R" Us Japan to three years of record sales and earnings growth. He also grew sales at toysrus.com from $2 million in 1998 to $336 million in 2002.
Barbour additionally worked at the GameHouse division of Real Networks, which adds to his credibility given the importance of downloadable games for the LeapPad and Leapster. He is also inordinately passionate about children's toys and the industry--see article here: http://bit.ly/155losU.
"Why did John return to the toy industry?
John told me that he returned because he loves (I underlined 'loves' because when he said the word he almost shouted it), not likes but loves, the toy industry, its people and its consumers. "
Most important, Barbour and team have changed the strategy of the firm to "educationally fortified entertainment." They even see their competition as Apple, Amazon, and other multimedia firms. Previous strategy over the years had been more on education and less on the entertainment. Current management has figured out that locking-in kids with lots of fun games and apps that are "parent-approved" makes good business sense and jives with the times.
This focus flows through the kind of thinker Barbour is: “How about a $200 curricula pack - full of stuff- for grandparents? They’d buy that. Why can’t we be in videos, DVDs, online? Why can’t we sell 'on the road packs' to parents to keep their kids entertained while in the car: an educational video, a Leapster license plate game? How about MMOG games? What about TV? I mean, what’s the difference between us and Sesame Street?” This type of enthusiasm, product complementarity, and "we can be everywhere" mindset is very Jobs-like.
Also, as you and I both mentioned, operational measures (COGS and R&D expenses) as a percentage of sales have steadily gone down, providing increasing evidence of better, leaner management. Full-time employees, as you stated in your article, have also been reduced significantly from the 900 to 500 range over the last 7 years.
Finally, Barbour is the consummate insider and is known, according to a Global Toy News article, as "JB" in the toy industry. This type of familiarity suggests intimate knowledge of the industry, particularly of market trends, consumers, competition, suppliers, and distributors. It also suggests that he is the perfect guy for making a potential sale (which he has been open on the record about). (Fortunately) I won't go into histories of the Toys "R" Us alums, but I bet there is strong camaraderie and teamwork there as well.
In terms of revenue estimates, these were definitely difficult given a) the lack of consistent operating results and b) issues related to the recent recession and business cycles, to which LeapFrog is particularly sensitive. My argument has a few components.
First, there is the macroeconomic portion. Regardless of what people think may happen in 3 months, the economy is likely on a sustainable recovery for the next 1-5 years, and as consumer spending and aggregate demand increase, LeapFrog will benefit tremendously. In the same vein, the company's sales stagnated for several years a row from 2007-2011, so sales over the next year (and from last year) probably will show strong growth given they spring from depressed levels.
Second, the 6% growth is obviously an average figure, but LeapFrog's brand and products are far above average and thus should benefit more from the rising tide. To what extent they benefit is an open question, of course, but I used management's guidance of "high single digits" as a baseline. Seeing as the company exceeded expectations and guidance multiple times in recent quarters, I assumed they were being conservative and thus growth on the order of 12% might be more likely.
Finally, LF should benefit not only from the rising industry tide, but from stealing some market share as well. Hasbro and Mattel are doing great financially, but a booming industry makes it difficult to make necessary strategic changes including addressing the rising threat from children's tablet and digital / downloadable products.
LeapFrog: Strong Buy [View article]
Thank you for the response and kind words. You make an interesting point worth addressing, as I think it highlights just what makes LF special.
It would be difficult to make a case for an Apple acquisition. Given that LeapFrog is focused in the children's space, there would likely be better strategic and operating synergies with a large children's product maker looking to transition more forcefully into the tablet and digital revolution--e.g. a Mattel or Hasbro.
Moreover, LF's core strategy revolves not only around more innovative children's products, but also around ones that exhibit substantial competitive advantages related to children's pedagogy and development, areas which I don't believe Apple has any significant interest.
Finally, Apple's focus is more on innovating in game-changing technologies that change the way every-day users interact with the world in a (revenue-significant) way. LF is likely too specialized, too mature, and too small for them to worry about. Better targets for Apple would probably include newer, more scalable technologies that integrate (rather than diversity) its core focus.
Good luck and best wishes,
Rohan
NCR: Room To Run, But End In Sight [View article]
Thanks for the comment and I apologize for the delay. The dividend payout should not affect the valuation. All that should matter are the discounted free cash flows, which is why a dividend discount model would not work for NCR. Also, technically one can look at overall capital appreciation at the stock sale date as a type of large "dividend."
As long as NCR can grow at a high enough pace beyond its cost of equity (and thus create value), then I'm fine with them not paying a dividend, as that value would be included in stock appreciation (since the money would stay in the company in the form of retained earnings and thus raise its stock value).
Leapfrog: Growth At A Reasonable Price [View article]
Thanks for the kind comments. I definitely agree that comparing notes and research in a positive way is beneficial not only for analysis, but for cultivating positive relationships in a shared purpose. All the best to you and let's hope LF does indeed get up to the $12 level!
Rohan
Leapfrog: Growth At A Reasonable Price [View article]
This is a great and timely article. Well done. Please check out my article on the topic as well ("LeapFrog: Strong Buy"). We both end up at around the $12 mark for a target price.
Best,
Rohan
LeapFrog: Strong Buy [View article]
Thank you for the comment and your personal perspective on the company's history. I completely agree with buying on the "fall on good news" pattern that has emerged in the past year for the company. I bought in at an average cost of about $8.30, so if investors can get in at that or an even lower price, I'd by very happy for them.
I've heard news here and there (public, of course) that the quarter has been going very well. How the stock performs after a good earnings announcement, that's anyone's guess. I personally stay away from event-driven, earnings arbitrage strategies.
I did try to contact Investor Relations to ask about decreasing R&D as a percentage of sales (given an increasingly competitive environment) and if they could break out the unit economics of the business more clearly, but as noted in the previous conference call, they are not communicating with analysts or investors until the next earnings release.
LeapFrog: Strong Buy [View article]
Thank you for the comment. I'm glad you enjoyed the article! Good luck and (have fun) investing.