LeapFrog Is Selling Below Its Liquidation Value

Summary

• LeapFrog is a leader in the educational industry.
• Currently, the stock is trading below $3.
• Based on its strong balance sheet, LeapFrog may be an interesting opportunity in the future.

LeapFrog (NYSE:LF) is an educational entertainment company based in California. The company has a strong brand and also a rich history of innovation. LeapFrog is recognized by its well-known LeapPad. For the last 20 years, the firm has gained substantial expertise in developing educational entertainment product.

A LeapPad 3

(Source)

Back in 2012, the stock was trading around $10. Since then, the firm encountered many problems with the sale of its famous LeapPad. As a result, the stock is currently trading below $3. In my mind, the market overreacted. I also think that the market does not take into account its strong balance sheet.

In fact, LeapFrog is currently selling below its net current assets value (NCAV). In a previous article, I talked briefly about the NCAV. On the other hand, the present article is definitely a more in-depth discussion about the liquidation value of the firm.

This metric was created by professor Benjamin Graham. The net current assets value is calculated by subtracting the total liabilities from the current assets. In other words, it is the liquidation value of a company. Indeed, this metric attributes no value to fixed and intangible assets. Consequently, it is possible to buy buildings, machinery and brand for free. With $355 million in current assets and $97 million in total liabilities, LeapFrog has an NCAV of $258 million. Based on a share price of $2.80, the company has a market capitalization of approximately $196 million. Subsequently, it is possible to calculate a margin of safety of 24%.

Moreover, LeapFrog is almost a net net stock. In fact, a stock selling below its net net working capital (NNWC) is not only a cheap stock. Indeed, it is a dirt-cheap stock. NNWC is a close cousin to the NCAV. The difference is that the NNWC value reflects a rapid fire sale.

The NNWC formula

(Source)

Consequently, the firm has an NNWC value of $142 million and a market capitalization of only $196 million. In fact, the NNWC value represents 73% of the market capitalization. It is important to remember that LeapFrog is a leader in the educational industry.

In conclusion, LeapFrog is selling 24% below its liquidation (NCAV) value and 38% higher than its fire sale value (NNWC). I agree that the company delivered weak performance in the last quarters, but the market clearly overreacted. Moreover, the stock remains very risky on the short term. Based on these positive aspects, I think that LeapFrog would be a great deep-value pick around $2. On the other side, please do your own due diligence before initiating a position in any stock mentioned.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

Analyst’s Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Comments

[MacKay Dave]

From Stockmarkets daily

A class action lawsuit is being filed by a law firm, against LeapFrog for potentially having released misleading business information to the investing public. If such a case is true, it certainly does not fill us with confidence in the management of the company.

[tradebr2010]

There seems to be a lot >1 class action lawsuits in the works. Look @ yahoo finance.

[SkylineView]

Yes, ambulance chasers. Are these things ever successful?

It's kind of hard to prove that executives who lost a lot of money on the stock themselves were withholding info that would have saved the shareholders.

[GrahamValue]

Please note that Net Current Asset Value (or NCAV) stocks are the most well-known of Benjamin Graham's strategies, and the source of the general misconception that Graham only recommended cheap stocks. But Graham actually recommended Index, Defensive and Enterprising stocks before NCAV stocks; and all were allowed higher Quantitative valuations and required greater Qualitative checks.

Graham also required true NCAV stocks to have positive current earnings.
True NCAV stocks would necessarily be selling far below their liquidation value, or Tangible Book Value Per Share (TBVPS).
(Additionally, the investopedia definition for a net net stock is NCAV and not NNWC)

Given below are the actual Graham ratings for LeapFrog Enterprises Inc (LF), with no adjustments other than those for inflation.

Defensive Graham investment requires all the ratings to be at least 100%.
Enterprising Graham investment requires the ratings to be at least - N/A, 75%, 90%, 50%, 5%, N/A and 137%.

LeapFrog Enterprises Inc - Graham Ratings
Sales | Size (100% ⇒ $500 Million): 110.72%
Current Assets ÷ [2 x Current Liabilities]: 249.23%
Net Current Assets ÷ Long Term Debt: 100.00%
Earnings Stability (100% ⇒ 10 Years): 40.00%
Dividend Record (100% ⇒ 20 Years): 0.00%
Earnings Growth (100% ⇒ 30% Growth): 476.19%
Graham Number ÷ Previous Close: 424.54%

The Final Graham Assessment for LeapFrog Enterprises Inc is also given below.
The Quantitative Result (Intrinsic Value ÷ Previous Close) for a stock has to be 100% for true Graham investment.

LeapFrog Enterprises Inc - Final Graham Assessment
Defensive Price (Graham Number): $10.83
Enterprising Price (Serenity Number): $8.65
NCAV Price: $4.43
Qualitative Result: Bargain / NCAV
Intrinsic Value: $4.43
Previous Close: $2.55
Quantitative Result: 100.00%

http://seekingalpha.co... shows how one can assess 5000+ NYSE and NASDAQ stocks by a similar exact Benjamin Graham assessment, with no adjustments other than those for inflation.

[tradebr2010]

Here you are with the Ben Graham crap again!

This is most a risk/reward play now that the stock came from $11, making a double top in Jul 2013, down to $ 2 bucks and change!

The thesis is simply the company will either be acquired, will go private through a LBO, or bankruptcy. Leave Ben Graham out of it! You're only looking a figures and ratios, and forgetting the underline broken business model. It's a very risky stock now.

[GrahamValue]

Graham's framework is designed to - among other things - identify troubled companies that are excessively undervalued by the market. Graham also designed his framework to work regardless of industry or business model.

But if you're looking for a great business that has no problems and is also selling at great prices, good luck!

[SkylineView]

I, for one, am happy to hear all opinions. Thank you, Serenity.

[MacKay Dave]

I assume that most of the volume on Friday was shorts trying to clobber it....... and a rebound is soon due.

[tradebr2010]

No pro go short on a $ 4 buck stock. Risk/reward is ridiculous!

[pra]

We need to know current cash levels and also the burn rate. Discount cash by 2 or 3 Qtrs before coming up with liquidation value as the company is currently not for sale. I do think leapfrog brand has some resonance with families and bigger companies can leverage the brand. I guess there will be restructuring charges (Inventory write downs, re-orgs etc.) as apparantly the current organizational structure is not scaling w.r.t costs. I may own this stock but need to do further analysis.

[Henrik Alex]

cash is down from $168 mln to $94 mln yoy...

[invest1234]

Value Sniper sounds like a broken record. His analysis was flawed in mid-December when he thought the stock was a good buy at $4.62. Most people leaving comments at that time, including me, disagreed with the author. It is now trading at $2.67. Value Sniper fails to appreciate how bad (incompetent and selfish) the management is at LeapFrog. The board has not done its job and there are now numerous law firms asking stock holders to get in touch with them (see today's Yahoo Finance).

[SkylineView]

Finally, some big money stepping in -- Bids for 56k @ $2.66 and 40K @ $2.64. Mostly small lots until now.

Would it make sense for LF to kick the share buyback into high gear right now? They will need the cash going forward, but might raise eps?

[Matija Snuderl]

burning through cash, not making money and spend more cash on share buyback....?
guys, don't get me wrong, I like the company, I like the product, but let's call it what it is, failure. Missing estimates SO MUCH is bad and no sugar coating or insider purchase or zero debt can solve it. Unless there is a significant change of strategy, next Christmas will be as bad as the last two... And eventually they will run out of money. Trying to make it look better is a bad idea for anyone who likes the company or has the position.

[SkylineView]

I understand the frustration if you have been long for long, but I'm just trying to be forward looking and figure out where this thing is going.

There's still a boatload of mystery about this -- still no discounting at any of the major toy retailers on LeapTV. Some discounting on Amazon, but many resellers say "Back-ordered. Due in stock January 30 -- order now to reserve yours".

Here's one plausible explanation: the insiders made their big market purchases in mid-November when they thought they had a hit with LeapTV, then port issues delayed arrival till too late in the shopping season.

If so, what does that mean going forward? Sellable inventory? Or big arriving shipments that will have to be discounted?

[Matija Snuderl]

I believe that the power of the company isn't hardware but educational content. Spreading it over other platforms would be WAY more viable & profitable option than trying to persuade parents to purchase another overpriced tablet. Being at the low end of the guidance is one thing. But missing it by 30% is a totally different ballgame, that really means they had no idea about the market.
The turnaround starts with firing the bad management.

[Lukebbb]

One of my favorite books is "Beating the Street" by Peter Lynch. One of his famous quotes says "Never forget that when a stock sinks to zero, you've lost ALL of your investment" Would you jump on a sinking ship?
I personally have made money with LF but want to wait and see on this time around. I think they are a good company. My kids like the products and I've bought them in the past. We live in a society of always wanting what is new. This is how Apple sells new iPhones. Nobody wants last years model. Until LF innovates and brings forth a new product that kids want and parents are willing to buy, I'd stay away.

[Greenfire87]

The problem with LF is that the only people buying it are the upper class parents. The middle class, which LF needs to succeed, are too lazy & cheap. They don't want to spend time to teach their kids how to use it. They just want cheap crap to entertain them on their own.
Personally, I think it's a great product.

[Cer44]

Matija- I disagree. Some insiders spent over 100k on share purchases and they are not the ones making millions in salary. It is a lot of money for them. They would not buy shares just to make investors feel better.

[SkylineView]

According to Bloomberg Business Week, Barbour's total compensation is close to $3M. Worth keeping.

http://buswk.co/1yS2Qbo

[clanza827]

not even close, read the proxy, they havent received a bonus in over 2 years and their base pay is only $300-$500K

[SkylineView]

Thanks, Good to know.

[Cer44]

Can anyone explain all the insider buying? I mean, they must have knows that sales are awful.
They must be stupider than I thought. Not only can't they run a business but they don't know how to invest.
They knew sales were slow, so why did they buy shares??
Maybe, just maybe, they know of some buyout offers. I have no other explanation...wow...what a lousy company.

[SkylineView]

Maybe they were trying to show some conviction to avoid losing their high-paying jobs? ...It's a mystery.

[Gregg Sterling]

Delusions of grandeur?

[Matija Snuderl]

they didn't buy that much... just to placate negative emotion of stock holders. Their salaries are worth way more...

[William Greenfield]

Thanks for the article.

However, you are mistaken about there current assets. According to a PRNews LF reported their current balance sheet positions See here http://yhoo.it/1zD2Eja.

As a comment above noted, since they are losing money they are burning through cash, so you need to take that into account. If their liabilities have stayed the same since last quarter then they have a Net Current Asset Value of ~$2.50. Beyond that, there exists the very real possibility that due to losses, LF will need to have borrowed in the last 3 months.

All in all, I think LF has some promising possibilities of being a genuine value play, but investors should be aware of all the risks involved.

[tradebr2010]

BTW, if $LF is screaming a buy, how come you are not in?

[tradebr2010]

I like your style. If one thesis don't work(your Dec's article) you jump to another!

Ben Graham was last written in 1949. I have actually gone through a real liquidation, and would caution you to use more conservative liquidation ratios specially in inventory(30%/40%).

I still like the actual thesis of an acquisition/going private for now. Other than that, my thesis hasn't changed for the past 4 years: The company should produce software for delivery in ipads, and other delivery vessels stopping manufacturing completely.

The Z Altman score should be showing distress area with the declining equity value, a bankruptcy soon to happen. I'll update my metrics as soon as financials are available.

[SkylineView]

Seems to be mostly fear running rampant in small investors.

[SkylineView]

Institutional ownership is >85%. So far, most orders are very small. No one is dumping yet. Time will tell.

[Matija Snuderl]

The author has completely missed the major problem. The issue with LF is not whether stock is worth $3 or $4... I have been reading for a year well meant and researched analysis how cash flow is good, and debt is zero and product is good. But it's the direction. And LF, sadly is going to HELL.

this company has GROSSLY incompetent management. Here I said it.

I have been following the company for 2 XMas seasons now. I like their products for my kid. First time, they blamed bad economy and delay in new products. Last year's holiday season the toy sales (industry) went UP, and they have top rated product. And they still failed to even meet the guidance. This announcement shows a total disaster in managing the company. Together with overpaid management, with salaries highest in the industry, we have a great example of management slowly but surely ruining the company. Babour will probably present another great powerpoint presentation what they will do, to extend his tenure and suck out a year or two worth of salaries more. But that will come at the expense of shareholders.

There are only two possibilities. Board/shareholders have to fire the management and significantly change the direction of the company. No little here or there, one or two new toys, a little bit more commercial time. The management that decimated shareholder value by more than 50% while the market had double digit growth, is incompetent. Either Board does what it is here for, or some activist shareholder get together. I know there has been talk that this is difficult based on the fact that majority of the shares are privately owned by two people, but come on, they can't be happy about losing their value either, right?

The second possibility, in US corporate environment more likely is, that this will go on for a few more years until the company is sold for scraps.

LF is a classic example, that the best analyst, is the Mr. Market itself...

[David Neubert]

Matija -I've been following this company for years because I like their products as you do. However, I sold my position at a small loss two years ago when my two year old would watch any of their content. He actually hated it and preferred other educationally focused shows. I realized that the problem with their model was a focus on producing what parents liked not what kids like. No amount of channel checking could overcome the judgement of a two-year old.

Currently, "trading below liquidation value" always gets my attention. I might have to take another look now.

[LiamSnooky]

I do have kids and as one of the other posters rightly pointed out, most parents will prefer free to having to pay 15-20 bucks for a game. The kids quickly get bored after playing the same game 3 or 4 times and then it's suddenly time to buy another one. Over a year, costs could quickly become significant. Hence the better alternative is to get an ipad or an old phone, download the tons of free educational games and let the kids have their fun without breaking the parents' budget.

[Oneslip]

I don't follow LF too closely so my comments may not be correct. If they are reporting 3QTR results and can not give guidance for yr ending March then either sandbagging 4th qtr or really have much bigger issues. We know last yrs holidays sales fell short so I am wondering how LF faired? It also sounds like a new management may be needed on some of these most basic missteps. I do not have kids either so I do not how the everyday kid uses these products as opposed to other such as playstation etc.
It does not sound good and to buy the stock is betting that a turnaround is possible.

[Henrik Alex]

The author obviously failed to understand the implications of last nights' earnings warning.

With a 40% sales shortfall compared to already lowered expectations and with management unable to provide guidance for the CURRENT quarter the bet on a sale of the company has lost most of its appeal.

Cash is down from Q3 when in fact it should be up substantially and the company will continue to burn more cash going forward. Even worse Leapfrog seemingly does not have a viable business anymore worth acquiring as consumers shy away from their offerings.

With the business imploding and elevated cash burn the company will face severe difficulties to sell itself.

[SkylineView]

"Even worse Leapfrog seemingly does not have a viable business anymore worth acquiring as consumers shy away from their offerings."

Screen space on Walmart, Target, and ToysRus websites does not bear that out.

The appeal is >$200M in cash and receivables, great brand sentiment, and a boatload of highly acclaimed educational software. That's worth something to someone.

Granted, current management warrants revulsion, but it's hard to imagine the Milken family, Board of Directors, and competing toy companies sleeping on that too long.

[MacKay Dave]

Maybe is going to profit an investor by being a take-over object. Technically there is 3 point bullish divergence, often a warning of a trend change.

Post market activity may have been opportunistic shorting, let's see what happens this morning at the open.

[User 4599631]

The time to bet your money on a takeover is when a company is operating from a position of strength, not weakness.

Liquidation value is meaningless while a company is a consistent money loser - it throws all calculations out the window because tomorrow that value is even less.

Liquidation value is also meaningless for an operating company and is usually inflated because inventory is usually overvalued even applying 50% discount to carrying value.