Leapfrog is a former leading manufacturer of educational electronic games for kids. The company’s main
products, the LeapPad and Leapster (handheldgaming console), were very popular platforms for which
kids bought various new cartridges. Please see Cuyler’s 2013 write up for more on the company’s history
and accomplishments. However, since that time, the company has seen a significant decline in sales due
to the popularity of iPhones, iPads, and other tablet devices that utilize apps which are much cheaper and
more accessible than LF’s games. The company is currently trading below net cash, suggesting that the
market believes it will not be able to compete in today’s environment.
There are a few options for Leapfrog.Either the company gets lucky and develops a new hot product and
sales rebound significantly (doubtful), or a competitor realizes the strong brand recognition and trust that
the company has built up over the past 20 years and decides to acquire it and license its brand for other
products in the educational / learning marketplace. Otherwise, at its current run rate, it will be a 0.
That being said… let’s take a look at LeapFrog as an acquisition candidate. The company’s SG&A has
averaged more than $80 million dollars per year over the past several years. Despite significant sales
declines due to the popularity of iPhones, iPads, and other tablets, the company believes it has a
turnaround plan that will stem the sales declines and continues to spend like drunken sailors. If the
company were to be acquired, most, if not all, of the SG&A would disappear. If Mattel, Hasbro, Jakk’s, or
any other toy maker were to acquire the company, they would probably pay a multiple of the company’s
sales. If they paid 1x sales, the stock would be $4. So a buyer doesn’t have to go out on a limb too far in
order to reap the benefits of an acquisition. In general, toy companies tend to trade between 0.5x sales
and 2.0x sales. Since LF has its own brand and the brand couldbe licensed for other products,I would
argue that 1x sales is not a stretch.
Why would the company sell now versus any other time? On July 15, investor Blue Pacific Partners started
to flex its muscle and recommended voting against the incumbent directors. Similar to my belief, BPP said
“We invested in LeapFrog because we believe that it is one of the most well-regarded and recognized
brands in the infant and toddler toy industry.” They then go on to talk about the poor financialresults
and highlight all of the company’s missteps which I will not bore you with. However, BPP does offer a new
strategic direction for the company which entails focusing on traditional toys and making LF’s content
available on various otherplatforms. This seems consistent with my thoughts that a competitor could
purchase the company and wipe out its cost structure by licensing the LeapFrog name for other categories.
In addition to being an acquisition target, LF has more than $200 million of NOL’s in the US. I don’t think
the company is in danger of using these anytime soon. However, what if LF were to acquire a private
competitor who is profitable? There are a couple of private companies in the US that could exit through
a sort of reverse merger into LF. LF could use its NOL’s to shield the profitability of these private
companies and the new combined public company could show strong cash flow and growth.