2013 SIMR Stock Pitch Competition

SIMR-PICCongratulations to MBA1 Bryce Webster, winner of the 2013 SIMR Stock Pitch Competition.  Bryce’s Buy recommendation on LeapFrog (LF) was selected from a field of 30+ MBA1 stock pitches on Sunday, October 6th. Runners up at the competition included Tim Wengerd and Evan Dryland.  Bryce, Tim, and Evan will represent Stern at Cornell’s 2013 MBA Stock Pitch Challenge, where they will compete against students from top MBA programs across the country. 

LeapFrog Enterprises (NYSE: LF)
BUY Recommendation
Current Price: $9.63
Price Target: $14.50
Potential Upside: ~50%
Time Horizon: (2+ years)
Primary Valuation: 6.0x 2016e EBITDA

Brief Company Overview
LeapFrog designs and develops technology-based learning toys for kids. LeapFrog’s recent hit products have included the LeapPad, LeapPad2, and the LeapPad Ultra – basically educational tablets for kids ages 3 – 9. Ask any parent with young kids and they’re likely to have heard of (or used) LeapFrog products. In addition to selling devices, LeapFrog makes money by developing and selling educational content for the tablets (apps, games, books, movies, music, etc.).

Recommendation
Over the past year a significant short interest has emerged in the stock (25% of total shares), largely on the thinking that LeapFrog can’t compete in the kids’ tablet space with the likes of Amazon (Kindle), Samsung (Galaxy 3 Kids), Apple (iPad mini), and even Toys “R” Us (Tabeo e2). However, I believe that the bears are overlooking LeapFrog’s competitive advantage in content. While LeapFrog is selling tablets, what they are really selling is high-quality educational content. I’m recommending a buy on the stock for the following reasons:

  1. Competitive advantage in content – over the last decade LeapFrog has developed a proprietary learning curriculum that includes over 800 items and 2,600 learning skills. The company does the majority of development in-house using a team of educators, child psychologists, and game designers. LeapFrog consistently receives excellent reviews on its games by both critics and end-users, and as a result, is able to charge premium pricing (up to $25 per app). Further, if LeapFrog were to move to a content-only business model, I believe the company could be just as profitable as it is today.
  2. International expansion – international sales make up just 27% of total sales for LeapFrog, and I think this number has a lot of room to grow (competitors have ~45% international sales). LeapFrog has recently reported strong results with the LeapPad2 in France, but currently just 5% of sales are in non-English speaking countries. This presents a tremendous opportunity to expand into other areas of Europe, South America, and eventually, China/India.
  3. Cheap Valuation – LeapFrog trades at 5.2x EV/EBITDA, just 10% higher than its 3-year trough multiple of 4.7x. Competitors (Mattel, Hasbro, Vtech, Zynga) trade at EV/EBITDA multiples in the 9x-12x range, approximately double that of LeapFrog.
  4. Strong balance sheet – LeapFrog has no short-term or long-term debt, and currently holds $180 million cash ($2.65/share) on its balance sheet. This cash is likely to be used for strategic acquisitions and company growth initiatives, but management may also consider stock buybacks.

In summary, I think LeapFrog (LF) is an opportunity to buy an out-of-favor company with ample growth opportunities at a reasonable price.

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