Real Client Managed Portfolio

TO: Real Client Managed Portfolio, Fall 2014

FROM: Yuan Chen, Chen Liang, Yiqi (Delia) Ye

SUBJECT: LeapFrog Enterprises Inc. Recommendation

DATE: November 19, 2014

RECOMMENDATION: SELL

Macroeconomic Outlook and Industry Overview

The world population keeps steadily increasing, so does the population under age 15. Also, the consumer confidence under each income level and per capita disposable income show upward trend in recent year. All macroeconomics statistics display bright future for toys and games industry. The industry is moderate in bargaining power of buyers and suppliers. The threat of new entrants and threat of substitutes are moderate as well. On the other hand, the degree of rivalry remains high. Traditional toys and games are still governing the industry, while the demographic and psychographic shifts will lead to rapid growth in multimedia and electronic toys market.

Company Overview and Business Strategy

Leapfrog Inc. was founded in 1995 and is based in Emeryville, California. The company’s core business is developing educational apps and hardware for young kids. They also produce toys, videos, and music. The majority of Leapfrog’s revenue comes from the sales of LeapPad tablets and downloadable contents. However, net sales has been declining rapidly since 2012. In October 2014, Leapfrog released its new multimedia platform, LeapTV, which is expected to boost its annual sales to its former level.

The company invests heavily in new platforms and online content library development, as the management believes that building a solid operational foundation is the key to future growth. Leapfrog is looking for global opportunities, especially in Asia. In addition, leveraging the company’s large online content assets is continuing to be a focus of the management team.

Portfolio Position

2000 shares were purchased on April 5, 2013 at $8.19 per share. It was trading at $5.45 per share on 11/19/2014. There’s an unrealized loss of 33.49%.

Valuation

Comparable Companies Approach

The team selected three comparable firms for LeapFrog. However there is no close approximation between the business model of LeapFrog and those of its comparable firms in the toy industry. After analyzing several trading multiples, the team discovered significant disparities among the multiples and decided that comparable company approach is not appropriate given LeapFrog’s current financial position as compared to other firms in the same industry.

Discounted Cash Flow Approach

The team set up three scenarios of assumptions for the DCF valuation, with variations in revenue growth rate for three different segments, total operating margin as well as sales projection for the fourth quarter of 2014. After weighting the three scenarios, the team calculated the final share price of $3.48, which is 36% discount to the closing price of Nov. 10th 2014.

Recommendation

Based on the team’s analysis and the weighted average share price calculated, the team recommends selling all of 2000 shares of LeapFrog in the portfolio at market price.