Leapfrog Enterprises Inc.

November 20, 2014

Yuan Chen, Chen Liang, Yiqi (Delia) Ye

Agenda Current Holdings Company Overview Macroeconomic Review Industry Review Business Strategy & Corporate Governance Financial Analysis Valuation Recommendation

Current Position

ABBVABTAEOALCOFJKHYLFNHCPETMSNAUNPWAGZIXI

LF 5.80%

2,000 shares bought on April 5th, 2013 @ $8.19 Current Price: $5.45 (11/19/2014) Total Loss: -33.49% Portfolio Shares (MV): 5.80%

Source: Yahoo! Finance RCMP Portfolio (https://finance.yahoo.com/portfolio/pf_1)

Relevant Stock Performance

Source: Bloomberg Finance: LF & Russell 2000 Index Spread

Company Overview Traded on the NYSE with ticker symbol LF

Founded in 1995 by Micheal Wood and Robert Lally and headquartered in Emeryville, California USA

GICS Sector: Leisure Products

Sub-Industry: Toys & Games

Focus: Educational entertainment toys

579 full-time employees as of December 31, 2013

Source: LeapFrog 10K 2013, Bloomberg Finance

Business Segments & Distribution Channel

Three main retailers:

Wal-Mart

Toys R Us

Target

United States; 70%

United Kingdom; 11%

Other Countries; 19%

Wal-Mart; 25%

Toys "R" Us; 15%

Target; 11%

Others; 49%

Global Revenue Breakdown:

Source: LeapFrog 10K 2013: Page 67,69

Major Products & Services Products:

Multimedia learning platforms

LeapPad Family of Learning Tablets (3-9 yrs.)

Leapster Family of Handheld Learning Game System (4-9 yrs.)

LeapReader Reading System (1-8 yrs.)

LeapTV (3-8 yrs.)

Learning toys

Dozens of Product Lines (0-6 yrs.)

Services: LeapFrog Learning Path

Over 1,200 downloadable Apps in Online Application Center

Source: LeapFrog Website http://www.leapfrog.com/en-us/store/

Major Products & Services

LeapPad 2 LeapPad Ultra LeapPad 3 LeapTV

Release Date June 2012 June 2013 June 2014 October 2014

Price $ 79.99 $ 129.99 $ 99.99 $ 149.99

Age Range 3-9 years 3-9 years 3-9 years 3-8 years

Apps Over 1,200 Apps 100+ Games & Videos

Peer-to-peer play × ✓ ✓ ✓Amazon Rating

4.5/5.0(860)

3.5/5.0(754)

4.5/5.0(143)

4.5/5.0(58)

Source: Amazon, LeapFrog Website http://www.leapfrog.com/en-us/store/

Macroeconomics Overview

Source: Federal Reserve Bank of St. Louis (http://research.stlouisfed.org/fred2/series/A229RX0)

Consumer confidence Per Capita Disposable income

Macroeconomics Overview

Source: Population Reference Bureau (http://www.prb.org/DataFinder/Topic/Bars.aspx?ind=14&loc=246,310,341,355,412,463,241), Statista (http://www.statista.com/statistics/194424/amount-spent-on-toys-per-child-by-country-since-2009/)

-

200,000,000.00

400,000,000.00

600,000,000.00

800,000,000.00

1,000,000,000.00

1,200,000,000.00

1,400,000,000.00

Population (Age<15)

2014 Population

2030 Population Projec-tion

United Kingdom

United States

France

Toy spending per child worldwide Child population distribution

Porter 5 Forces Analysis ― Toys and Games Industry

Porter 5 Forces

Barrier to entry:Moderate & Decreasing· High-cost and long-term nature of brand reputation· Declining life-cycle· Targeting niche markets

Competition:High & Steady· Numerous players· Low profit margin· Short-lived and/or seasonal· Technology· Other leisure activities

Bargaining Power of Buyers:Moderate & Decreasing· Players being retailers· Low individual profitability and prevalence of available end customers

Bargaining Power of Suppliers:Moderate & Steady· Licensing rights on popular brands· Less substitute products· Forward integration· Government regulation

Threat of Substitutes:Moderate & Increasing · Psychographic shifts· Digital games, education and entertainment· Low switching costs· Peer affect

Competitors Analysis Multimedia learning products

Vtech Holding Ltd.

Fuhu, Inc.

Learning toy category

Vtech Holdings Ltd.

Mattel, Inc.: Fisher-Price brand

Hasbro, Inc.: Playskool division

General tablet computers and eBook readers: Apple, Amazon and Samsung, and the Sony and Nintendo handheld gaming systems

SWOT AnalysisStrength Weakness

• Higher quality educational products• Age-appropriate and personalized

education curricula• Award-winning learning solutions• Online learning world for children• Easy-to-use parent resource center• No interest-bearing long-term debt

• Price premium• All products under single brand• Seasonal• High fixed costs

Opportunities Threats

• Demographic and psychographic shifts• International expansion• New platform • Downloadable content library

• Safety standard• Competitors• Loss skilled workers• Industry declining• Highly changeable consumer

preferences

Source: Q2 2015 LeapFrog Enterprises Inc. Earnings Call, LeapFrog Enterprises Inc. 10-K

Weakness and Risks Price Premium

High Fixed costs

Overly Concentrated Distribution Channel Three biggest retailers accounts for more than 50% of net sales

Highly Seasonal and Fluctuating Sales More than 70% of sales is made during holiday season each year

Highly Changeable Consumer Preference and Product Trend Sales is highly depend on new product

Source: LeapFrog 10K 2013, Page 10-17

Risk Factors – A Special Concern Suspicious Earnings of 2012 and 2013

Changes in Valuation Allowance account for 50% and 75% of Net Income in 2012 and 2013, respectively

2011 2012 2013

18,765

61,960

33,826

19,902

86,452 84,009

13,222

42,814

21,250

Net Income after Valuation Allowance Ad-justment

Taxable Income Net Income Adjusted Net Income

Source: LeapFrog 10K 2013, Page 42, 56-58

Business Strategy

Build an operational foundation to support future Invest heavily in new platform and content library development

Looking into international market Increase international revenue to 50% of total revenue

New Chief International Officer, Antony Hicks

Leverage content assets across many platforms 1200+ apps for tablets & 100+ games and videos for LeapTV

Source: LeapFrog Website, Earnings Call Transcript Q2 2015: Page 3-5, 10

Corporate Governance Aged Management Team & Board Directors:

Average Executives And Board Mambers Age: 57+

Management team’s capability is questioned

High Level of Executive Compensation: 11.18 million, 2% of net sales

Competitors’ compensation/net sales ratio is under 1%

(Hasbro 0.8%; Mattel 0.4%)

ISS Governance QuickScore is 8, as of Nov 1, 2014. Audit: 5; Board: 8; Shareholder Rights: 7; Compensation: 8

Source: LeapFrog 10K 2013, Morningstar Company Report: Page 13-18, Yahoo Finance: Corporate Governance

Technical Analysis

Source: Bloomberg as of 11/19/2014

Ratio analysis

2009 2010 2011 2012 2013 2014E0.0

1.0

2.0

3.0

4.0

5.0

6.0

Current Ratio Quick Ratio

2009 2010 2011 2012 2013 2014E-20%-10%

0%10%20%30%40%50%

Gross margin Net margin

2009 2010 2011 2012 2013 2014E-0.5

0

0.5

1

1.5

2

2.5

3

Return on Equity Tax burden

Other expense burden Operating margin

Asset turnover Leverage

2009 2010 2011 2012 2013 2014E-0.4

-0.2

0.0

0.2

0.4

0.6

Greenblatt ratio 1 (EBIT/Tangible Assets)

2009 2010 2011 2012 2013 2014E-20%

-10%

0%

10%

20%

30%

Return on equityReturn on asset

Liquidity ratio Operating efficiency

Greenblatt ratio Return ratio

Dupont analysis

Source: LeapFrog 10K 2013

Trading comparable analysisComparables

(USD'000)

Company NameMarCap

($mn) P/E P/BVEV/

EBITDAEV/

EBITEV/

RevenueEV/Forward

RevenueEV/Forward

EBITDA       

LeapFrog (NYSE:LF) 354.3 4.80x 0.90x 7.20x 11.70x 0.50x 0.51x 8.79xMattel (NasdaqGS:MAT) 10,500.2 14.90x 11.40x 10.60x 13.20x 2.00x 1.95x 10.45xHasbro (NasdaqGS:HAS) 6,789.3 18.90x 12.00x 9.80x 12.70x 1.90x 1.81x 9.31xVtech Holdings (SEHK:303) 3,439.3 16.30x 6.70x 12.50x 14.20x 1.70x 1.68x 11.70x

       High 18.90x 12.00x 10.60x 13.20x 2.00x 1.95x 10.45xLow 4.80x 0.90x 7.20x 11.70x 0.50x 0.51x 8.79xMedian 14.90x 11.40x 9.80x 12.70x 1.90x 1.81x 9.31xMean 12.87x 8.10x 9.20x 12.53x 1.47x 1.42x 9.52x

     

     14E

Revenue15E

Revenue15E

EBITDALeapFrog Financials 435,016 479,407 20,831 EV 638,023 682,357 198,237 + Cash     150,868 150,868 150,868 Equity Value 788,892 833,225 349,105 Shares outstanding 70052 70052 70052Implied share price     11.26 11.89 4.98

Source: Capital IQ as of 2014/11/17

SCENARIO

2015 2016 2017 2018Multimedia GrowthOptimistic 20% 15% 12% 12%Base case 15% 12% 12% 10%Pessimistic 12% 10% 10% 5%

Learning toys GrowthOptimistic -5% 0% 0% 0%Base case -5% -5% 0% 0%Pessimistic -8% -8% -5% -5%

All others GrowthOptimistic -5% 0% 0% 0%Base case -5% -5% 0% 0%Pessimistic -8% -8% -5% -5%

Cost of sales AssumtionsOptimistic 60% 59% 58% 57%Base case 60% 59% 58% 57%Pessimistic 60% 60% 59% 58%

2014 4th quarter as % of total salesOptimistic 54.0%Base case 50.0%Pessimistic 46.0%

REVENUE       

  2011 2012 2013 2014ESegment Multimedia learning platforms

315,300

463,100

441,200

351,572

% of total 69% 80% 80% 81% Growth   47% -5% -20%

Learning toys

132,000

113,500

109,500 80,849

% of total 29% 20% 20% 19% Growth   -14% -4% -26%

All other

7,800

4,700

2,900

2,595 % of total 2% 1% 1% 1% Growth   -40% -38% -11%

Total net sales

455,100

581,300

553,600

435,016 Growth   28% -5% -21%

COSTS          

Cost of sales

268,988 336,344 337,565 283,639

% of sales

59% 58% 61% 61%

DCF Assumptions & Three scenarios

Seasonality      

4th quarter net sales as % of total sales46% 42% 34%

Source: LeapFrog 10K 2013

FCF, WACC and Terminal ValueStep 1: FCF calculation            

2014 2015 2016 2017 2018(USD'000)EBIT (37,407) 11,047 22,095 36,146 50,513- Tax 0 695 1,412 2,323 16,277= EBIAT or NOPAT (37,407) 10,352 20,684 33,822 34,235+ Depreciation & amortization 11,044 10,784 11,484 12,919 14,502- CAPEX (34,908) (33,403) (27,110) (21,999) (14,068)- Capitalization of goods (8,801) (7,518) (6,523) (7,071) (7,554)- Increase in NWC 38,451 (5,008) (5,369) (10,332) (8,493)= FCF (31,621) (24,794) (6,833) 7,340 18,623

Step 2: WACC calculation

         

Risk free rate 2.5% S&P regression BetaMarket risk premium 6.5% 5 year 1.49

Equity beta 1.19

4 year 1.07

Cost of equity (CAPM) 10.27% 3 year 1.035-year annualized return 11.76% Average Beta 1.19Average 11.01%Business risk premium 2.00%

Debt to Asset ratio 0

WACC 13.01%

Step 3: Terminal value calculation    

Growing perpetuity method

Normalized FCF (last yr of projections) 18,623.4

Assumed perpetual growth rate 3.0%

Implied terminal value (at 2018) 191,610

Source: LeapFrog 10K 2013

DCF and Sensitivity Analysis Step 4: Discounted cash flows                (USD'000)FCF (31,621.0) (24,793.5) (6,833.3) 7,340.1 18,623.4 Counter (present = end of 2014) 0.0 1.0 2.0 3.0 4.0Discount factor 100.0% 88.5% 78.3% 69.3% 61.3%Discounted CFs (31,621.0) (21,939.1) (5,350.4) 5,085.6 11,417.6 Sum of PV of CFs (42,407)PV of terminal value 117,473

Implied EV 75,065

+ Cash 127,467 Equity Value 202,532.5 Diluted shares outstanding (‘000) 70,052.0

  Implied share price (USD) 2.89

   Step 5: Sensitivity analysis                

Perpetual growth rateImplied share price (USD) 2.89 2.50% 2.75% 3.00% 3.25% 3.50%

14.01% 2.61 2.65 2.68 2.72 2.7613.51% 2.70 2.74 2.78 2.82 2.87

WACC vs. perpetual growth rate

WACC 13.01% 2.80 2.85 2.89 2.94 2.99

12.51% 2.91 2.96 3.01 3.07 3.1212.01% 3.04 3.09 3.15 3.21 3.27

Perpetual growth rateImplied share price (USD) 2.89 2.50% 2.75% 3.00% 3.25% 3.50%

1.49 2.62 2.65 2.69 2.73 2.771.39 2.67 2.71 2.75 2.79 2.83

Beta vs. perpetual growth rate Beta 1.29 2.74 2.78 2.82 2.86 2.911.19 2.80 2.85 2.89 2.94 2.991.09 2.87 2.92 2.97 3.02 3.07

Implied share price (USD) 2.89

Current share price (USD) 5.45

% premium / (discount) to current (46.95%)

Source: LeapFrog 10K 2013

Recommendation Weighted stock price valuation

Case Implied share price Weighting

Optimistic 5.81 30%

Base 2.89 60%

Pessimistic 0.06 10%

Weighted share price $ 3.48  

Current price $ 5.45  

% premium / (discount) to current (36.1%)  

Sell 2000 shares @ mkt

Recommendation