The Evolving Dynamics of the U.S. Toy Industry

Kiran is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

There has been a gradual shift in preference in the US toy industry. Studies have shown that children aged between six to 12 desire tablets (iPads) as their preferred toys. This move away from traditional toys is somewhat reflected in the declining sales of toys in the US. Domestic sales stood at $16.5 billion during 2012, compared to $16.6 billion in 2011.

This decline in the toy industry is attributed to persisting weakness in the US economy coupled with the growing popularity of mobile devices amongst children. In such an environment, companies that have the product line to cater to the demand for new-generation toys are most likely to reap rich dividends in the near future.

Emeryville, CA-based LeapFrog Enterprises (NYSE: LF) is a designer, developer and marketer of technology-based products for children. The company offers multimedia learning-platform products.

Promising growth profile and popular products

LeapFrog Enterprises has reported strong growth in its top line over the past few years. During 2012,  overall revenue grew 28% year-over-year (Y-o-Y) to $581.3 million. Domestic revenue also grew 24% to $424.8 million; international revenue grew 38% to $156.5 million.

During 2012, multimedia learning platforms accounted for 83% of net sales,and the remaining 17% came from learning toys. First-quarter 2013 results were above expectations as consolidated net sales grew 15% quarter-over-quarter (Q-o-Q.)

LeapFrog's success is primarily underpinned by a wide range of its products that are in line with digital market trends. The company has strategically  targeted the growing demand for tech-based toys. In contrast, competitors such as Mattel (NASDAQ: MAT) and Hasbro (NASDAQ: HAS)) have struggled to emulate LeapFrog.

During 2012, LeapFrog Enterprises offered four of the top-10 selling toys in the U.S. The leading toys on the U.S. list included the tablet and LeapPad. In June, the company is expected to launch new products in addition to new apps for iPads and iPhones.

LeapFrog is now shifting its focus to international markets, such as France and Canada, and the company recently launched its flagship LeapPad in the same markets. LeapFrog has witnessed strong growth in international sales over the past two years. The company plans to invest in developing customized products for new international markets in order to capitalize on growing demand in those regions.

Keep in mind

As per the valuation offered by MarketGrader, the present share price of around $8.58 is a highly attractive proposition. The valuation report also suggests that the company is building consistent momentum and continuously gaining market share. Investors should note that LeapFrog generated $1.17 as cash per share during the last twelve months. The present share price of $8.58 is 7.33 times its LTM cash flow. This presents a compelling argument in favor of buying this stock as, the company also has a highly conservative capital structure with no long term debt on its balance sheet.

Competitive landscape

LeapFrog is a relatively smaller player with a market cap at around $580 million. Larger players, such as Mattel and Hasbro, presently boast market caps of around $15.7 billion and $6.1 billion, respectively. Mattel is a worldwide leader in the design, manufacture and marketing of toys. Its key products include the iconic and best-selling brands Barbie and Hot Wheels. Similarly, Hasbro has several iconic brands such as Transformers, Monopoly and G.I. Joe in its portfolio

During fiscal 2012, Hasbro reported net income of around $336 million, or $2.55 per diluted share. Revenue was marginally above $4 billion. The company's board of directors declared a quarterly cash dividend of $0.40 per common share. Likewise, Mattel reported net income at around $776.5 million, or $2.22 per share on net sales of $6.4 billion.

Mattel and Hasbro’s market share positions are presently estimated at around 16% and 11%, respectively. However, both companies have struggled to incrementally develop and create innovative electronic toys for children. Unlike its competitors, LeapFrog with its focus on electronic gadgets, has carved out a niche of its own.

Possible buyout target?

LeapFrog is a potential buyout target for either Mattel or Hasbro given that both players are expected are expected to launch product lines to initiate new trends in the U.S. toy market

LeapFrog, with its promising product range, makes an excellent strategic buyout target for both Mattel and Hasbro. It is understood that both companies have operating cash greater than the market cap of LeapFrog. The majority of LeapFrog’s shares are held by institutional investors; thus, a buyout would occur at a significant premium over the present market value of the company. Hence, buying LeapFrog's stock at current levels could prove highly profitable if a buyout materializes.

The Foolish bottom line 

I believe LeapFrog's stock may be  undervalued and overlooked. In the present scenario, sales of electronic gadgets are expected to grow exponentially. I believe LeapFrog is in an ideal position to capitalize on the escalating demand for digital toys.

Additionally, a foray into the international markets should contribute to the top line of the company. The stock promises strong appreciation going forward, thus, investors with a long-term horizon should include this stock in their portfolios.   

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Kiran Gulati has no position in any stocks mentioned. The Motley Fool recommends Hasbro, LeapFrog Enterprises, and Mattel. The Motley Fool owns shares of Hasbro and LeapFrog Enterprises. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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