Old LeapFrog's New Tricks Can't Compete with Real Tablets

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Shares of LeapFrog (LF) opened lower on Thursday after posting uninspiring quarterly results. By market close, it was down almost 9 percent.

The leading maker of electronic learning toys for children had warned investors that it would disappoint during the seasonally potent holiday quarter. Back in November, it stunned the market by forecasting sales to drop by 9 percent to 17 percent.

It turned out to be a lot worse.

From Learning Leader to Laggard

Sales plunged 24 percent to $186.7 million, well short of the $215.4 million that analysts were expecting. LeapFrog broke even on an adjusted basis, missing Wall Street projections calling for a small profit.

LeapFrog knows that young children have abandoned its signature handheld learning toys for apps on full-function tablets. Its own entry into the tablet game failed to generate material buzz in a market that's now overrun with cheap kid-friendly devices. Retailers also didn't help by discounting its entry-level LeapPad2 tablet in December to drive traffic to their stores, a move that disrupted the value proposition of its more expensive higher margin LeapPad2 Power and LeapPad Ultra.

LeapFrog used to be on top of the toy world. It was the toast of the industry in 2011 with the debut of its original LeapPad tablet. The rugged touchscreen device didn't surf the Web nor fire up third-party apps, but it dovetailed nicely with its proven ecosystem of learning programs, including storybooks where the words get more complex as a child's aptitude grows.

Parents flocked to the brand, and by mid-November of that year LeapPad was the most requested toy on Walmart's (WMT) layaway program.
Demand outstripped supply, and by early December, bids for the learning tablet on eBay were roughly twice the suggested retail price.

LeapFrog was ready in 2012. It introduced the enhanced LeapPad2, making sure that there were plenty of both tablets available for shoppers. LeapFrog was thriving, but the success didn't last.

Today, the stock is hitting lows last seen nearly two years ago. Is it too late for the leader in electronic learning toys to learn a few new tricks of its own?

C Is for Competition

LeapFrog updated its product line again last year, adding a long overdue recharger in the LeapPad2 Power. It also introduced LeapPad Ultra.

This should have been a proud moment for LeapFrog. It was an evolutionary leap forward from the LeapPad and LeapPad2, an ambitious push toward something that resembled an actual tablet with Wi-Fi access. Kids couldn't surf the Web or stream YouTube clips, but LeapPad Ultra worked with hundreds of educator-approved apps.

It could have been a game changer, but then came negative reviews, analyst skepticism, and an onslaught of cheap kid-friendly tablets.

Apple (AAPL) had introduced the iPad mini in 2012, but it dropped the price of the original petite tablet to $299 in the fall of 2013. It wasn't just Apple. Samsung took its popular Galaxy Tab 3 device and repurposed it with a sturdy cover that could sustain the clumsy pounding of young users. The Galaxy Tab 3 Kids cost a little more than the original tablet when it hit the market in October, but it also offered parental controls, a restricted app store, and dozens of free apps.

Amazon.com (AMZN) also blurred the marketplace for kid tablets by continuing to lower Kindle Fire prices and making its Kindle FreeTime service for kids more compelling.

This all added up to a difficult market for LeapFrog. Instead of positioning its LeapPad Ultra as a more complete tablet experience than the original LeapPad, it had to face tech giants with full-blown tablets at low prices.

LeapFrog thinks it can win young users back, but if it's right, it won't happen right away. The toymaker isn't forecasting sales to grow again until the second half of this year. However, after seeing its stock shed nearly half of its value since peaking two years ago, there's so much to gain if LeapFrog can buck the trend and fight its way back to relevance for young families.

Motley Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Apple and LeapFrog Enterprises. The Motley Fool owns shares of Amazon.com, Apple and LeapFrog Enterprises.

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