Mergers & Acquisitions

VTech poised for interim profit slump as takeover of rival remains under probe, analyst says

As Britain continues its probe into firm’s recent US$72m acquisition of US rival LeapFrog, one-off costs expected to hit half-time performance

PUBLISHED : Tuesday, 18 October, 2016, 9:44am
UPDATED : Wednesday, 19 October, 2016, 10:08am

VTech Holdings, the world’s largest supplier of electronic learning products, is predicted to post lacklustre earnings for the six months to September as its acquisition of rival LeapFrog Enterprises remains under investigation in Britain.

Hong Kong-listed VTech’s shares have been downgraded to “Sell” from “Neutral” by Citi Research, whose analysts said in a report they anticipate the interim results announcement next month to show a “deep earnings decline”.

The company’s share price opened at a low of HK$90.05 on Tuesday, down from its close of HK$90.30 on Monday, but rallied in early afternoon trading to finish up 0.28 per cent to HK$90.55.

“We forecast interim profit to slide 29 per cent to US$71 million from US$100 million a year earlier,” said Citi Research analyst Eric Lau, the lead author of the report.

Lau said that estimate includes a one-off provisional charge for compensation due to the anticipated layoffs of about 200 staff at California-based LeapFrog, which VTech bought for US$72 million in April.

The senior management at VTech, also the world’s biggest supplier and contract manufacturer of cordless telephones, said they plan to retain only 100 of LeapFrog’s total 300 headcount for content development, software programming, and research and development, according to Lau.

Those to be let go are administrative, sales and so-called back office staff.

“This one-off charge may range from US$20 million to US$40 million in our estimation, which includes both layoff compensation and bonuses to retain staff,” Lau said.

We forecast interim profit to slide 29 per cent to US$71 million from US$100 million a year earlier
Eric Lau, analyst, Citi

“We do not rule out the possibility that VTech may sacrifice shareholder dividends again to finance the one-off restructuring charge. The management has not yet given guidance for this one-off charge.”

A VTech spokeswoman could not comment because the company is in the quiet period before its interim results announcement.

Lau said VTech management expected the company to record “low to mid-single digit growth, along with about US$240 million of LeapFrog sales per our estimation”.

Electronic learning products accounted for 37 per cent of VTech’s total US$1.86 billion revenue in the year to March. The company shipped around 49 million electronic learning toys, designed for infants, toddlers and pre-school children, to 78 countries in 25 languages during that period.

Those included activity desk platforms, smart watches and tablets. Its biggest geographical markets for these products are Europe and North America.

Allan Wong Chi-yun, VTech’s chairman and group chief executive, said in May that the company’s takeover of LeapFrog would complement the company in terms of geographical strength, product mix, skill sets and operations.

Britain’s Competition and Markets Authority (CMA), however, continues to probe the LeapFrog acquisition. Kate Collyer, the CMA’s deputy chief economic adviser, said in a statement there was concern the marriage “could lead to price rises, the quality of products going downhill or the range on offer being reduced”.

The authority has set a late-November deadline for all the relevant parties to make submissions. It will issue provisional findings and possible remedies in December.

“While we understand that the CMA is duly protecting consumers from a less competitive marketplace, we argue that VTech’s acquisition of LeapFrog was a white knight bid that saved the LeapFrog brand and its products from disappearing from the market altogether, particularly given LeapFrog’s previously dire financial situation,” Daiwa Capital Markets analyst John Choi said in a report.