Completed Acquisition by VTech Holdings Limited of LeapFrog Enterprises Inc. Initial Submission to the Competition and Markets Authority 11 October 2016 i ii Table of Contents Contents Page I. EXECUTIVE SUMMARY ........................................................................................................ 2 I.1 No realistic counterfactual scenario, let alone the most likely one, is substantially more competitive than the post-Transaction outcome ..................................................................... 3 I.2 In any event, the Transaction fails to raise substantive issues even against a more typical counterfactual .......................................................................................................................... 4 I.3 Conclusion ............................................................................................................................... 9 II. THE PARTIES ....................................................................................................................... 10 II.1 VTech .................................................................................................................................... 10 II.2 LeapFrog ............................................................................................................................... 12 III. THE TRANSACTION ............................................................................................................ 14 III.1 Transaction structure ............................................................................................................. 14 III.3 Transaction rationale ............................................................................................................. 14 III.4 Transaction background ........................................................................................................ 15 III.5 Internal documents relating to the Transaction ..................................................................... 15 III.6 Changes since completion of the Transaction ...................................................................... 16 IV. COUNTERFACTUAL ............................................................................................................ 17 IV.1 Standard for determining the counterfactual at Phase II ...................................................... 17 IV.2 Overview of the Parties’ submissions on the counterfactual ................................................. 18 V. PARTIES’ ACTIVITIES AND MARKET OVERVIEW ............................................................ 21 V.1 Overview of Parties’ activities ............................................................................................... 21 V.2 Supply-side characteristics of the Parties’ products in the UK.............................................. 22 V.3 Demand-side characteristics of the toy industry ................................................................... 26 VI. MARKET DEFINITION ......................................................................................................... 33 VI.1 Product market ...................................................................................................................... 33 VI.2 Geographic market ................................................................................................................ 49 VII. NO EXPECTATION OF UNILATERAL EFFECTS ............................................................... 51 VII.1 Overview ............................................................................................................................... 51 VII.2 No loss of actual or potential competition ............................................................................. 57 VII.3 Existence of countervailing factors ....................................................................................... 99 VIII. CONCLUSION .................................................................................................................... 109 iii TABLE OF ANNEXES 1 Counterfactual discussion 2 CRA report on response to CMA decision on merger dated 10 October 2016 3 VTech’s top 20 customers in the UK, and their respective Confidential to VTech share of 2015 UK sales 4 LeapFrog’s top 20 customers in the UK, and their Confidential to LeapFrog respective share of 2015 UK sales 5 Description of the Parties’ main customers 6 Details on the lifecycle of the Parties’ products in the UK 7 CRA Evidence on market dynamics dated 10 October Confidential to LeapFrog 2016 Confidential to VTech 8 Argos catalogue in 2013 and 2016 9 Hot toys list published by Toy Retailers Association and Argos from 2010 to 2015 10 CRA margin concentration analysis dated 10 October Confidential to LeapFrog 2016 Confidential to VTech 11 “Solutions through fun” publication by the British Toy and Hobby Association 12 “The Value of Play” leaflet published by the National Toy Council 13 Pictures of toy display at Smyths toy store in Slough taken 4 October 2016 14 Examples of reviews commenting on Hudl 2’s child- friendly features 15 Buyers’ responsibilities at Smyths 16 Internal correspondence between LeapFrog Confidential to LeapFrog representatives regarding listing with [Confidential] of 14 July 2015 17 Shares of supply for all NPD segments and sub-classes Confidential to the Parties where the Parties overlap 2011-2016 YTD 18 Correspondence between VTech and [Confidential] Confidential to VTech regarding [Confidential] dated 22 February 2016 19 Correspondence between LeapFrog and [Confidential] Confidential to LeapFrog dated 14 June 2016 20 Correspondence between LeapFrog and [Confidential] Confidential to LeapFrog dated 16 June 2015 iv 21 Correspondence between [Confidential] and VTech dated Confidential to VTech 3 October 2016 22 Correspondence between LeapFrog and [Confidential] Confidential to LeapFrog dated 14 August 2015 23 Correspondence between LeapFrog and [Confidential] Confidential to LeapFrog dated 14 May 2015 24 Correspondence between LeapFrog and [Confidential] Confidential to LeapFrog dated 19 March 2015 25 Correspondence between LeapFrog and [Confidential] Confidential to LeapFrog dated 25 April 2016 26 Correspondence between VTech and [Confidential] dated Confidential to VTech 30 September 2015 27 Correspondence between VTech and [Confidential] dated Confidential to VTech 1 May 2015 28 Correspondence between VTech and [Confidential] dated Confidential to VTech 21 April 2016 29 Correspondence between LeapFrog and [Confidential] Confidential to LeapFrog dated 17 December 2014 30 Correspondence between VTech and [Confidential] dated Confidential to VTech 9 December 2015 31 Correspondence between VTech and [Confidential] dated Confidential to VTech 30 September 2015 32 Correspondence between VTech and [Confidential] dated Confidential to VTech 12 February 2016 33A Correspondence between VTech and [Confidential] dated Confidential to VTech 19 February 2016 33B Correspondence between VTech and [Confidential] dated Confidential to VTech 24 December 2015 v INDEX OF TABLES 1 Volatility in ranking of toys in the NPD Infant/Toddler segment 2 Parties’ overlaps according to NPD categories – 2014-2016 3 Parties’ overlaps in bespoke sub-sub classes considered by CMA 4 Parties’ share of supply of Infant/Toddler/Preschool Toys in the UK in 2015 5 Parties’ share of supply of Infant/Toddler Toys in the UK in 2015 6 Dynamic nature of the toy industry vi INDEX OF FIGURES 1 Purchaser-recipient relationship 2 Media or advertised influence via how purchased 3 Persistence of top quartile products within Infant/Toddler and Preschool toys over time 4 Proportion of new products to previously existing products within the NPD Infant/Toddler and Preschool segments and number of manufacturers from 2014 to 2016 YTD 5 Monthly toy sales in the UK 2014 to 2015 6 Categories in which purchases are made for children up to 4 years old 7 VTech’s Little Love Doll 8 VTech’s FY16 gross and net margin, by NPD sub-class 9 VTech and LeapFrog’s gross margin against NPD sub-class shares 10 Parties’ FY16 gross and net margins for tablets against other products – over (log) gross Sales 11 Screenshot of Apple UK’s education homepage 12 Total UK sales, Preschool Electronic Learning Toys NPD segment 13 Google search queries on Innotab or LeapPad 14 Google search queries on Innotab 2 and Innotab Max 15 Main reason for item purchase 1 COMPLETED ACQUISITION BY VTECH HOLDINGS LTD OF LEAPFROG ENTERPRISES INC. INITIAL SUBMISSION TO THE COMPETITION AND MARKETS AUTHORITY *** The problems with allocating time and resources to the tablet and content segment are simple: there are virtually no barriers to entry, penetration rates are now very high, and new competitors enter the field every year. Earning any profit, let alone an acceptable return on capital, is incredibly difficult, and at this point in time, seemingly unattainable. Open letter of Blue Pacific Partners LLC to the LeapFrog Board of Directors, 15 July 20151 *** Post-merger: number of new LeapFrog learning toys to be launched in the first season: [Confidential] Pre-merger: average total of LeapFrog learning toys launched per season in 2015/2016: [Confidential] Counterfactual: LeapFrog learning toys launched in the most likely counterfactual: 0 I. EXECUTIVE SUMMARY2 1. On 4 April 2016, VTech completed the acquisition of LeapFrog, in lieu of LeapFrog’s liquidation. The latter was the inevitable alternative given the absence of other credible and timely bidders that could forestall the likely exercise