Genius Brands: It’s all up to you, Shaq (NASDAQ: GNUS)

Marks of genius (NASDAQ: GNUS) continued to expand its children’s content, with the “Kidaverse” subscription service launching in April and the highly anticipated (internal) launch of “Shaq’s Garage” slated for Q4 22.

Despite GNUS developing at a rapid pace, this was achieved from a small base with a large inorganic contribution. My investment thesis is still bearish on GNUS, much of the basic offerings and content have gained little popularity with consumers and this is reflected in the results.

Growing fast…from a small base

Q2 results Press release came with a catchy title (unsurprisingly):

For those unfamiliar with Genius Brands, the company has been known to issue exuberant press releases like these regarding numerous business developments. The company’s meteoric rise in stock price in May 2020 was fueled by numerous back-to-back striking press releases, the announcement of “Stan Lee’s Superhero Kindergarten” being the most notable of these. This market excitement soon began to steadily wane over time as the company drastically diluted shareholders and the hype did not convert to financial gains, since March 2020 the total number of shares outstanding has increased by more than sixfold and many of the highly anticipated developments have not generated much shareholder value. The majority of this increase has come in 2020/21, but even in the last six months the number of shares outstanding has increased by almost 14 million.

Basically, GNUS has achieved exceptional revenue growth, but much of this growth can be attributed to the acquisition of Wow which closed in April of this year:

The segment that generated the greatest contribution to revenue was production services, which relates entirely to “Wow”. Wow revenue also makes up the majority of content distribution revenue. In the first quarter of this year, before the acquisition of “Wow”, GNUS revenues were only $1.4 million. Almost all of GNUS’ alleged strong growth is inorganic, which I think is disappointing considering that 18 months have passed since the launch of “Kartoon Channel!” (KC). Over the past year, GNUS has significantly expanded KC’s reach, launching on Pluto TV and Roku. Yet this has brought little success so far, the only real success GNUS has had is through acquisitions, which have increased revenue and expanded content.

High costs and cash burn

Operating costs totaled $30.7m in Q2, an increase of nearly 200% over Q1. Most of this increase is attributable to direct operating costs. This was caused by the consolidation of service salaries and distribution expenses related to the acquisition of “Wow”. Now that GNUS has benefited from the scale of “Wow”, operating margins have improved, but the company still has a large absolute operating loss ($8.6 million). Cash burn is also very high, operating cash flow was -$17.6 million in the first quarter alone, which more than doubled year-on-year. Free cash flow was -$10.11, a loss of $6M more sequentially.

Genius Brands financed much of these losses and acquisitions by borrowing more capital from its margin loan ($56.6 million). Investors will note that this loan is recognized as a current liability, here is why (in 10Q):

Margin account borrowings do not mature but are payable on demand since the custodian can issue a margin call at any time.

So essentially GNUS can be ordered to repay the $56.6 million in full at any time, with only $7 million in cash, how would the company repay that? Well, Genius Brands has $97 million worth of marketable securities on its balance sheet, they’re all liquid, and Genius could sell them quickly to pay off the loan if needed. Given the high cash burn, I suspect they will sell some of these marketable securities to fund operations in the next quarter. If the company chooses not to sell marketable securities, the risk of further dilution by more equity offerings is real to cover cash burn which is expected to remain at current levels as the launch of Shaq’s Garage approaches.

Shaq’s Garage

I believe that much of Genius Brands’ future success depends on the success of Shaq’s Garage’s upcoming launch. A lot of capital has been pumped into this release, in the last quarter film and television costs increased by $15 million, of which $9.5 million was from “Wow” and the rest mainly due to Shaq’s Garage production. This means that unlike many other pieces of content rolled out on KC, Shaq’s Garage must generate a return on investment or market sentiment will worsen.

Following the acquisition of Wow, there is some leeway as the company can fall back on a larger operational footprint. If they hadn’t multiplied shareholders by six to fuel inorganic growth, there would be a vast array of content on its channels, but no substantial revenue to underscore the success of that content. Nevertheless, GNUS is still a growing company and it needs projects like Shaq’s Garage to run well in order to have a chance of becoming profitable. Shaq is a big name that gets a lot of attention, but he’s also a successful entrepreneur and he knows a lot when he sees one. The payment GNUS offered him to produce Shaq’s Garage was probably too good to ignore.

The essential

Genius Brands is burning through big bucks as it reinvests in its content library. KC has brought little success in holding children’s content since its launch. Kidaverse, a $3.99 per month channel, has now also launched but is entering a very competitive subscription streaming market. I don’t believe Shaq’s garage is going to reverse the trend of relative underperformance in content at Genius Brands. Sale.