The internet has lost its mind over the past few days trying to figure out what in the world is going on with Genius Brands (NASDAQ:GNUS) and GNUS stock.

The stock has, for all intents and purposes, turned into the hottest name in the market.

GNUS stock entered May as a 30-cent penny stock. By early June, shares were trading hands up near $12 — a jaw-dropping 40-fold gain in a month.

So, what in the world is going on here? And should you chase the rally?

In short, GNUS stock is exploding higher because Genius Brands, a small children’s entertainment company, is trying to become “the Netflix for kids,” through its soon-to-be-launched Kartoon Channel. The channel will debut on services like Roku (NASDAQ:ROKU). While the prospects of creating such a platform are very enticing, Genius Brands probably won’t be the company that pulls it off.

So, I suggest avoiding the parabolic rally in GNUS stock. Let the traders flip it for now. Monitor the company’s fundamental developments over the next few months. If signs emerge that the Kartoon Channel platform is gaining meaningful traction, then maybe buy Genius Brands’ stock at that point.

Until then, sit this one out to avoid injecting your portfolio with unnecessarily large risk.

The Netflix for Kids?

The meteoric rally in GNUS stock started when the company announced in early May that it was going to launch a its brand new platform on June 15 across all platforms, and attempt to become a free Netflix (NASDAQ:NFLX) platform for kids — or an ad-supported streaming-video-on-demand (AVOD) platform comprised exclusively of content for children ages 2 to 11.

This is a huge idea — with potentially huge rewards.

Kids watch TV, too. And just like their parents, they are spending less time with linear TV channels, and more and more time with internet TV platforms, like those offered by Netflix, Amazon (NASDAQ:AMZN) and Disney (NYSE:DIS). Since 2014, the age 2 to through 11 demographic has decreased linear TV time by more than 25%, and upped internet engagement by more than 20%.

But, most of the internet media platforms for kids entertainment are either paid or not exclusive to kids. That is, Netflix, Amazon and Disney+ all have a bunch of kids content — locked behind a paywall. None are kid-exclusive. Meanwhile, while ad-supported YouTube Kids is a thing, it’s actually the broader YouTube platform that attracts the lion’s share of kids viewing time and ad dollars.

In other words, there exists a clear opportunity for a kids-specific AVOD platform to emerge over the next several years.

That’s exactly what Genius Brands is trying to create. And if they pull it off, it could be a huge success.

A Billion Dollar Company, Maybe

In an “everything goes right” scenario, Kartoon Channel could turn Genius Brands into a multi-billion-dollar company.

Global kids ad spend measured $4.3 billion in 2019, and has been consistently growing by about 2% per year, supported by stable end-market demand in verticals like toys. About 27% of that ad spend is in the digital channel. That’s up from 15% in 2016, equating to roughly 100% growth in kids digital ad spend from 2016 to 2019.

The accelerating consumption shift among kids towards digital channels will continue to spark bigger increases in the digital ad spend penetration rate. PwC expects digital ad spend penetration to rise to 37% by 2021.

Assuming this trend persists, then global kids digital ad spend is well on its way to 50%+ penetration rates by 2030, translating to a potentially $4+ billion market (assuming global kids ad spend sustains approximately 2% growth per year, too).

That market is presently dominated by YouTube. Nearly a quarter of all kids digital ad spend is allocated to YouTube. That share will only grow as YouTube Kids gains traction.

But if Genius Brands can successfully create a widely watched AVOD platform in a market absent of an incumbent, kids-centric AVOD platform (excluding YouTube), then it reasons that the company could nab about 10% of the $4 billion global kids digital ad market by 2030.

That implies $400 million in sales. Gross margins at scale should hover around 80%, since this is a digital ad business. Opex rates will be elevated, probably around 60%, because Genius Brands will have to spend an arm and a leg on marketing to increase brand awareness.

That equates to 20% operating margins. Assuming a normal 20% tax rate, then we are talking about $64 million in 2030 profits, which — using an application software historically normal 35-times forward multiple — implies a future valuation of over $2 billion.

Lots of Execution Risk

The problem with GNUS stock is that Genius Brands is unlikely to travel down an “everything goes right” path.

Creating the Netflix for Kids will be a challenge. There are tons of execution risks.

Not only do you have to drum up awareness of your brand to get people watching, but you have to also: 1) create compelling enough content to get people to stick, 2) compete against big players like Netflix, Disney and Amazon who collectively spend $3 billion on making kids content, 3) navigate around exceptionally strict data protection laws which all but restrict the use of targeted advertising for kids and 4) not run out of money in the process (before Netflix became Netflix, it burned billions and billions of dollars).

Genius Brands doesn’t seem like a company well positioned to manage and tackle those execution risks.

Before Kartoon Channel was announced, this was a penny stock with a sub-$10 million valuation. Revenues plunged more than 70% in the first quarter of 2020 to just under $335,000. The company’s content portfolio features some stars, like Warren Buffett and Arnold Schwarzenegger, but overall lacks sufficient firepower to compete against the incumbents in the space. Just look at how few YouTube views most of Genius Brands’ content gets on YouTube.

The company burns a ton of money. Cash on the balance has dwindled from nearly $8 million two years ago, to just over $300,000 at the end of 2019. That $300,000 won’t go a long way in creating new content, and/or acquiring good content.

Zooming out, then, while a high-quality, multi-billion-dollar AVOD platform for kids will emerge over the next decade, it is unlikely that this platform will be made by Genius Brands.

Bottom Line on GNUS Stock

Up 40-fold in a month, GNUS stock is captivating.

But it’s not a good buy. Rather, it’s not a smart buy. There’s simply too much risk and too many unknowns here.

I like the space. I think that out of the kids internet media world, a multi-billion-dollar AVOD platform will emerge over the next few years. But it’ll likely be YouTube Kids, or an offshoot of Netflix or a well-funded startup that has acquired a bunch of high-quality content.

In other words, it likely won’t be Genius Brands. And for that reason, I say stay away from volatile GNUS stock — at least until we get more data on how the Kartoon Channel is performing.