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Deep Dive: Grom Social Enterprises

Developing and managing digital content for children is emerging as one of the fastest growing markets for media companies. The importance of a kid-centric strategy is growing particularly for large streaming giants like Netflix and Amazon Prime especially after the recent set of results have shown a limited growth potential of streaming users based on regular, adult content. There are relatively few incumbents in this children’s digital consumption market, particularly for kids below 13 years of age, who comply with the COPPA (Children’s Online Privacy Protection Act) and provide the parents with complete control over the content consumed by their kids. Not many companies today are focused on offering setups such as joint viewing of screens for children and parents or caregivers to help the parent advise their kids children to understand the content better and shape their interpretations by encouraging or discouraging the social content of the programming. Today, I am looking forward to carrying out a detailed due-diligence of one such player within the animation and social media industry for children under 13 years of age that could pose a genuine threat to the streaming giants looking to penetrate the kids market – Grom Social Enterprises (NASDAQ:GROM).

What Does Grom Social Do?

Grom Social Enterprises, Inc. is a media, technology, and entertainment company focused on producing children’s content and distributing it through the company’s own social network and content platform. Its animation studio, Top Draw produces animated films and televisions series; and provides web filtering services to schools and government agencies. Grom essentially caters to children below 13 years of age and its core focus is the delivery of quality kid-safe content which is done in a safe and secure environment that is easy for parents to monitor. 

Source: Grom Website

The above snip from Grom’s website gives a wonderful overview of what the company does coupled with all the relevant safety compliances that it adheres to (its largest selling point). With the Grom app, kids can create their own customized “Gromatar” profiles and interact with others through direct messaging that includes liking/commenting, drawing, photo sharing, and more. 

Grom produces a lot of highly relevant content for kids which is evident from its Youtube channel – https://www.youtube.com/user/GromSocial

The company was founded in 2012 and is headquartered in Boca Raton, Florida.

Solid Business Model

Grom’s biggest revenue earner and the largest contributor to its operating income is its animation studio subsidiary, also known as Top Draw Animation. It has been in the 2D animation business for over 2 decades and produces award-winning animation content for some of the largest international media companies in the world.Grom produces close to 250 half-hour episodes of 2D animation each year and caters to some of the top animation clientele in the world such as Disney, Warner Brothers, Scholastic, Nickelodeon, Hasbro, DreamWorks, and Cartoon Network.In addition, the company is not only COPPA (Children’s Online Privacy Protection Act) compliant but also a powerful tool through which parents can monitor their children’s online activity and ensure that the child is only consuming age-appropriate content.For children, the platform provides an excellent social media experience as kids can record and share videos, write comment, use hashtags, send messages to communicate with each other online, chat with cartoon characters, and stream the relevant video content. This is the reason why Grom Social has more than 15 million users as of today including both children and parents.

Top Draw Animation Studios

While Grom has been in 2D animation for a while now, its major breakthrough came in the form of the acquisition of Top Draw Animation, a Philippines-based animation studio in June 2016. The company has a 30,000 square feet animation studio based in Manila in the heart of the Philippines. It has accumulated the production of more than 2000 half-hours under the Top Draw banner which indicates a strong content base for Grom’s social media platform.

Source: Top Draw website

Top Draw is the main revenue earner for Grom today and serves a vast variety of clients as shown in the above extract. It employs skilled animation experts which serve the needs of the top production houses. In fact, the animation studio was recently in the news for being qualified for financial incentives under the Film Development Council of the Philippines and its Film Philippines Office’s (FPO) Film Location Incentive Program for the production of its animated TV series Bionic Max. The studio has a stellar reputation after having worked for many well-known international productions, including My Little Pony: The Movie (2018), The Hollow (2018), and Penn Zero: Part Time Hero Season 2 (2017). From a revenue standpoint, Top Draw has a particularly large order book position since 2020. The execution of these orders was forced to be on standstill in 2020 given the lockdown caused by the Covid-19 pandemic but all its projects are back on track in 2021. It is worth highlighting that Grom’s revenues were $8.3 million in 2019 prior to the pandemic and these delays forced the top-line down to $6.16 million in 2020. However, with Top Draw executing the project pipeline, the company already has a trailing twelve-month revenue of $6.74 million and if the current momentum continues then it should possibly go past the $10 million mark this year. In this way, Top Draw acts like a wonderful revenue generating cushion for Grom as it attempts to popularize its Grom Social platform and start monetizing on the same.

Rising Content Consumption On The Internet

The media & entertainment industry particularly the over-the-top market gained a massive user base in 2020 given the Covid-19 lockdown forcing people to stay at home. Subscriptions for giants like Netflix, Disney, Amazon Prime, and many others shot through the roof and are expected to follow a steady growth trajectory. Grom appears to be well-positioned to gain from this with the recent acquisition of Curiosity Ink Media which provides extensive opportunities to the company in creating original content.

Also, the proliferation of internet users and the high adoption rate of smartphones and portable devices are the key catalysts behind the ongoing growth of the global online media market. Increased preference to create High-Definition (HD) content, especially for video marketing, given its higher resolution, considerably higher number of pixels, and improved content quality compared to standard-definition content, is likely to positively impact the growth. Moreover, the development of online platforms with display ads, digital videos, rich media, and mobile advertising formats is one of the prominent drivers of the market. Innovative marketing solutions such as online content and image-centric marketing may put forward alternative opportunities for market growth. Notably, the increasing availability of mobile-friendly content and diversification in social media is expected to attract more users.

Online Content For Kids – Is It Safe?

In the current environment, parents are more worried about their children using social media and technology than drugs, alcohol, or smoking. According to a report by Zion Market Research, global parental control market was valued at around USD 1.4 billion in the year 2016 and it is expected to reach approximately USD 3.3 billion by 2025. The global parental control market is expected to exhibit a CAGR of over 11.5% between 2017 and 2025.

Source: Company Presentation

It is not surprising at all that behemoths like Facebook and Tiktok have been fined billions of dollars for being unable to filter out safe content for children. As of today, streaming giants like Netflix are eyeing the children’s content market as a huge growth opportunity. As a matter of fact, PwC’s research from 2019 indicated that the kid’s digital media market is well over $1 billion dollars and is expected to grow at a CAGR of more than 20%.

Grom Social – A First Mover’s Advantage

Grom Social has a definite first mover’s advantage. It is one such company that is COPPA (Children’s Online Privacy Protection Act) compliant and offers a safe online community, hence increasing customer confidence and maintaining a positive image in the society. Moreover, Grom Social is the only kid-friendly platform that provides features like recording and sharing videos, lives commenting, hashtags, streaming video, direct messaging, music, and thousands of hours of Grom TV content in a safe and secure manner.

In addition, the rising consumption of media and entertainment content for kids is expected to drive the demand for 3D animation which bode well for companies like Grom Social that can benefit from the growth of its Top Draw Animation that produces 3D animation for Technicolor. It is also worth highlighting that, 3D animation solutions are creating new opportunities in the education and academics sector by exploiting the motion and sight benefits of the technology for students.

Acquisition of Curiosity Ink Media

In April 2021, the company announced its plans to acquire Curiosity Ink Media, a producer, and developer of original kid-friendly content. Curiosity is a global media company that produces feature films, television series, and physical books for a modern generation of kids and families. This acquisition will open new opportunities for Grom like original programming, including operating as an original content pipeline for Subscription Video on Demand (SVOD) services. Moreover, this move will allow the company to create cross-platform synergies whereby Curiosity content can debut on Grom Social and the company can also gain user feedback and help inform series development. There is a strong human resource upside as well as Curiosity Ink Media’s top management team comprises ex-Nickelodeon President Russel Hicks and animation industry veteran Brent Watts who have been associated with some of the most legendary animation names such as Scooby Doo, SpongeBob and Dora franchises from Nickelodeon, the Dr. Seuss franchise, Shrek and Kung Fu Panda of DreamWorks Animation, and the Spider-Man franchise of Sony Pictures. Taking all these factors into consideration, Grom is poised to get a solid base in conceptualizing, developing, and creating original content which seems like an amazing opportunity to accelerate growth and efficiently monetize the platform in the near term. 

Strong Management Team

Source: Grom Presentation

Grom Social is headed by a team of well-specialized personnel including CEO Darren Marks who has more then two decades of management experience. Mr. Marks co-founded and served as Vice-President of Sims Communications, Inc. a telecommunications company where he was responsible for the creation, design, and funding of a national telecommunications program Darren is supported by Melvin Leiner who acts as the CFO and brings about 50 years of entrepreneurial domestic and international business experience ranging from product creation, development to sales and marketing for public and private companies. Mr. Leiner attended Marshall College where he studied business.In addition, Dr. Thomas J. Rutherford has served as a director of the Company since August 2017. He is an oncologist and a national expert in cancer, with more than 30 years of highly specialized surgical and clinical expertise in gynaecologic cancer care. His great operational experience led company to appoint him as a Director.Another highly skilful Director who brings huge financial experience in the table is is Robert Stevens Mr. Stevens founded Somerset Capital Ltd., a private capital firm that employs industry-specific skillsets to make strategic investments in distressed and turnaround situations as well as merger and direct investments in private and pre-public companies and has served as its president and managing director since 2001.Overall, Grom Social appears to be well-positioned to leverage its highly competent management team and therefore culminate a successful business in the years to come.

Recent Catalysts

Grom Social most recently announced that Curiosity is introducing Santa.com, an online hub where kids and adults can experience classic holiday joy in a modern digital holiday venue. The platform will offer a special place to kids for registering their Christmas wish lists and also experience a virtual tour of the North Pole. This acts as a medium to de-stress the holidays for parents by providing them with tools to send personalized gifts that arrive wrapped, from the comfort of their very home. Santa.com will be launching in the fourth quarter of 2021 and can be a key catalyst for growth given this curated holiday hub can come as a unique experience in the market-leading to an increase in subscribers at large. In addition, the company also announced its plans to produce an original animated music holiday special which is inspired by annual classics like “Rudolph The Red Nosed Reindeer” and “Elf”. This production will focus on Santa’s efforts to modernize his North Pole workshop with the help of some technical upgrades making it all the more appealing to the kids. With the acquisition of Curiosity Ink, Grom is well on track to unlock its potential in the original content space and has ample of opportunities to grow in this space.

Key Risks

One of the biggest risks that Grom Social faces is its ability to continue as a going concern because the management does not expect that existing operational cash flow will be sufficient to fund presently anticipated operations. Therefore, the company will need to raise additional funds and is currently exploring alternative sources of financing.

If Grom Social fails to retain existing users or add new users, or if its users decrease their level of engagement, the revenue, financial results, and business of the company may be significantly harmed.

In addition, there is a possibility that the company’s strategy to create new and original content, charge users for that content and attempt to secure advertisers to pay to advertise on its app, could fail to attract or retain users or generate revenue. Maintaining and enhancing the brand will depend largely on management’s ability to continue to provide age-appropriate, enjoyable, reliable, trustworthy, and innovative content and services.

Moreover,there is also a possibility that users may be able to circumvent the controls Grom has in place to prevent abusive, illegal or dishonest activities and behavior on its website, and may engage in such activities and behavior despite these controls

Lastly, the company’s ability to provide reliable service to its users largely depends on the efficient and uninterrupted operation of the Grom Social platform, relying on people, processes, and technology to function effectively. Any significant interruption to, failure of, or security breaches affecting, the platform could result in significant expense, a loss of users, and harm the business and reputation.

It is worth mentioning that Grom Social has experienced net losses for several years, since inception, and has a high accumulated deficit. While this is great from the point of view of reducing future taxes, if the management is unsuccessful in implementing several initiatives to improve revenues, it can have an adverse impact on its business, prospects, operating results, and financial condition.

Grom hasn’t yet reached break even and its ability to continue as a going concern is contingent upon the ability to raise additional capital through the sale of securities and incurrence of debt. Additionally, the future capital requirements of Grom depend on many factors including the rate of revenue growth, its subscription pricing, and so on.

It is worth highlighting that the extent to which Covid-19 impacts the financial results of Grom is highly uncertain and could significantly disrupt the operations including sales and production of online content. It could also result in social and economic instability in various parts of the world where Grom’s content is consumed.

The company’s future success depends on its ability to build new content for kids as well as retain its highly experienced workforce that has been building children’s content for years. There is a possibility that the company may not be able to do the same.

Global economic, political and other conditions may adversely affect trends in consumer, business and government spending, which may adversely impact the demand for Gaucho Group’s services and its revenue and profitability.

Valuation

Source: TIKR

The above extract shows the trading multiples of some of the largest media companies that have a presence in the streaming and online content space. Interestingly, most of these are highly mature companies like Netflix and Disney and continue to trade at a mean EV/Revenue multiple that is well above 4x. Logically, a small and fast-growing company like Grom within the same domain deserves a much higher multiple of at least 9-10x as of date. Now here is a look at Grom’s multiples:

Source: Gurufocus

Can you believe it? Grom is trading at BARELY 2.2x its book value and its EV/Revenue is hardly 3.89 that is well below Netflix and Disney although Grom has the ability to double is subscribers and revenues practically every year whereas both these companies have seen a visible slowdown in subscriber growth since the past 2 quarters. Moreover, the green and yellow bars indicate that Grom’s multiples are among the lowest in the media and entertainment industry despite being a small-cap. This is probably the strongest buy signal in favor of the stock.

Final thoughts

As we can see in the chart above, the stock price of Grom Social has more than doubled in the past 12 months but still appears to be trading at an extremely low valuation given the growth potential of the overall industry and compared to its peers in the sector. The company is trading at hardly $4 a share whereas it could easily be at an $8 valuation through pure multiples expansion (revenue and profitality growth would be separate).  It is also worth noting that the company witnessed a 45% increase in sales in the first quarter of 2021 which is a dramatic rebound bringing it almost entirely back to where revenues were just prior to the March 2020 shutdowns related to Covid-19.  In addition to the increase in revenues, there was also a 17.7% increase in new users and more than an 11% increase in the online duration of visits and these KPIs are expected to continue growing over time. In addition, the company has already begun to generate positive momentum with the anticipated debut of Santa.com. Overall, Grom’s improved financial results and the continued expansion activities make the stock a compelling investment for investors looking to invest in the media and entertainment industry.

Disclaimer

No Positions.

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