Unity Software Earnings: A Cautionary Outlook On Near-Term Prospects (Upgrade)

Unity's Profit Potential is Modest At Best

We are over halfway through 2023 and Unity has ample visibility into its year-end. At this juncture, Unity has upwards revised its EBITDA profile from $300 million to $340 million.

Even if Unity ends up delivering around $360 million of EBITDA in 2023, that's not going to support its market cap. This would mean that investors are paying more than 40x this year's EBITDA for a business that, despite its alluring rhetoric, is growing at approximately 10% CAGR on the top line.

How should investors think about 2024? Looking ahead to 2024, Unity declares that it can get to $1 billion of annualized EBITDA by the end of 2024.

On the one hand, that would clearly support its market cap valuation. This leaves Unity priced at 16x next year's EBITDA. A very fair entry point, particularly for bulls.

On the other hand, consider this:

U Q2 2023

U Q2 2023

The vast majority of Unity's EBITDA is made up of add-backs that are non-negotiable costs. For instance, management's stock-based compensation will never go away. Or consider its amortization of intangibles that increased 3-fold, undoubtedly due to a write-down associated with its IronSource acquisition.

My argument is thus, there's no need to be bearish on Unity, but the stock isn't all that attractive either.

The Bottom Line

After analyzing Unity Software's recent performance, I, as a professional investor, initially believed the results would be worse than they turned out to be. Consequently, I have decided to withdraw my sell rating on the stock.

While there are still some concerns about Unity's near-term prospects, particularly in light of economic challenges, the company's dollar-based net expansion rates are showing signs of stabilization.

Unity's revenue growth rates, while impressive, need to be interpreted with caution due to its acquisition of IronSource. The proforma guidance indicates a 10% CAGR, suggesting it's no longer a high-growth company.

Profit potential seems modest at best, and while the company projects significant EBITDA by 2024, a substantial portion of it comprises non-negotiable costs.

Overall, I don't see a need to be overly bearish on Unity, but the stock's attractiveness remains limited. $Unity Software Inc.(U)$

SOURCE: SEEKINGALPHA