Summary
- Unity has developed a business model that allows them to capture revenue throughout a game's life, both during development and post-publication.
- Unity has been prioritizing growth over profitability in a bid to capture significant market share, which can be converted to significant profitability down the line.
- Unity seeks to benefit from significant market growth, as its technology finds significant applications outside of the video game space.
- Unity's business today is dominated by the gaming space. Within the next decade, video games may just be a fraction of the company's overall sales as other segments grow.
- I do much more than just articles at The EV Supply Chain: Members get access to model portfolios, regular updates, a chat room, and more.
Unity (NYSE:U) is a software developer currently focused in the gaming space. However, as technology continues to evolve, Unity is exploring alternative applications for its technology. These alternative applications could provide extraordinary growth opportunities for Unity, which is alreadygrowing rather quickly. This article will examine the company’s current and future businesses, as well as its financial standing, to determine if it is worthy of your hard-earned money.
Operate Solutions
Before getting into Unity’s game engine and the metaverse, I’d like to discuss Operate Solutions. This is a less exciting component of Unity’s business but, given that it made up 65% of the company’s saleslast quarter, it should be a primary focus for investors. As the name suggests, this segment is focused on assisting game developers and publishers with their game’s operations. Namely, Unity’s Operate Solutions division assists with monetization throughUnity Adsandin-app purchases.
Because the majority of mobile games are free, monetization is a critical part of their success. There areover 2.2 billionactive mobile gamers in the world, 56% of which play more than ten times per week. To put that in perspective, that’s .61x the amount of people that use social mediaaround the world. That’s a huge market for developers to tap into and Unity aims to facilitate that.
The company’s ad program offers integration of all of the typical formats, such as banners, videos, and interstitials, that developers can integrate into their games. The company’s ad service also allows developers to introduce monetization across all app stores within the same process, which greatly simplifies the process for publishers. While there isn’t necessarily anything particularly noteworthy here, Unity simply does all of this very well to create a complete service for its customers.
Though, Unity doesn’t only provide its services to game developers. The companyalso offersits services to companies hoping to advertise on mobile games. Unity offers targeted advertising, which it claims is it is able to make more effective due to the swath of games at its disposal and, consequently, the incredible amount of data. Understanding that perhaps some players are more likely to pay for items within a game, maybe means that they can be best monetized by being advertised towards games that have a robust in-app purchasing system. Similarly, it may be a waste of money to advertise those games to players that aren’t going to buy anything, meaning they may receive ads from games that use ads to generate income.
Unity’sAudience Pinpointeris the main tool with which advertisers aim to maximize their revenue. Again, using the data from Unity’s more than22 billion ad impressions every monthand over 2 billion active monthly users, the world’s most popular ad service for mobile games has a vast data advantage in this specialized sector. Unity is able to provide advertisers with an expected return on their targeted ads, giving advertisers piece of mind and clear expectations. With real-time valuations of each player, Unity’s service breaks down ad spending to the individual. Unity has a clear advantage over peers in the mobile ad space, with more data available than anyone else and far greater utilization, making it one of the company’s stand out products.
It should be noted that Apple (AAPL)is now tryingto severely limit how companies can gather data on users through their apps. This would be a decent blow to Unity’ offering, which essentially promises the best targeting in the mobile game sector. While the company’s lead in mobile gaming (to be discussed later) will aid in retaining customers, this is something for investors to be aware of. Though, it should also be noted that78% of mobile gamingis done on Android devices, meaning this wouldn’t affect the vast majority of Unity’s data pool.
In the United States, the average amount spent on smartphone games is $137 while average revenue generated per user is $131.21. The global mobile gaming industry generatedover $163 billionin revenue last year, demonstrating the efficacy with which these “free” games are able to monetize their play experiences. Unity, being the lead enabler of this marketplace, is an incredibly exciting opportunity.
Currently, the company is working on developingUnity Economy, a system for developers to create a more effective in-game economy. The goal of this service, among other things, is to create effective monetization tactics that the publishers can profit from. The creation of an effective economy is an important part of a game’s enjoyability, regardless of whether or not it is monetized, making this operating solution one that will likely see a lot of use upon its release. The service will also automatically keep track of players’ inventory, both currency and items, to reduce the overhead for the publishers.
Unity doesn’t only provide monetization services for its customers, however. There’s much more that’s needed to make a game run smoothly in operation once it’s gotten past the developmental stage, and Unity has the services to facilitate that.Multiplayis one of Unity’s core offerings and, as the name suggests, it enables a multiplayer experience.
Multiplayer, especially when looking at console or PC games, is one of the most common ways for people to enjoy games. This is especially true for more casual players, who may simply enjoy the game for the company of their friends rather than the actual content. Multiplay claims to be a cheaper alternative to public clouds, with the performance required of a truly global game. The company cites Electronic Arts’ (EA) immensely popular Apex Legends, which went from 0 users to 50 million users in 24 days, as a prime example of the service’s capabilities. With servers across the globe, Multiplay aims to provide a quality experience for all of a game’s users, no matter their location.
Unity
To bolster its multiplayer experience, Unity also offersVivox, an in-game voice and text communication service. This service is used by many of the world’s premiere multiplayer games, such as Valorant, League of Legends, and PUBG. Just for a bit of context, League of Legends averages117 millionunique monthly users. Unity is also currently in beta testing of itsLobbyservice, which will enable players to join multiplayer servers in a smaller group. These can be invite-only, or open-ended. Lobbies are a major component of most multiplayer shooting games, such as Apex Legends, and Unity’s service aims to reduce development overhead and costs associated with enabling them.
More backend capabilities build upon the Economy service’s ability to maintain accurate records of player inventories. For example, Unity’sCloud Saveallows game publishers to offload the storage of players’ game progression and statuses. While it would be a bit redundant to highlight every one of Unity’s different services, the point I am aiming to make should be clear at this point. Unity’s Operate Solutions cover a wide range of products that aim to improve upon, or lower the cost of, necessary operating overhead for game publishers. The company also doesn’t limit its client base for any of its services to those that developed their games using the Unity game engine.
Game Engine
While the company doesn’t limit its users to only those that have used its game platform, it could still find moderate success if it did.61%of mobile games are developed using Unity’s game engine, making it the most popular mobile game engine in the world. By a wide margin.Over halfof the world’s games, across mobile, PC, console, and VR also use Unity’s engine. Now, before getting too far ahead of ourselves, it’s important to understand what exactly a game engine is.
A game engine is essentially the framework for a game that developers can piece together to create a final product. Within a game engine, there is a detailed physics simulation, animation system, shading and coloring detail, sound systems, rendering - essentially anything you need to make a game “run” (hence, engine). While it’s up to the game developers to take these multiple systems and simulations and turn it into a game. The engine is also responsible for communicating with the platform with which it is being played on, be that iOS, Windows, or PlayStation. Without a universal engine, like Unity, game developers would need to make new engines for different platforms and for new games. Creating an engine, as you may imagine, is a lot of work and, small developers especially, don’t really have the resources to do it. That’s where Unity comes in, with a game engine that anyone can use to create a game.
Further Potential
This is where things begin to get exciting. Unitydescribes itselfas “the world’s leading platform for creating and operating interactive, real-time 3D content.” I think that this phrasing, specifically the absence of anything to do with games, indicates where Unity sees itself progressing. Now, mobile gaming doesn’t translate too well to a metaverse-like application, with the engine behind console or PC games being far more relevant. Unreal’s fairly massive lead in that space may be a bit concerning for investors, but Unity has been buildinga lead in XR. In fact, according to Unity’s CEO John Riccitiello, the company’s lead in XR is even greater than its lead in the mobile game sector. With the company holding more than 60% to 70% of the XR development market, I think it’s safe to say that Unity currently dominates the space.
XR, or extended reality, is an umbrella term that covers virtual reality (“VR”) and augmented reality (“AR”), which is the space that many expect the metaverse to occupy. For those that don’t know, VR is a computer-generated experience that aims to completely immerse the user in an alternative environment, thus creating a “virtual reality”. AR allows the user to remain fully cognizant of their real-world surroundings and aims merely to enhance a user’s perception of their environment, often by providing supplementary information. Heads-up displays, which are becoming increasingly more popular in high-end vehicles, are a great example of this, as are Apple’s Animojis.
So, clearly, XR extends well beyond video games and Unity is taking full advantage of that.A case studyof the company’s work with Audi (OTCPK:AUDVF) to develop the first VR car configurator and a packing training course details one of many potential applications. The virtual training course allows the company to allocate more time to train its employees on proper technique, without needing to deploy more capital. The company alsopartnered with PiXYZback in 2018 to develop a platform to utilize CAD files in real-time. These, among others, are steps the company has taken over the past several years to develop its XR capabilities beyond those offered by its peers. The lead Unity has built is clear and looks to be a lasting one.
Financial Health
The first thing I’m interested in determining here is the company’s current capital burn rate and, subsequently, how long its current cash can last. The figure below examines the company’s cash flows since 2018, demonstrating that there hasn’t exactly been any outstanding consistency. Though, this is largely due to a few anomalous events since Unity has gone public. This includes the company’s IPO,which nettedthe company $1.418 billion,the acquisition of Weta, which cost the company $1.58 billion, andthe issuance of convertible notes, which netted the company $1.725 billion.
Long Term Tips
Regardless of anomalous events, a company cannot expect to sustain any sort of cash flow if it cannot generate stable profits. The figure below depicts Unity’s EBITDA since 2018. You may notice that, unlike the company’s cash flows, there does appear to be an identifiable pattern here. The trend here is clearly negative as, despite rising revenues, Unity’s operating expenses continue to balloon.
Valuation Discussion
In response toa Quora postnine years ago inquiring about Unity’s business model and how it makes money, David Helgason, the company’s founder, stated “Pretty old fashionedly I must admit. We make money primarily by selling Unity software to small and big customers (in that order), and a tiny bit from our 30% cut in the Asset Store. After that it's just tiny bits and pieces. We don't publish our revenue numbers, but we are nicely profitable from this all and growing very robustly.” It’s that last bit that I’d like to focus on.
Unity, at its early stages, was profitable. Yet, now generating hundreds of millions in sales, the company is unable to turn a profit. What went wrong? The simple answer is: nothing. In today’s energized market, we consistently see unprofitable companies with incredible growth, gaining favor over those which are merely churning out static profits. Whether or not this is right is a completely different issue, the question this article is concerned with is to what extent investors should value this growth.
Though, Unity is a far different company now than it was nine years ago. Its profitability then doesn’t really mean squat as far as its profitability today, or in the next few years, is concerned. It seems that one of the company’s biggest expenses, as it currently stands, is stock-based compensation. The company’s total stock-based compensation in the most recent quarter was $97.8 million, 30.9% of the company’s total revenue. As the company continues to rapidly add more employees, growing its headcount by 31% last year, employee-related expenses, such as stock-based compensation, will only continue to grow. However, Unity’s revenue is growing faster.
Growing 43.77% last year, the company’s revenue is outpacing the addition of new employees, which is its greatest expense. Additionally, the companyis expectedto grow its revenue by another 34.8% next year, according to consensus estimates. As sales grow, so too will profitability as expenses begin to become less significant relative to earnings. Analystscurrently expectthat Unity will ultimately become profitable in the second quarter of 2023 as its growth persists.
The critical question now shifts from whether or not Unity can become profitable, to how much growth Unity can really sustain. This was already discussed briefly, when discussing the impact of stock-based compensation, but I’ll be taking a deeper dive here.As of Q4 2020, the last time Unity provided an update, 94 of the top 100 game development studios, ranked by revenue, were Unity customers. Furthermore, 71% of the top 1,000 mobile games were developed using Unity. This second metric is up significantlyfrom 2019, when the software company was responsible for the development of 53% of the top 1,000 mobile games. In 2019, the company also maintained 93 of the top 100 game development studios as customers. While no specifics were provided this time around, Unity claims that its market share has continued to rise inits most recent filing.
Thesis Risks
Whenever there’s an investment thesis that hinges heavily upon significant growth, there is significant risk. There is potential for some, or many, of these opportunities to simply never materialize as expected. If that is indeed the case, it is likely that Unity will continue to struggle with profitability and the company will need to make significant changes to its business and operations. Massive layoffs can often be terminal for a company’s growth, as current employees flee a toxic and uncertain environment.
Furthermore, as with any sector of extreme growth, Unity will likely come to face some competition. Now, Unity does have a strong product and talent moat, which makes the barrier to entry quite high, but it is still breachable. While Microsoft (MSFT) and Meta (FB) could be huge customers, given their desire to develop virtual environments, they could also arise as competitors. Both companies have vast resources, including talent, that they could leverage to simply cut Unity out of the picture. Though, I feel confident that Unity’s service will offer greater quality at a lower cost. The multi-year lead is something that can’t really be bought, unless, of course, it becomes an acquisition target. With Microsoft looking to bolster its gaming business, Unity could certainly be an interesting target for them.
Investor Takeaway
I like Unity, I really do. But it’s expensive. To an extent, I can’t help but be reminded of the original dotcom bubble. While there was a lot of trash there, there were also a few good companies that just got too hot too soon. Yet, even those companies took years to provide returns to investors as they had been hyped up far beyond their fair values. You could have the right idea, but simply be too early. Being too early is just as bad, if not worse, than being too late. Virtual environments have tremendous potential, certainly, but that future is still a very long way out.
All that being said, I don’t think it’s too early for Unity. The company already has a very strong business in the gaming industry and is making the right investments to grow the application of its industry-leading products. Going back to the GPU comparison, those within the space foresaw the industry expanding dramatically as new technological advancements required the products. To me, Unity offers the equivalent opportunity in which investors can take part in a major industry evolution.
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