Unity Software: Surfing On The Rising Tide Of 3D Digital Content

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Unity Software: Surfing On The Rising Tide Of 3D Digital Content

seekingalpha2021-08-23

Summary Investors buying in to Unity at current valuations are believers that newer technologies such as RT3D, VR/AR and the Metaverse will grow rapidly in upcoming years beyond gaming. The company ...

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kukumolu
·2021-08-23
$sklz
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Lklim
·2021-08-23
Happy to hear that the company is on the right track
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Unity has put up a DBNER of above 130% since Q3 2019.\nUnity added 888 customers generating more than $100,000 of revenue TTM in Q2 21, up from 716 a year earlier, which represents 24% YoY growth.\nThe company reported a 48% year-over-year increase in revenues to $274 million for the quarter, which is the 11th consecutive quarter of 30% or greater growth.\nUnity is currently a buy for investors looking to add a good growth stock with high upside to their portfolio.\n\ngremlin/E+ via Getty Images\nThe basic thesis of Unity Software (NYSE:U) is that the rising tide of 3D digital content usage will over time, carry the company's fundamentals and stock price much higher.\nUnity Software's growth is largely driven by the growth in 3D digital content, as currently, linear and flat 2D digital content usage is rapidly transitioning to interactive 3D digital content usage.\n\n The dramatic growth of end-user demand for interactive content is driving industries beyond gaming to embrace the advantages of real-time 3D content.\n\n\n Source:Unity S-1\n\nInvestors buying in to Unity at current valuations are believers that newer technologies such as RT3D (Real-Time 3D), VR/AR and the Metaverse will grow rapidly in upcoming years beyond gaming to touch every part of human life, and that Unity Software, as part of a duopoly with Epic Games, will become one of the primary enablers of such technologies.\nThe areas that investors should monitor to judge the company's progress are:\n\nCreate Solutions generating optionality in other industries besides gaming.\nStrong Dollar-Based Net Expansion Rate (DBNER)\nGrowth in customers contributing more than $100K in revenue\nMovement towards becoming Free Cash Flow positive\n\nFirst What Is RT3D technology?\nReal-time 3D (RT3D) is a computer graphics technology that allows viewers to see and interact with 3D images or scenes that appear to be moving in real time. In order to achieve a very high degree of photorealism, RT3D technology generates 3D interactive content that is faster than human perception, with the minimum acceptable RT3D rendering speed being around 24 frames/sec, the minimum a human eye needs in order to create the illusion of movement.\nReal-time 3D content has the ability to be deployed to mobile devices, computers,Augmented Reality,Mixed RealityandVirtual Realitydevices, as well as other platforms.\n\n Interactivity is at the core of real-time 3D. Unlike movies for example, which create the perception of motion but offer the same passive experience to the audience - real-time 3D immerses people in a digital reality that feels authentic, while giving them control over their experience, much like a video game.Source:Unity Software\n\nReal-time 3D content will also be very important in building an interesting concept known as the Metaverse.\nWhat is the Metaverse?\nThe Metaverse\nThe Metaverse can be thought of as virtual \"universes\" where users will have the ability to interact with each other.Wikipediadefines the Metaverse as \"a virtual shared space created by the convergence of virtually enhanced physical reality and physically persistent virtual space, including the sum of all virtual worlds, augmented reality, and the Internet\".\nThere are already some virtual worlds emerging as part of the Metaverse, with perhaps the most well-known one currently beingRoblox(NYSE:RBLX). However, there are some other major players looking to build out their own virtual worlds like Facebook's (NASDAQ:FB)metaverse, Snapchat's (NYSE:SNAP)metaverse, Nvidia's (NASDAQ:NVDA)metaverseand Adobe's (NASDAQ:ADBE)metaverse. This is only the beginning of various entities creating virtual worlds that will collectively be known as the Metaverse.\nUnity Softwarehas its own plansfor developing tools to support many virtual worlds as part of the Metaverse. What Unity Software ultimately would like to do is create interoperability across the walled gardens of each virtual world that gets created.\nUnity Software's CEO John Riccitiello believes that the adoption of technologies like real-time 3D will ultimately change the way people interact with digital content and entertainment.\nEpic Games CEO Tim Sweeney, in anLA Times interview, essentially stated that he believes that there will be a point in time where every company will have a real-time 3D presence which he believes could eventually lead to barriers between different walled garden platforms being eliminated.\nThis article, in the section titled,The Metaverse, discusses the implications of Tim Sweeney's worldview on both Unity Software and Epic Games, which if that view comes to fruition could lead to the Unity and Unreal engine being the foundational layer of the Metaverse. What this means for investors is that the Metaverse has the potential to make Unity Software an extremely high upside stock, especially since no one is factoring into Unity's future projections what the Metaverse could ultimately mean for Unity's growth or profitability quite yet.\nUnity's Recent Business Performance\nOptionality: Create Solutions' ability to build RT3D applications hasmany other applicationsin industries outside gaming, thereby giving Unityoptionality. What investors want to see long term is continued growth in use cases for Create Solutions outside gaming.\nDuring Q2 2021, Unity's Create segment added three new automotive manufacturers, three leading consumer product companies, and three leading aerospace and defense manufacturers to their customer list. The consumer product brands included an eyewear manufacturer and retailer, and an appliance manufacturer known for advanced designs.\nIn Unity's Q2 earnings announcement, they also added that they have entered new markets and called out a new contract withThe Nature Conservancyas an example. The Nature Conservancy plans on utilizing RT3D digital technologies to convey information about water usage inNew York State.\nDollar-Based Net Expansion Rate (DBNER): This is a critical metric to track for software companies that operate in the cloud. In an article titled,Why I Like High DBNERs, it mentions that companies that have consistently high DBNERs will grow revenues faster than similar businesses with a lower DBNERs, while also experiencing significant stock price appreciation.\nThe DBNER metric can also give insight into a company's competitive moat, its pricing power, the quality of the product/service and the stickiness of the company's business. TheWhy I Like High DBNERsarticle also mentions that the author considers a DBNER over 120% as very good and a number over 130% as outstanding.\nHere is Unity's DBNER history:\nSource:Unity Software 10-Q | Quarterly Report\nUnity logged a Dollar-based net expansion rate of 142% in Q2 21. This is in comparison to last year's Dollar-based net expansion rate of 142%, in the same period. Unity indicated the high DBNER primarily comes from sales of additional subscriptions and services to existing Create Solutions customers, expanded usage among existing Operate Solutions customers, and improvements in cross-selling.\nUnity software has been putting up excellent DBNER over a relatively long period of time and my experience with companies that consistently put up such high DBNER numbers is that they eventually have a stock price that outperforms.\nCustomers contributing more than $100K to revenue: Unity Software strongly focuses on this metric because it represents the segment of the company's customer base where the majority of the revenue and revenue growth comes from. Interestingly, however, no one customer currently accounts for more than 10% of the revenue, so Unity does not currently have customer concentration risks. In fact, the company could be considered widely diversified.\nThis metric is measure of Unity's penetration of larger enterprises, which includeAAA gaming studiosand large organizations in industries other than gaming.\nUnity added 888 customers generating more than $100,000 of revenue TTM in Q2 2021, up from 716 a year earlier, which represents 24% YoY growth. This strong growth is a trend that Unity management expects to continue moving forward.\nCash from Operations and the Free Cash Flow:\nData byYCharts\nThe trends in Cash from Operations and the Free Cash Flow can be viewed as a yellow flag and should be monitored. While Unity Software does have an excellent balance sheet and is not in any near-term danger, the fact that Unity is showing that current operations can't produce positive cash flow will likely be used against it to strongly sell-off the stock if macroeconomics causes investors to dump high-risk growth companies.\nUnity Software Q2 21 Earnings\nUnity reported a 48% year-over-year increase in revenues to $274 million for the quarter, which is the 11th consecutive quarter of 30% or greater growth. The number beat company guidance and beat analyst forecasts by $30.85M. Unity's Q2 was also the first quarter the company crosses $1 billion in annual revenue run rate.\nUnity Software has three revenue sources named Create, Operate and Strategic Partnerships:\n\nCreate Solutions- Create Solutions is a free set of tools that can enable creators to create, edit, run and deploy real-time 2D and 3D content. A user can create content once and that content will work seamlessly on more than 20 different platforms like Microsoft, iOS, Android and many others. When Create Solutions is used to build gaming applications, the tools are free until the creator of the game collects over $100K in revenues and then the creator must pay a subscription fee for using the Unity editor tools. Although, Create Solutions was originally used to build game applications, it has since evolved to being used for many other applications in different industries outside gaming like automotive, film, aerospace, engineering and many more. Create Solutions is 26% of Unity Software's revenue mix in Q2.\nOperate Solutions- Operate Solutions is an integrated system of tools for monetization, engagement, and content delivery for game developers. The primary purpose of Operate is to ensure that theCustomer Acquisition Costis less than his or herLTV (Lifetime Value)to the game. If the cost to acquire is above the LTV, then the game will fail financially. Operate Solutions uses a revenue share model for their monetization tools such as Unity Ads, Unity IAP (in-app purchases) and billing. Other Operate Solution tools includedeltaDNA (engagement analytics), Multiplay (game cloud hosting), privacy controls, identity, security, and in-game communications throughVivox, which are all monetized via minimum fixed-fee usage-based contracts. Operate Solutions is currently 67% of Unity Software's revenue mix.\nStrategic Partnerships & Other- Unity Software has established a number ofStrategic Partnershipswith hardware, operating system, device, game console, and other technology providers. Revenue from these contracts is recognized as the services are performed. These Strategic Partnerships generate revenues through either fixed fee royalties or revenue-share agreements. Other revenue is generated from an app store owned and run by Unity calledAsset Store, which operates on a revenue-share model. Strategic Partnership & Other is currently 6.6% of Unity Software's revenue mix.\n\nSource:Unity Software Second Quarter 2021 Financial Result\nCreate had a strong quarter with revenue of $72 million up 31% year-over-year. Operate revenue of $183 million was up 63% year-on-year and strategic partnerships revenue of $18 million was up 9% year-over-year.\nCreate Solutions revenue growth was largely derived from an increase of new customers and the expansion of existing customers.\nOperate Solutions revenue growth was largely attributable to an increase in revenue per customer. Unity's customers increased the usage of many usage-based Operate tools, largely because Unity's customers were seeing higher levels of user engagement from their customers. Operate Solutions also gained many new customers, which also helped with revenue growth.\nOne thing of note for investors to pay attention to is that Operate Solutions is both the biggest portion of Unity's revenues and also the fastest growing, which bodes well for Unity if the trend of the largest revenue contributor, growing the fastest should continue.\nSource:Unity Software Second Quarter 2021 Financial Result\nUnity's Cost of Revenue was $57.72 million and GAAP Gross profit came in at $215.84 million. Unity's Q2 2021 GAAP gross margin was 78.90%, compared to 78.07% of Q2 2020.\nSource:Unity Software Second Quarter 2021 Financial Result\nUnity, however, focuses on non-GAAP numbers that include the stock-based compensation expense and the employer tax related to employee stock transactions.\nIn theearnings call, CFO Luis Visoso mentioned that the non-GAAP gross margin of 81% was up 300 basis points on a year-on-year basis due to better operating efficiency and also a benefit from the product mix. Additionally, CFO Luis Visoso indicated that the company remains confident that gross margins can be sustained above 70% over the long term.\nNon-GAAP Total Operating Expense was $224.82 million with non-GAAAP R&D making up 42% of revenue, non-GAAP Sales & Marketing making up 21% of revenue, and non-GAAP General & Administrative making up 19% of revenue. It was mentioned on the earnings call that the company will continue to invest in their business with an emphasis on R&D, as the company believes that they have many attractive opportunities to go after and I agree.\nUnity Software's Q2 2021 non-GAAP operating loss was $3.2 million compared to 8.7 million last year, as the number was helped by strong revenue growth. However, I don't think Unity is focused on quickly becoming profitable as Unity has indicated that they will continue investing in their business to drive growth and long-term value creation, so expect operating losses to continue into the near-term future.\nUnity Software's Q2 2021 Non-GAAP EPS was -$0.02 beating analyst estimates by $0.10; GAAP EPS was -$0.53 missing analyst estimates by $0.19.\nBalance Sheet\nSource:Unity Software Second Quarter 2021 Financial Result\nUnity ended the quarter with $1.59 billion in Cash, cash equivalents and marketable securities.\nTotal Current Liabilities $556.40 million. Unity has a Quick Ratio of 3.47. A company with a quick ratio of 1.0 and above can easily pay current liabilities.\nUnity Software does not have any long-term debt as of Jun. 2021. Unity has aDebt-to-Equity ratioof 0.07, which is a measure of the ability to pay long term liabilities. Companies with a Debt-to-Equity ratio of less than 1.0, means a company tends to use more equity than debt to finance operations which is generally less risky than firms whose Debt-to-Equity ratio is greater than 1.0.\nFor the 3 months ended in Jun 2021, Unity's Net Income from Operations was $-148.34 Mil. Unity's total Free Cash Flow for the months ended in Jun. 2021 was $-33.5 Mil. Unity generated a Q2 '21 free cash flow margin of -12% compared to -43% in Q1 2021.\nThe Cash from Operations and the Free Cash Flow number is an area that investors should watch carefully as Unity currently is not producing any cash from its operations, which can be a warning sign if losses trend down in these metrics. Currently, Unity's strong balance sheet doesn't make this a short-term worry.\nGuidance\nSource:Unity Software Second Quarter 2021 Financial Result\nUnity raised the revenue guidance for the full year by another $45 million to a range between $1.045 billion and $1.060 billion, which represents 35% to 37% revenue growth year-on-year.\nUnity is reducing the fiscal year non-GAAP income loss guidance from a range of 90 million to 100 million to a range of 55 million to 65 million. Non-GAAP Operating Margin is projected to be -5% to -6%.\nUnity projects Q3 2021 revenue of 260 million to 265 million, which represents 29% to 32% revenue growth year-over-year. This year's Q3 faces a tough comparable against last year's quarter which was affected by the pandemic that boosted engagement more than in prior years.\nUnity's non-GAAP operating loss for the quarter is expected to be between 15 million and 20 million. Q3 Non-GAAP Operating Margin is projected to be -6% to -8%.\nUnity CFO Luis Visoso reminded investors on the earnings call that the company remains committed to reachingnon-GAAPprofitabilityin 2023. This is an indication that over the short term, investors can expect that Unity will continue to heavily invest in R&D, in order to extend Unity's technological lead.\nRival: Epic Games\nBoth Unity Software and Epic Games' Unreal engine makes tools for their customers that can create the real-time 3D graphics that look so realistic.\nThe reason why I believe Unity Software has a slight edge over the Unreal engine is that Unity has tremendously benefited from the gaming world's shift to mobile gaming.\nFor a variety of reasons that is examined in depth in thisUnity Deep Divearticle under the section namedThe Gaming Industry, mobile gaming has really risen in popularity in comparison to the PC or console. Mobile gaming revenue has recently grown at about 27% per year compared to PC and console revenues have growing at about 5% per year.\nAccording to theNewzoo Global Games Market Report 2021, Mobile game revenue will account for 52% of the global gaming market in 2021. It is Unity's market share in mobile gaming that currently gives the company a big advantage over Epic Games, as according to a Unity survey, 61% of mobile games are made on the Unity platform.\n\nOverall, the Create Solutions segment, had a market share exceeding 50% of the overall market for the year ending 2020, with their market share slightly higher in the fastest-growing subsegments of mobile gaming and VR/AR.\nUnity also has an advantage in AR/VR over Epic Games, mostly because it has been operating in the segment longer. About60% of AR/VR contentis made on Unity3D.\nRisks\nUnity lack of profitability\nUnity Software has experienced net losses in each earnings period since inception and there is a risk that the company will never become profitable. Unity Software is still a relatively early-stage company that reinvests all of their Gross Profit in R&D, S&M, their technology infrastructure, acquisitions, etc., in order to grow the business. Investors in Unity Software have to be comfortable with Unity investing substantial sums into their business.\nIDFA updates by Apple could affect mobile games on operate side\nUnity derives a significant portion of their revenue from the Operate Solutions segment, with a large part of those revenues either directly or indirectly dependent on advertising.\nMobile game developers rely on Unity to attract a broad range of advertisers to the company's platform to generate demand for ad impressions through Unity's Unified Auction. If advertisers begin finding that Unity's platform can't serve their needs then they might shift their ad dollars to more effective competing solutions, which could then have an adverse effect on Unity's revenue.\nApple's IDFA changes had the capability to significantly affect Unity's ability to create an effective ad platform for their customers. In the Unity Q4 2020 Earnings Results, the company indicated that they expected an Apple impact.\n\n We expect the arrival of Apple's iOS14's privacy modifications on IDFA will affect the way mobile game developers acquire customers and how they optimize lifetime customer value. Although it's difficult to estimate, our guidance assumes IDFA changes begin in the spring and will reduce our revenue by approximately\n $30 million, or 3% of revenue, in 2021.Source:Unity Q4 2020 Earnings Results\n\nHowever, Unity had several years of advanced warning of Apple's potential changes and over the past couple of years the company has developed a contextual advertising model based around the first-party user engagement data that Unity collects. Unity's new advertising model currently appears to have the ability to work around Apple's IDFA changes.\nAlso, of particular note, Unity Software just beat consensus analyst revenue estimates for the quarter by$30.85M, and since the company's ad revenue is included in its Operate Solutions, the largest and fastest growing business segment, it appears advertising might have helped account for much of the earnings beat, thereby quelling many concerns, for now, on Apple's IDFA changes.\nValuation\nSource: Yahoo Finance\nThe above is based on 13 Wall Street analysts offering 12-month price targets for Unity Software in the last 3 months. The average price target is $129.46 with a high forecast of $170.00 and a low forecast of $75.00. The average price target represents a 9.8% increase from the last price of $117.92.\nConclusion\nThis was Unity's 11th consecutive quarter with at least 30% revenue growth and the company looks well positioned for that type of growth to continue. Virtually all of the metrics that I look at with Unity appear to be trending in a positive direction, with the only yellow flag that I see is the fact that the company is unprofitable, while also being Free Cash Flow negative.\nHowever, I view Unity as a relatively early-stage company that is investing in a few different areas that could have major upside long-term. I believe Unity should continue investing for growth at this stage of their development. Right now, Unity's profitability and cash flow metrics do not concern me, although, those numbers could be a near-term risk should the market turn sour on highly valued unprofitable growth stocks.\nUnity is currently a buy for investors looking to add a good growth stock with high upside to their portfolio.","kind":"news","is_publish_news":true,"is_publish_highlight":true,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[{"id":835433670,"gmtCreate":1629730575390,"gmtModify":1676530115493,"author":{"id":"3581984006176179","authorId":"3581984006176179","name":"kukumolu","avatar":"https://static.tigerbbs.com/968c9b6dacd85f184faef66f2db6a7a7","vip":1,"crmLevel":2,"crmLevelSwitch":0,"idStr":"3581984006176179","authorIdStr":"3581984006176179"},"htmlText":"$sklz","listText":"$sklz","text":"$sklz","images":[],"top":1,"highlighted":1,"essential":1,"paper":1,"likeSize":0,"commentSize":0,"repostSize":0,"link":"https://ttm.financial/post/835433670","repostId":1114854195,"repostType":4,"isVote":1,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"tweetType":1,"langContent":"EN"},{"id":835433170,"gmtCreate":1629730572690,"gmtModify":1676530115502,"author":{"id":"3571340260989494","authorId":"3571340260989494","name":"Lklim","avatar":"https://static.tigerbbs.com/3c4603e4908f22fa9707d66da60246b0","vip":1,"crmLevel":3,"crmLevelSwitch":0,"idStr":"3571340260989494","authorIdStr":"3571340260989494"},"htmlText":"Happy to hear that the company is on the right track","listText":"Happy to hear that the company is on the right track","text":"Happy to hear that the company is on the right track","images":[],"top":1,"highlighted":1,"essential":1,"paper":1,"likeSize":2,"commentSize":0,"repostSize":0,"link":"https://ttm.financial/post/835433170","repostId":1114854195,"repostType":4,"isVote":1,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"tweetType":1,"langContent":"EN"}],"hasMoreComments":true,"newsSizeData":{"likeSize":14,"commentSize":2,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false}}