While Epic Fights With Apple, Unity Preps IPO

Game engines have been getting an awful lot of attention lately. Epic Games, maker of Fortnite and Unreal Engine, is currently engaged in an escalating legal war with Apple. The Mac maker has retaliated with a scorched-Earth strategy that could cripple Unreal Engine -- and millions of developers that rely on the back-end 3D graphics technology.

On the sidelines of that conflict, Epic's chief rival, Unity Software, is now preparing to go public under the symbol "U." Unity's game engine powers prominent games like Niantic's Pokemon GO, Tencent's Arena of Valor, and Sony's Iron Man VR. Here's everything investors need to know about Unity's upcoming IPO.

Image source: Unity.

The business basics

This week, Unity filed its S-1 Registration Statement with the SEC, opening its books to the public for the first time. While we can't compare many of the figures with Epic, which is still private, here are some pertinent metrics for Unity:

Data source: S-1. *Over the past six months. TTM = trailing 12 months.

Unity has three main segments: Create Solutions, Operate Solutions, and Strategic Partnerships and Other. The Create Solutions segment uses a subscription model, with pricing ranging from free to $200 per month per seat for access to the company's development tools. The Operate Solutions business includes hosting (usage-based revenue) and monetization services (revenue sharing) like advertising and in-app purchases. The Strategic Partnerships and Other segment is a smaller side business where Unity is paid through various partnerships with hardware makers or platform operators.

Create Solutions accounted for about 29% of revenue in the first half of 2020, with Operate Solutions bringing in another 62%. Strategic Partnerships and Other was the remaining 9%. The Create Solutions division feeds into the Operate Solutions segment. A developer might use Unity's creative tools and game engine to develop a mobile game and then proceed use the company's operational offerings once the game is launched.

Operate Solutions supports content created on with other engines or platforms, but most of these customers are coming from the other side of the business. As you'd expect, there are efficiency gains and various types of integrations available if an Operate Solutions customer is using Unity's own creative tools. In the first half of 2020, 64% of Operate Solutions revenue came from existing Create Solutions customers that were contributing over $100,000 in annual revenue.

Those 716 large customers are absolutely critical to the business, representing 74% of total TTM revenue.

Governance matters

Last summer, venture capitalists and other private investors bought as much as $525 million of Unity stock from existing shareholders (employees looking for liquidity) through a tender offer at a $6 billion valuation. That came a couple months after raising $150 million through a Series E funding round at the same valuation.

At this point, Unity's largest shareholders are VC Sequoia with 24% and private equity firm Silver Laker Partners with 18%. CEO John Riccitiello has a 3.4% stake in the company. The most notable related-party transaction was a 2014 loan of $12.1 million from Unity to Riccitiello, which the chief executive repaid in full a couple months ago in June.

In terms of governance, there is only one share class and each share is entitled to one vote.

Going public while Epic faces an "existential threat"

Game engines are some of the most important pieces of technology today. Unity estimates that 53% of the top 1,000 mobile games on the iOS App Store and Google Play were built with its engine, and 93 of the top 100 game development studios by revenue are Unity customers. These engines are also rapidly expanding beyond video games and starting to find use cases in other industries like film, architecture, manufacturing, and transportation.

While Epic has grand ambitions of expanding into other areas like game publishing and content distribution, Unity is relatively more focused on its core engine. In fact, Epic's most prominent first-party game, Fortnite, is at the center of its conflict with Apple. While that conflict has yet to be resolved, the good news for Unity is that one of its biggest competitors is facing an "existential threat" by its own admission.

It's a pretty good time for Unity to go public.