Unity Software (NYSE:U) completed its IPO at $52 a share on Friday, adding to a long and growing list of hot newcomers to public markets in recent months. On the heels of the viral Snowflake (NYSE:SNOW) debut, Unity generated plenty of buzz of its own. The company raised over $1.35 billion in cash, and shares surged to over $68 a share by the end of its first day of public trading, making for a market cap of $17.9 billion. With the video game industry in high-growth mode, this software platform is worth a deeper dive.

Game development easier than ever before

Video games have been a hot commodity this year amid the pandemic. Sales in August alone increased 37% compared to sales a year ago.

Success in the industry is being shared like never before. There are major game developers like Activision Blizzard and Electronic Arts as well as mobile gaming specialist Zynga, but a myriad of smaller outfits are also getting their titles into the hands of gamers.

Small publishers is owe a lot of their success to video game development platforms that offer subscription-based access to tools that speed up the game creation and deployment process. One platform is Unreal Engine, a product of Fortnite developer and Tencent (OTC:TCEHY)-backed Epic Games -- which is currently locked in a legal battle with Apple over the iPhone-maker's cut of App Store sales and content distribution. 

Then, there's Unity Software. The company isn't itself a game developer, but instead is solely focused on the operation of its 3D real-time video game development platform. With 1.5 million monthly active users worldwide as of the end of June 2020, it is the leading platform for creating and operating games on PC and mobile platforms, as well as consoles like Microsoft's Xbox and Sony's PlayStation. In addition to video games, Unity can also be used for design projects in architecture and engineering, automotive manufacturing, and video content.  

A young woman laying on the floor using a smartphone.

Image source: Getty Images.

A sizable war chest to promote growth

Unity will use the proceeds from its IPO to pay down the rest of a $125 million loan it took earlier in 2020 to help manage the COVID-19 crisis. Following the IPO, the company will have some $1.6 billion in cash and equivalents on its balance sheet and no debt. Management says it may use some cash to make acquisitions to further build out the capabilities of its software ecosystem.

Game makers are drawn to the accessibility and ease-of-use of the Unity sandbox. In 2019, Unity's total revenue grew 42% to $542 million. Free cash flow (revenue less cash operating and capital expenses; basically what gets added to or subtracted from the balance sheet) was negative $95 million. Through the first half of 2020, the company is setting a similar pace. Its base of customers that pay at least $100,000 a year numbered 716 at the end of June (up from 515 the same time last year) and the average existing customer was spending 42% more with Unity than it was in 2019 (as indicated by a dollar-based net expansion rate of 142%). While free cash flow remains negative, the company is quickly homing in on breakeven.

Metric

First Half 2020

First Half 2019

Change

Revenue

$351 million

$253 million

39%

Gross profit margin

79.4%

75.4%

4.0 pp

Free cash flow

($34.7 million)

($29.6 million)

N/A

Data source: Unity Software. Pp = percentage point.

Is it worth your hard-earned money?

Demand for hot IPO stocks is continuing, and Unity's stock price increase -- up over 30% on day one -- didn't disappoint. At its $68 closing price Friday, representing a $17.9 billion market cap, Unity Software is selling for some 27 times trailing-12-month revenue. Given the crazy multiples other high-growth software names like Snowflake -- currently well over 150 times trailing revenue -- are attracting, this makes Unity a relative value. However, Unity also isn't growing nearly as fast.

Still, the size of the video game industry -- Unity estimates global 2019 sales surpassed $140 billion -- and the rising popularity of games in the entertainment industry, as well as the software platform's ability to go after professional design and TV and movie work, makes Unity at least worth keeping on your watch list.