Please ensure Javascript is enabled for purposes of website accessibility

My Top Tech IPO to Buy in March

By Nicholas Rossolillo - Mar 5, 2021 at 8:42AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

From the 2020 IPO class, Unity Software has the ability to disrupt the status quo like no other.

2020 was fast and furious for IPO stocks, and 2021 is getting off to a similar start. Technology is transforming the economy at a record pace, and many of these businesses are far more profitable than the old incumbents they're replacing.

Of all the IPOs and SPACs that have debuted in the last six months, though, I think Unity Software (U 6.17%) is the one to focus on for the long haul. Here's why I think it's a buy in March.

Tough comps and iOS updates ahead

Unity already reported a solid finish to 2020 -- its first year as a public concern. Revenue increased 43% from 2019 to $772.4 million, and free cash flow was negative $20.2 million (although it turned free-cash-flow positive in the fourth quarter, generating $3.6 million). However, this is a growth company through and through. Unity no longer needing to use cash from its balance sheet is an important milestone, but the trajectory of its expansion is of utmost concern in this chapter of its story.  

A laptop, smartphone, and cup of coffee sitting on a desk in front of a window.

Image source: Getty Images.

And that's where things start to look a little dicey in the short term. Management reiterated its long-term forecast for revenue to grow about 30% annually. But in 2021, guidance has revenue growing "only" 23% to 26% to a range of $950 million to $970 million. For a company expected to generate little in the way of profits for some time and trading for over 50 times trailing 12-month sales at the tail end of 2020, Unity stock was priced to perfection ahead of the fourth-quarter update. Perfection was not in the immediate-term outlook, so shares are down 45% from all-time highs as of this writing.

What accounts for the below-average revenue outlook? For one, Unity will be lapping an estimated $25 million revenue benefit it got from the pandemic last year as it experienced an acceleration in use of its development platform. In tandem with that, it also expects an estimated $30 million drag in 2021 from Apple launching iOS 14, which will include user opt-in to application activity tracking. This will have an impact on digital marketing, making it harder for app developers and publishers utilizing Unity to reach mobile users.  

In total, the $55 million impact ($25 million pull-forward last year plus $30 million Apple headwind this year) equates to about 5% to 6% of Unity's expected revenue in 2021. If you add this figure back to the full-year outlook, the 30% long-term growth forecast is intact. Plus, let's not forget cloud software companies' habit of under-promising and over-delivering. In its brief history as a public company, Unity has done just that so far, and the year-end result could wind up being higher than the initial outlook anyway. 

Expensive but not so unreasonable given the long-term potential

Regardless, I think Unity is worth a serious look right now. Yes, even after the stock has fallen in recent months, it remains priced at a premium 27 times 2021 expected revenue. But given the company's long-term potential (and enviable war chest of $1.75 billion in cash and zero debt), it's expensive for a reason.

The nature of the software development platform itself is powerful. Unity enables real-time 3D content development in the cloud. The early use case was for video games, but Unity is finding no shortage of utility beyond that. We already know from NVIDIA how high-end video games can spawn innovation elsewhere. I believe something similar is happening with Unity. Sure, the video game industry is quickly becoming a staple of entertainment these days and has plenty of growth left in the tank, but Unity's software is also being applied to architectural and engineering design, manufacturing, robotics, marketing, and filmmaking, to name just a few examples.  

Put simply, this isn't just a video game company anymore. An increasingly digital world needs a better software platform to blur the lines between real and virtual, and Unity looks like it could be it. Plus, while Apple's privacy updates are going to be a headwind in 2021, it could leave the door open for Unity to disrupt the status quo in the mobile app distribution ecosystem in subsequent years. Apple making it harder for developers to monetize their work means they'll be turning to another partner for help. Unity's platform is independent and includes marketing and distribution tools as a value-added service. Management thinks there's opportunity there.  

The sum of these parts means Unity is in control of its destiny, compared to a company that relies on growth from the industry it operates in. The use cases for this cloud-computing platform are limitless, and the company is constantly adding new features to deepen its relationship with existing users and attract new ones. It's no value, but this is a premium-priced stock for good reason. Assuming you plan on holding for at least a few years, I think the recent pullback in share price presents an excellent buying opportunity.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Unity Software Inc. Stock Quote
Unity Software Inc.
$38.37 (6.17%) $2.23
Apple Inc. Stock Quote
Apple Inc.
$149.24 (2.54%) $3.70
NVIDIA Corporation Stock Quote
NVIDIA Corporation
$181.77 (5.29%) $9.13

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/18/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.