Facebook (NASDAQ:FB) has taken an early lead in the virtual reality (VR) industry, and we're unlikely to see anyone catch the company in the next year or two when it comes to headsets. The Oculus Quest 2 has become the most popular headset in the industry, with estimates as high as 5 million units sold since launching in mid-2020, although the company doesn't break out volume. We do know that Facebook's non-ad revenue jumped from $297 million in the first quarter of 2020 to $732 million in the first quarter of 2021 on the back of Quest 2 sales, so this is a high growth business.
The bet for Facebook is that "owning" the hardware for VR and eventually augmented reality (AR) will give the company a leg up in the next computing platform and continue its run as a high growth stock. It's effectively trying to be like Apple (NASDAQ:AAPL) is in smartphones.
But Facebook may not be building the most valuable components and software in VR today. I argue that Unity Software (NYSE:U) is actually going to fill that role and that may mean Facebook's position is less like Apple's in smartphones and more like Motorola or Samsung, hardware makers that generate far less value per device than Apple.
What we know about VR today
VR is still a very small industry with headsets a rarity for consumers worldwide. Quest 2 is changing that with a few million units sold, but adoption is still low when compared to the 1.9 billion daily active users on Facebook's social media platform.
Headset makers have also not reached a very mature state. Apple has reportedly been working on VR and AR headsets for years without launching anything. Snap (NYSE:SNAP) is slowly advancing its AR glasses technology but is in an early phase. Taiwan-based HTC was once the industry leader and recently announced a refresh of its headsets, while upstarts like Pico are still building their hardware strategy. Given all of the different strategies and form factors, the VR industry feels more like the cellphone industry in the late 1990s or early 2000s than the late 2000s when the iPhone was released and Apple began to dominate the market.
There's a lot of consumer education that needs to take place along with advances in hardware technology before this is truly a ubiquitous platform. Yes, Facebook could dominate the industry from a volume standpoint short-term, but its lead is far from secure from a hardware standpoint, and that may not be the most valuable place in the technology stack anyway.
I believe investors really need to think about how the VR and AR industry will mature on the software supply side. Today, Unity Software is the primary platform for building VR content and is popular for AR as well. Software made with Unity can be distributed to any platform like Steam or Oculus or even Pico with minimal effort. As a headset-agnostic platform, Unity could hold the most powerful position in VR and essentially make headsets themselves a commodity.
VR and AR lines are blurring
As VR and AR technology develops, we are also seeing the lines between the technologies blur. 3D assets can be used in both VR and AR platforms, tools like Unity are built for VR and AR, and we know Facebook (through Oculus) has a VR headset and is working on AR glasses while Apple is a leader in AR and is reportedly developing a VR headset.
Headsets are becoming more portable and less expensive, and as that happens, we'll continue to see the lines blur between VR and AR technology on the hardware side. What does that mean for Facebook's leading VR headset? It may not only have to worry about other VR headsets from HTC and Apple, but also AR headsets and glasses that could be competition.
Here again, VR and AR hardware could come in many form factors, but the common platform in the industry is the game engine Unity.
How to invest in VR and AR today
Facebook is the clear leader in VR hardware today and is making the technology accessible to millions of people around the world. In 2021, VR will likely be a multibillion-dollar business for the company, and more than double versus a year ago if the current trend continues. So, there's a huge opportunity here for Facebook.
But when you see all of these technology and platform factors converging, I think the common thread is that Unity is actually the crucial platform for the growth of VR and AR. It's where developers are building apps, and it could play a big role in the future of advertising in VR and AR given its ad insertion technology.
Headsets have more or less become a commodity, and given so many use cases for the technology, I don't see this being a winner-take-all market on the hardware side. Facebook is trying to separate off its platform by tying users to a Facebook account and building a store for content, but that may backfire and push users to competing headsets that are more open and don't have a link to a social network. And software developers aren't tying themselves to one platform or another, partly because they're relying on Unity more than any specific headset.
My long-term bet on VR is on Unity because it's the development platform and can be flexible with headset developments. And I think we'll see competition from Apple, HTC, Pico, and others take market share from Oculus in VR hardware over the next few years. Facebook has a big lead, but I don't think this will be the biggest winner in VR and AR long term.