Unity Software (U -0.38%) initially looks like a gaming company. Its game engine, which simplifies the development of cross-platform titles, is used to create more than half of the world's mobile, console, and PC games. It also helps developers analyze their games and monetize them with in-app purchases, ads, multiplayer tools, and other services.
However, Unity's cloud-based tools can also be used to develop non-gaming digital experiences for the educational, enterprise, e-commerce, and mixed reality markets. Its recent acquisition of Weta Digital, which created the special effects for movies like The Lord of the Rings and TV series like Game of Thrones, also gives it a firm foothold in the filmmaking market.
Unity locks in all those customers with three tiers of paid subscription plans. This prisoner-taking business model makes Unity seem like a younger Adobe (ADBE -0.19%), which also locks customers into cloud-based subscriptions for its digital media and enterprise software.
So could Unity, which trades at roughly one-seventh the market cap of Adobe today, eventually become as large as that cloud software giant? Let's review their similarities, differences, and growth trajectories to find out.
The similarities and differences
Unity's business strategy resembles Adobe's, but it's much less diversified. Unity's entire business revolves around its namesake game development engine, which serves as the foundation for value-added services (such as ads and in-app purchases) and strategic partnerships. Adobe's portfolio includes dozens of apps -- including Photoshop, Illustrator, and Acrobat -- which serve a broad range of creative and enterprise customers.
Unity operates three main businesses: Create Solutions (29% of its revenue in 2021), which houses its core development engine; Operate Solutions (64% of its revenue), which provides its value-added services and revenue-sharing plans for developers; and Strategic Partnerships and Other (7% of its revenue), which signs partnerships with other companies.
Unity mainly competes against other game engines, such as Epic Games' Unreal Engine. However, expanding deeper into the 3D graphics design market could turn Unity into a competitor for Autodesk, which owns 3ds Max and Maya, as well as Adobe's Dimension.
Adobe operates two main businesses: Digital Media (73% of its revenue in 2021), which includes its Creative Cloud and Document Cloud services; and Digital Experience (25% of its revenue), which hosts its enterprise-oriented analytics, marketing, e-commerce, and e-signature services.
Adobe's Creative Cloud services compete against a wide range of smaller competitors, while its Digital Experience services compete against similar services from Salesforce, Microsoft, Shopify, and other tech giants. Adobe is firmly profitable by generally accepted accounting principles (GAAP) and non-GAAP measures -- but Unity isn't profitable by either metric yet.
How Unity could become the next Adobe
Unity's revenue rose 43% in 2020, 44% in 2021, and it expects 34%-36% growth in 2022. The company believes it can generate more than 30% annual revenue growth "over the long term" and break even on a non-GAAP basis in 2023. By comparison, analysts expect Adobe's annual revenue to rise at a compound annual growth rate (CAGR) of just 13.3% between 2021 and 2024.
Unity's long-term growth could be driven by the secular expansion of several markets. Mordor Intelligence estimates the global video game market will still expand at a CAGR of 9.6% between 2022 and 2027. The virtual and augmented reality markets could also grow at a whopping CAGR of 40.7% between 2022 and 2030, according to Report Ocean, as more companies develop immersive metaverse experiences.
The development of more first-party, in-app ads -- which should be immune to the ongoing platform-related changes on iOS, Android, and other operating systems -- could also generate tailwinds for Unity's Operate Solutions business. Unity will also likely acquire additional companies to expand its Operate Solutions portfolio to cross-sell additional services.
If Unity maintains a 30% CAGR from 2021 to 2030, its annual revenue would rise from $1.1 billion to nearly $12 billion by the final year. That would put in the same league as the present-day Adobe, which generated $15.8 billion in revenues in 2021.
Why Unity could become the next Adobe
If Unity can maintain its target growth rates, it could generate massive multibagger gains over the next decade. The diversification of its cloud services beyond video games could also make it more similar to Adobe.
I own both of these stocks, and I believe Unity resembles a younger and hungrier Adobe. It's leveraging its dominance of the gaming market to expand into other markets, its margins are gradually improving, and it's shrewdly locking in customers with a sticky cloud-based ecosystem. Unity's stock isn't cheap at 19 times this year's sales, but Adobe was also trading at similar valuations -- but offering less than half the growth -- just a few months ago.
Therefore, investors who can stomach the near-term volatility should consider accumulating some shares of Unity at these levels. This is a promising company that could be mentioned in the same breath as Adobe, Autodesk, and other cloud-based design giants in the near future.