Shares of Unity Software (U -2.31%) were hammered following the release of the company's first-quarter results on May 10 with the stock dropping 37% in a single session as investors panicked at its terrible guidance.
Though Unity delivered record quarterly revenue and impressive gains across its business segments, it expects a major slowdown in its top-line growth this quarter. However, a closer look indicates that its problems are likely short term in nature.
What's more, the huge end-market opportunity the company is sitting on in real-time 3D content makes buying Unity stock a no-brainer following its big plunge.
Unity Software's results weren't all that bad
First-quarter revenue of $320.1 million was up 36% year over year, and the company reported an adjusted loss of $0.08 per share, down from the year-ago period's $0.10 loss. The top line was slightly lower than the Wall Street estimate of $320.7 million, while the loss was in line with expectations.
The impressive increase in revenue was driven by robust growth in customer spending. Unity had 1,083 customers last quarter that generated more than $100,000 in revenue over the trailing 12 months, up 29% from 837 such customers at the end of the year-ago quarter.
The company also reported a dollar-based net expansion rate of 135%. This is another indication of an increase in customer spending since it compares the revenue generated in the current period to the revenue generated in the prior-year period from the same set of customers. A reading above 100% points to stronger adoption of Unity's offerings among its users.
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More importantly, the company saw healthy demand across both its key business segments. The create segment -- which enables developers, creators, artists, engineers, and architects to create interactive, real-time 3D content -- reported a 65% year-over-year increase in revenue to $116 million, or 36% of the top line. Unity credited this terrific growth to the growing adoption of real-time 3D content.
With the global market for 3D content creation expected to clock nearly 14% annual growth through 2027, this segment seems built for impressive long-term growth. However, the operate segment -- which uses revenue-sharing agreements to monetize the content created on its platform by developers -- dragged the company's results lower last quarter.
Though operate revenue increased 26% year over year to $184 million, it ran into monetization challenges due to internal factors. There was a flaw in Unity's Audience Pinpointer tool that enables creators and developers to target the right users on the company's platform, and that led to a loss of revenue last quarter. The company estimates a $110 million revenue loss due to this flaw in 2022 and points out that the harm due to this issue will be limited to the current year only.
But revenue growth will take a severe hit in the current quarter due to the ongoing monetization challenges. Unity anticipates revenue to increase just 6% to 8% year over year to a range of $290 million to $295 million. But full-year guidance indicates growth should pick back up in the second half of the year.
Full-year revenue growth should land between 22% and 28% in a range of $1.35 billion to $1.43 billion. What's more, managements expects the company to become profitable by the fourth quarter of 2022, which would be ahead of its original target. Management also foresees full-year profitability in 2023.
The good part is Unity expects to clock impressive growth in the long run with CEO John Riccitiello saying on the latest earnings call that "Unity will sustain and sustainably grow revenue at or above 30% per year over the long term even as we gain scale." That won't be surprising given the multibillion-dollar market where the company is gaining traction.
This multibillion-dollar opportunity can supercharge the stock
Unity Software is witnessing robust growth in the digital-twins business, a market that's gaining traction thanks to the metaverse. Digital twins are virtual representations of a physical object in the real world. The metaverse -- a 3D virtual platform wherein people can collaborate and socialize through their virtual avatars -- is predicted to fuel an explosion in demand for digital twins in the long run.
Mordor Intelligence estimates the digital-twin market could generate $61 billion in revenue by 2027, clocking a compound annual growth rate of just over 34%. As it turns out, Unity is on its way to capitalizing on this massive opportunity already.
The company had 3,000 customers for its digital-twins solutions at the beginning of 2022. That number should have increased by now, because it closed 34 deals for its digital-twin solutions with each valued at more than $100,000 in the first quarter, an increase of 126% over the year-ago period.
Management also points out that its digital-twin customers "are spending more time with us as we land and expand to drive tangible outcomes with real-time 3D across the enterprise." Its products here are serving customers across various verticals such as manufacturing, construction, automotive, and advanced simulation, among others.
So growing adoption of digital-twins offerings should boost the top and bottom lines in the future, and analysts' forecasts indicate the same. Unity is expected to clock annual bottom-line growth of 69% for the next five years. That's why investors looking to add a potential long-term winner might want to take advantage of the stock's latest drop and buy its shares while they're trading at 9.2 times sales, a big discount to last year's peak of more than 50.
