2022 has been a rough year so far for stocks, particularly ones in the tech sector like Unity Software (U -1.06%). Unity stock prices are down nearly 85% from 52-week highs set last November and well below the August 2020 IPO price of $52. But while Unity's share price slide can definitely cite the broader market decline related to inflation and recession fears as a contributing factor, the company's first-quarter earnings report (released May 10) is likely the main source for the sell-off.
Unity stock is definitely a buy at its current share price, but before deciding to invest in this video game software development company with metaverse potential, it's worth digging into company performance in 2022 to get a better understanding of Unity's challenges and strengths with an eye toward what long term potential it really has.
Unity's current challenges
The bulk of Unity's revenue comes from two segments of its business: Create Solutions and Operate Solutions. Create Solutions offers subscriptions for real-time 3D software development tools while Operate Solutions offers additional services, such as monetization tools for video game developers, as well as hosting and in-game voice-chat services.
Operate Solutions generated roughly 57% of Unity's first quarter fiscal 2022 revenue. It's also the segment that encountered two major technical problems in Q1. Unity made changes to how its platform targets ads to consumers, then discovered issues with its targeting accuracy. This problem combined with a second issue: Unity's ad targeting technology relies on data to power its algorithms, but in Q1, the platform ingested bad data from one large client, hurting the reliability of its algorithms predictions.
Unity management estimates the problems will cost the company about $110 million (about 8%) of its full-year revenue in 2022, with much of the damage expected to come in the second and third quarters. Unity can fix the issues but doing so will likely delay the rollout of some additional revenue-generating products.
Another area of concern is Unity's widening net loss. It's common for tech companies to operate at a loss as management focuses more on generating growth early on. This approach has allowed Unity to grow revenue, but its net loss has grown as well. Its first-quarter net loss was $177.6 million, up from $107.5 million in Q1 2021. On an annual basis, Unity's net loss has gone from $163.2 million in 2019 to $532.6 million last year. The majority of that net loss in 2021 can be attributed to stock-based compensation expenses.
Unity has positives, too
Despite its challenges, Unity possesses many appealing qualities. The company is still experiencing strong growth with Q1 revenue reaching $320.1 million, a 36% increase year over year. The company's Q1 performance is the latest result in a multiyear trend of rising revenue.
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Double-digit percentage revenue growth is forecast in 2022 as well, even with the Operate Solutions segment's problems. Unity expects revenue to total $1.4 billion in 2022, a 22% increase over 2021's $1.1 billion.
Revenue growth remains strong because Unity created a successful ecosystem for software developers to build video games, then promote and sell those games through Unity's platform. This end-to-end solution makes it easy for game developers and creates a competitive advantage. As of mid-2020, Unity controlled roughly 50% of the game engine market share with 1.5 million monthly active creators subscribed. Unity also says that 93 of the biggest 100 game studios are customers.
The Create Solutions segment employs a software-as-a-service (SaaS) model to generate revenue. The segment accounted for about 36% of overall revenue and delivered $116.4 million in Q1, a 65% year-over-year increase.
Unity will also reach a key milestone this year. With 2022 revenue impacted by technical issues, the company plans to cut expenses, estimating a cost reduction of more than $100 million compared with its original plan. Thanks to these cuts, CFO Luis Visoso stated that "we will achieve profitability (on a non-GAAP basis) in the fourth quarter of this year" and management expects to remain profitable in 2023.
Unity is also expanding adoption of its 3D tools in sectors outside the video game industry. It's tools are being used in car design for the automotive industry and, through its December 2021 purchase of special effect studio Weta Digital, for visual effects for film and television. Mercedes-Benz and Lockheed Martin are among the customers using Unity's platform for applications beyond gaming.
To buy or not to buy Unity stock
While Unity's current challenges have alarmed some investors, they are expected to only be temporary. The management team is addressing the technical issues and applying insights gained from the experience to strengthen its platform.
Unity's SaaS model and ecosystem have a track record of successful revenue generation. Also, its balance sheet is excellent, with $4.9 billion in total assets at the end of Q1, including $1.2 billion of that in cash and equivalents, compared with $2.6 billion in total liabilities.
Investors with an eye toward the long term can benefit from Unity's current stock price drop, even if the U.S. economy slips into a recession. Research shows the stock market historically bounces back from recessions, particularly the tech-heavy Nasdaq Composite. Unity's strengths make the stock a worthwhile long-term investment.
