Share prices of 3D content creator Unity Software (U) plunged 25% last week, with most of the drop occurring after the company announced it was acquiring ironSource (IS), a leading monetization platform for mobile app developers. The addition of ironSource is highly complementary to Unity's game services business.
However, the timing and terms of the deal are raising eyebrows. Unity said the deal was an all-stock transaction worth $4.4 billion, which could change depending on how the stock performs in the near term. But given that Unity stock has already fallen 84% off its highs this year, investors are not looking favorably on the company's decision to dilute shareholders by issuing more shares to finance the deal.
Moreover, in the same announcement, management lowered its full-year revenue guidance. It now expects full-year 2022 revenue to come in between $1.3 billion to $1.35 billion, compared to previous expectations for $1.35 billion to $1.425 billion. The company cited economic headwinds and competitive dynamics with respect to its app monetization business, which added fuel to the fire.
All that aside, when looking at the value ironSource brings to Unity in terms of profitability, this deal should add tremendous value for long-term investors.
The true cost of acquiring ironSource
When the deal closes, each share of ironSource will be exchanged for 0.1089 shares of Unity, which is expected to be completed during the fourth quarter of 2022. The current $4.4-billion transaction value represents a 74% premium to the 30-day average exchange ratio, so the value could change depending on stock performance.
But there's more. To offset the dilution to shareholders, Unity announced it would repurchase up to $2.5 billion of stock upon closing of the transaction. This adds to the expense of the deal since more shares will lower the percentage ownership of Unity for existing shareholders. In fact, current Unity shareholders will own approximately 73.5% of the combined company after closing.
On the surface, the acquisition is expensive, but let's consider what Unity is getting in return.
ironSource will make Unity more profitable
Over the last year, ironSource generated $139 million in free cash flow on $623 million in revenue, which is more than four times Unity's trailing-12-month free cash flow. ironSource offers tools to help app creators launch, monetize, and attract users. This includes a platform where advertisers can bid to have their ads placed in a developer's app.
Data by YCharts.
These are two large players in game creation and monetization. While Unity also offers monetization tools with the Unity Ads platform, its specialty is its software engine which is used to make about half of all video games across mobile, console, and PC platforms.
Likewise, ironSource is used by 88% of the top 100 most-downloaded games in the Apple App Store in the U.S. The combination of Unity and ironSource will provide mobile game creators a way to test monetization strategies before the game is even launched. That's incredibly valuable in mobile games where it's difficult to predict which games are going to be successful, especially for smaller studios.
The value to investors will accrue quickly. Management expects the merger to deliver $1 billion in adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) by the end of 2024. By the end of 2025, or year three, synergies between the companies should deliver an additional $300 million to adjusted EBITDA.
Market participants are focused on near-term issues, such as the weak guidance caused by a temporary problem Unity is having with one of its ad products, in addition to the cost of acquiring ironSource. But that ignores the long-term impact on profit margin and growth this acquisition will have on Unity's business.
