AppLovin's (APP 3.65%) stock price plunged 10% on Aug. 9 after the company made an unsolicited takeover bid for Unity Software (U -1.02%). AppLovin is offering to exchange 1.152 shares of its Class A voting stock as well as 0.314 shares of its Class C nonvoting stock in exchange for each outstanding share of Unity. The bid values Unity at about $58.85 per share, which would be 17% higher than its closing price on Aug. 9 but more than 70% below its all-time high from last November.

If the merger is approved, Unity's shareholders would receive an equity stake of 55% in the combined company, but only retain a 49% voting stake due to the inclusion of AppLovin's non-voting shares. AppLovin wants Unity's CEO, John Riccitiello, to become the CEO of the combined company, and for its own CEO, Adam Foroughi, to become COO.

A couple plays mobile games together at home.

Image source: Getty Images.

AppLovin's investors seemingly hated the proposal, since the merger would significantly dilute their shares. It also suggested that the company -- which had just bought Twitter's MoPub advertising platform in January for $1.05 billion -- was running out of room to grow. Meanwhile, Unity's stock barely budged, which indicates that most of its investors expect the offer to be rejected. It's unclear what will happen next, but should investors buy AppLovin's stock after its recent decline?

What does AppLovin do?

AppLovin operates two main business segments. Its business software platform segment provides app monetization tools for other companies. These services enable developers to integrate ads into their apps.

It expanded this segment by acquiring MoPub, and it could be further strengthened if it merges with Unity, which provides a game development engine and integrated advertising services for developers. Unity recently agreed to buy AppLovin competitor ironSource (IS) to strengthen its own struggling advertising platform, but AppLovin is asking Unity to kill that deal and approve its unsolicited bid instead.

AppLovin's apps business segment primarily hosts first-party games and apps. This portfolio, which housed more than 350 free-to-play games at the end of 2021, generates most of its revenue from ads and in-app purchases. Merging with Unity could also strengthen this business since Unity's game engine already powers many of AppLovin's mobile games.

How fast is AppLovin growing?

Prior to acquiring MoPub and making a play for Unity, AppLovin had already made several acquisitions. As a result, there's been a large gap between its reported and organic growth rates.

In 2021, AppLovin's revenue rose 92% (70% on an organic basis) to $2.8 billion. Its business software platform revenue increased 225% (188% organically) to $674 million as its machine learning and recommendation platforms AppDiscovery and AXON continued to gain more customers. Its apps revenue rose 70% to $2.1 billion as its gaming portfolio locked in more than 200 million monthly active users at the end of the year.

During its fourth-quarter conference call in February, CEO Adam Foroughi insisted that AppLovin was "not a games company." Instead, he said it merely monetizes a portfolio of first- and third-party games with ads and leverages them as tools to collect more data for its advertising business. The number of monthly active payers (MAPs) across AppLovin's ecosystem rose 29% year over year to 2.7 million in the fourth quarter, while its average revenue per MAP increased 7% to $44.

AppLovin's profitability is also improving. Its adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) jumped 110% to $727 million in 2021, which boosted its adjusted EBITDA margin 90 basis points to 27.9%.

Darker days could be ahead

This year, AppLovin only expects its revenue to rise just 2%-12% as macro headwinds throttle the growth of the advertising market. However, it still expects its adjusted EBITDA to soar 65% to $1.2 billion.

Those growth rates aren't too bad for a stock that trades at 4.5 times this year's sales and 11 times its adjusted EBITDA. But they're also not impressive enough to win back investors as the broader ad market faces cyclical headwinds. Apple's privacy changes on iOS, which make it harder to craft targeted ads, could exacerbate that pain.

That's why AppLovin wants to merge with Unity before it takes over ironSource and becomes a tougher competitor. AppLovin believes that by merging with Unity, it can generate over $7 billion in annual revenue and more than $3 billion in annual adjusted EBITDA by the end of 2024. It also expects the merger to create at least $500 million in adjusted EBITDA synergies in 2024 and more than $700 million in such synergies in 2025.

That marriage would make a lot of sense for both companies, but Unity will likely reject the bid as too low and refuse to abandon its plans to buy ironSource. Unity's investors also probably won't be keen on letting AppLovin maintain a majority voting stake in the new company by funding part of the merger with its non-voting shares.

Since AppLovin will likely need to sweeten the pot to get Unity to take the offer seriously, it simply isn't a good idea to touch its beaten-down stock -- which stands to get diluted even more -- until the smoke clears.