On Aug. 9, 2022, most investors thought the biggest news for Unity Software (U 0.23%) would be its second-quarter earnings report. That morning, however, AppLovin (APP +2.03%) publicly submitted a buyout proposal to Unity's Board of Directors, pinning its enterprise value at $20 billion.
This offer included a major contingency regarding merger plans Unity had previously set in motion. The company has yet to officially respond to AppLovin's offer, but here's why Unity should reject the merger proposal.
Image source: Getty Images.
Why does AppLovin want Unity?
On July 13, 2022, Unity announced it will merge with ironSource (IS +0.00%), valuing the latter at roughly $4.4 billion in a bid to help spur Unity's monetization services, which have been lacking lately. Unity's Operate solutions -- services for game developers to help them run, scale, and monetize their games -- saw revenue decline 13% year over year in the second quarter. ironSource specializes in this arena, so the acquisition could help Unity fill this gap in its business.
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But the buyout proposal from AppLovin has one catch: Unity would have to terminate its pre-existing agreement with ironSource.
Why would AppLovin want to do this? The company is a direct rival to ironSource as it helps mobile apps scale, grow, and monetize their businesses. Therefore, if ironSource and Unity were to merge, AppLovin would have to compete against a larger, more formidable rival. This merger proposal from AppLovin looks like a strategy to preemptively dismantle a potential competitor.
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Unity's response
While AppLovin's proposal did offer an 18% premium on Unity stock based on its closing price prior to the announcement, the latter has remained tight-lipped about the deal. Management reaffirmed its plans with ironSource during the second-quarter earnings call: "On July 13, we announced a definitive agreement to merge with ironSource, which we expect to close in the fourth quarter of this year."
ironSource, on the other hand, did comment on AppLovin's offer. In an internal email to employees, Chairman and CEO Tomer Bar-Zeev noted AppLovin's proposal looks like a last-ditch effort to hamstring the existing Unity deal:
We view this as a testament to the value of our proposed deal with Unity and the power of the combined company we will create. We think it reflects a defensive, desperate move from AppLovin, and we feel strongly that our deal is superior.
Why Unity is making the right decision
For Unity, sitcking with ironSource is a wise choice considering the value it could bring to the table. In addition to the synergies and the benefits of ironSource's monetization expertise, the company also brings some desperately needed profitability to Unity. Over the trailing 12 months, Unity has lost over $659 million, but ironSource generated $66 million in net income. On the other hand, AppLovin is unprofitable as it lost $69 million over the same period.
ironSource also has a much healthier balance sheet with $387 million in cash and deposits and no debt, while AppLovin has over $3.2 billion in debt and only $952 million in cash. Given the financial picture, it's understandable Unity would prefer to proceed with its ironSource deal.
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Should you buy this combined company?
While there are reasons to like a Unity-ironSource tie-up, there are risks to be aware of too. Unity's all-stock offer represents a 74% premium for ironSource shareholders, leaving open the possibility Unity is overpaying. Related to that, existing Unity shareholders will experience significant dilution.
Even if AppLovin's merger proposal looks like the inferior option, successful execution of the deal with ironSource will present its own challenges. Therefore, Unity investors should watch this deal closely and be prepared for continued volatility.
