In the mobile app creation and monetization space, three of the biggest public companies are Unity Software (U -4.00%), ironSource (IS), and AppLovin (APP -4.14%). And this space has suddenly become an epicenter for merger activity.
On July 13, Unity Software and ironSource made a surprise merger announcement. And this apparently left AppLovin shaking in its boots. This characterization may sound hyperbolic, but consider that less than one month later, AppLovin proposed its own merger with Unity with terms so attractive it hints at desperation. Here's what it all means for investors.
What's going on in the app space?
All three of these companies primarily serve the video game industry. Unity has a 3D content creation engine that is distinct from ironSource and AppLovin. For its part, ironSource partners with mobile carriers to assist in app discovery, something the other two don't do. And AppLovin has an operating segment of first-party mobile games unlike Unity and ironSource. But all three overlap in partnering with third-party app developers to get them discovered and monetized.
According to third-party research group Sensor Tower, player spend on mobile games jumped 13.7% in 2021, continuing a long streak of gains. However, mobile game spend peaked in June 2021 and has been slightly declining in 2022. Unsurprisingly, shares of Unity, ironSource, and AppLovin are all down about 70% from their highs.
However, Unity's problems are internal as well as external. Specifically with its app-monetization segment, its software algorithm was fed faulty data. And this part of the business -- the Operate segment -- is now underperforming as a result. Revenue in the second quarter of 2022 dropped 13% year over year, the first decline the Operate segment has recorded for as far back as the public data goes.
Unity faces a lengthy process to fix its software, but it may be trying to fast-track its recovery by merging with ironSource, a company excelling at app discovery and monetization. Consider that companies can publish mobile games through ironSource's Supersonic platform, and Supersonic is currently the top platform in the world for downloads, suggesting it delivers for its customers.
In short, Unity wants ironSource for good reason.
AppLovin's boots are shakin'
Now, let's consider AppLovin's offer to Unity. The press release said it was "compelling," and indeed, it might be the most generous merger offer I've ever seen. Here are two items that shocked me:
- Unity would represent 55% of the combined company, even though AppLovin's market capitalization was slightly higher than Unity's at the time of the announcement, and its trailing-12-month revenue is more than double that of Unity.
- AppLovin's founder and CEO, Adam Foroughi, would relinquish his role in deference to Unity CEO John Riccitiello, leaving Foroughi in the COO position -- a self-appointed demotion, if you will.
Let's now consider AppLovin's strengths relative to Unity. First, in the second quarter of 2022, its Software Platform segment revenue was up 118% year over year to $318 million. This segment competes closely with Unity's Operate segment, which we already noted dropped 13% last quarter to $159 million.
On the bottom line, AppLovin's Software Platform reported adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) of $197. By contrast, Unity faced an EBITDA loss of $155 million.
Finally, AppLovin is thinking about selling or spinning off its first-party apps business. Consider this segment is expected to generate more than $2 billion in revenue this year. For comparison, mobile game company Zynga was acquired for $12.7 billion earlier this year and had roughly $3 billion in annual revenue. In other words, there's precedent for AppLovin's app business to be sold for some serious cash, leaving the company in a strong net-cash position.
Looking at these factors, one would think AppLovin was in a position of strength not needing a merger with Unity. At the very least, you'd think it would offer to acquire Unity on better terms, but AppLovin made its "compelling" offer only after Unity decided to merge with ironSource.
For the record, Unity formally rejected AppLovin's offer on Aug. 15, instead choosing to move forward with its ironSource merger.
Of the top 1,000 mobile games, more than 700 were created using Unity's solutions, as of the second quarter. And of the top 100 most downloaded mobile games, 85 used ironSource's software. In my opinion, combining the top game-creation engine with the top game-download software creates an incredibly potent company. And it's why I consider Unity a growth stock worth buying right now, taking advantage of prices still more than 70% off their highs.
So while I'm no mobile app expert, I'll take AppLovin's offer proposal as a clear signal that Unity and ironSource will be a force to be reckoned with.