Share prices of Unity Software (U) have taken off big time in the past month, jumping roughly 60%. Investors seem to be excited about the company's pending merger with ironSource, as this deal is expected to unlock a lot of value in the long run.
Unity, which is known for its video game engine and 3D content creation platform, announced the merger in mid-July. The deal is expected to accelerate Unity's monetization efforts and grow its advertisement business. However, a closer look at Unity's latest quarterly results released on Aug. 9 suggests that the stock may have run up too much at a time when it is finding it difficult to grow organically.
Unity Software's latest results were mixed
Unity reported second-quarter revenue of $297 million, an increase of 9% over the prior-year period. The company's adjusted net loss increased to $0.18 per share from $0.01 per share a year ago. The results were mixed from Wall Street's perspective, as analysts were looking for a loss of $0.21 per share on revenue of $298.3 million.
Unity's poor growth last quarter can be attributed to the weakness in the operate solutions segment, which produces 53% of its revenue. The operate segment enables creators and developers to monetize their content, but it has run into rough weather thanks to Apple's iOS privacy updates, which threw Unity's advertising algorithm out of gear.
Unity executive Ingrid Lestiyo said on the latest earnings conference call that the bad data issue is now resolved. However, the company has reduced its full-year outlook, citing "negative macroeconomic factors and the complexity of accurately forecasting the timing of the changes in [the] trajectory of the monetization business."
Unity now expects full-year revenue of $1.3 billion to $1.35 billion, down from its prior forecast of $1.35 billion to $1.45 billion. That would translate into 17% to 22% revenue growth over 2021. Analysts were expecting Unity to deliver $1.36 billion in revenue this year, but it looks like the recent decline in digital ad spending is going to weigh on the company's performance.
Unity's steep valuation is a concern
The muted growth forecast is the reason why Unity stock may take a beating in the near term, especially considering that it is trading at an expensive 14 times sales. That's substantially higher than the S&P 500's price-to-sales ratio of 2.6.
Moreover, investors shouldn't forget that global ad spending is expected to grow 8% in 2022 as compared to the earlier forecast of 9.1% growth, according to Zenith Media. If those estimates head lower on account of headwinds such as inflation that could weigh on ad spending, Unity may be forced to adjust its expectations accordingly in the coming months.
All this indicates that investors may be able to get their hands on Unity stock at a cheaper valuation in the future. So it may not be too late to buy Unity stock yet. More importantly, investors should consider grabbing Unity stock at a more attractive valuation since the company is serving fast-growing niches.
Unity has plenty of future growth to tap into
Unity serves multiple industries such as gaming, automotive, architecture, and animation, among others. The demand for real-time content creation in these markets is booming, as evident from the 66% year-over-year growth in Unity's create segment revenue last quarter to $121 million. This segment could continue to clock impressive long-term growth, as the 3D mapping and modeling market could hit $12 billion in revenue by 2028, compared to $4.5 billion last year.
Meanwhile, Unity also signed its largest agreement to date to provide digital twin services in the second quarter. This could open the doors to another massive opportunity for Unity, as the digital twin market could grow at an annual pace of nearly 35% through 2027, according to Mordor Intelligence.
In all, analysts are upbeat about Unity's long-term prospects and expect the company's earnings to increase at an annual rate of 69% for the next five years. That's why investors should consider taking advantage of any pullback in Unity stock and buy it if it becomes available at a cheaper valuation, which it could given the near-term headwinds.
