What happened
Shares of Unity Software (U 3.47%) fell 14.3% in February, according to data provided by S&P Global Market Intelligence. The drop happened after the company reported financial results for the fourth quarter of 2022 and gave guidance for 2023.
And while management tried to cast everything in a positive light, it clearly has a lot of challenges to overcome, which is why the stock was down for the month.
So what
In the fourth quarter, revenue jumped 43% year over year to $451 million, surpassing management's guidance. But before getting too excited, consider that the company acquired competitor ironSource, which contributed to its overall revenue growth. How much it contributed is uncertain because management didn't break this out. But it was likely significant.
So Unity is likely growing very slowly organically. Moreover, its acquisitions are accelerating its losses according to generally accepted accounting principles (GAAP) -- acquisitions are costly in this way. In the fourth quarter, Unity's net loss was $288 million, compared with a net loss of $162 million in the prior-year quarter.
Another glaring negative for Unity is the rate at which it's diluting shareholder value. The company issued shares to acquire ironSource, but through a financing arrangement it planned to use $2.5 billion to repurchase shares.
Unity has already used $1.5 billion from this authorization, and yet its share count was still up 22% year over year in the fourth quarter. Moreover, the company averaged about 351 million shares in the fourth quarter.
But the company projects there will be 493 million shares by the end of 2023. That's a massive 40% additional increase from here. Granted, management still has $1 billion at its disposal. But it can't offset all of it.
Considering how big the challenges are in creating shareholder value for the foreseeable future, it's no wonder the market bailed on Unity stock in February.
Now what
There are some positives for Unity. The ironSource acquisition is costly but is yielding inorganic revenue growth at least. For 2023, management expects to generate between $2.05 billion and $2.20 billion, which would be a 47% to 58% year-over-year growth rate, which is nothing to sneeze at.
Moreover, Unity is seeing impressive growth outside of its core mobile-gaming customer base. The company divides its business into two main segments -- operate and grow -- with 42% of revenue in 2022 coming from the create segment. According to management, 30% of revenue in the create segment comes from "industries" -- customers who might use Unity's software for things like creating digital replicas of their factories.
Not only does this expand Unity's market opportunity, the opportunity is also fast-growing. Revenue from industries was up 118% in 2022, which is encouraging.
That said, management will need to focus intensely on revenue growth and expense control over multiple years for it to overcome share dilution and the debt load it's taken on to fund acquisitions. Therefore, this might be a stock to wait on in 2023.
