Shares of Unity Software (U -3.31%) have taken a big beating in the past year, losing 70% of their value thanks to multiple factors such as slowing growth, the broader stock market sell-off, and an expensive valuation that worked against the stock in a bear market scenario. But Wall Street seems positive about its prospects over the next year.
Unity, which is known for its video gaming engine and 3D content creation platform, has been taking steps to improve monetization and finished 2022 strongly. A consensus of 19 analysts covering Unity has a median price target of $40 on the stock, which points toward a 42% upside from current levels. The Street-high price target of $67 would translate into a 139% jump from current levels.
But can this beaten-down tech play actually deliver the upside that analysts are expecting from it? Let's find out.
Unity Software expects a solid 2023, but investors are skeptical
Unity Software finished 2022 with record revenue of $1.39 billion, a 25% jump over the prior year. The company ended the year positively with $451 million in revenue, which exceeded the higher end of its guidance range of $425 million to $445 million. The company has issued a solid outlook for 2023. It expects revenue of $2.05 billion to $2.20 billion, which would be a jump of 47% to 58% over 2022.
However, not all this revenue growth will be organic. That's because in November 2022, Unity completed the acquisition of ironSource, an app monetization company it purchased for $4.4 billion in an all-stock deal. Unity hasn't revealed exactly how much revenue ironSource is going to add to its top line, but at the same time, investors seem worried about the potential dilution in shareholder value thanks to the all-stock deal.
That's why Unity stock saw a big sell-off in February after the release of its fourth-quarter 2022 results. The company averaged 351 million outstanding shares at the end of the last quarter, but it expects the number to jump to 493 million by the end of 2023. That would be a massive increase, though the number could be lower, as Unity has $1 billion worth of share buyback authorization available under its ongoing repurchase program.
However, investors would do well to focus on the bigger picture as Unity expects the merger to drive significant bottom-line gains. The company anticipates adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) to land between $230 million and $300 million in 2023. The figure is expected to accelerate strongly throughout the year, as Unity is forecasting adjusted EBITDA of $7 million to $12 million in the first quarter. Adjusted EBITDA margin is expected to come in between 11% and 14% for the full year as compared to 1% to 3% for the first quarter.
At the same time, investors should note that Unity's offerings are gaining traction beyond the gaming market. The company saw a 118% year-over-year jump in demand for its solutions from industries beyond gaming. Unity offers tools and services for content creation to architects, engineers, developers, and content creators through this segment, and this segment has been benefiting from the increasing adoption of digital twins.
Fortune Business Insights estimates that the digital twin market could grow at over 40% annually through 2029, suggesting that the demand for Unity's Create solutions should remain healthy. Additionally, the company sees the acquisition of ironSource as another catalyst for driving higher customer spending and growth.
Unity finished Q4 2022 with a dollar-based net expansion rate of 116%, an increase over the third quarter's figure of 111%. A reading of over 100% in this metric suggests that customers increased their usage of the company's offerings. The metric was heading lower prior to the completion of the ironSource acquisition, declining from 140% in Q4 2021.
Unity had 1,340 customers with spending of at least $100,000 in the trailing 12 months at the end of Q4, up 27% from the year-ago period. Excluding ironSource, Unity's dollar-based net expansion rate would have stood at 109%, and it would have had 1,056 customers with trailing 12-month spending of over $100,000.
So, the acquisition seems to be paying off for Unity and could play an important role in boosting the company's business in 2023 and beyond.
What should investors do?
The ironSource acquisition will clearly be the key growth driver for Unity in 2023, causing solid growth in the company's revenue and earnings. In fact, analysts expect Unity to turn in a profit of $0.28 per share, compared to a loss of $0.39 per share in 2022. What's more, Unity's bottom line is expected to head higher in 2024 as well.
U EPS Estimates for Current Fiscal Year data by YCharts
All this makes Unity Software an enticing stock to buy. But investors shouldn't miss the fact that it trades at an expensive 98 times forward earnings and 6 times sales. Those are rich multiples considering that the Nasdaq 100 index has a forward price-to-earnings ratio of 25. The S&P 500, meanwhile, sports a price-to-sales ratio of just 2.3.
Concerns of potential shareholder dilution and weakness in the in-game advertisement market could continue to weigh on this tech stock. Investors may want to tread cautiously before buying Unity Software based on Wall Street's rosy price targets.
