Global revenue for mobile video games has declined sequentially for five consecutive quarters, according to an in-depth gaming report from mobile-app research company Sensor Tower. The report, however, only goes through the end of the fourth quarter of 2022. Therefore, with the first quarter of 2023 now at an end, mobile-game revenue may have dropped for six consecutive quarters.
The majority of revenue for Unity Technologies (U -1.22%) comes from the mobile gaming space. Naturally, the company benefits when this market is strengthening, not weakening. However, management is sharpening its focus on two industries beyond video games -- two industries that might surprise you.
But first, let's talk video games
Unity has two main business segments: Create Solutions and Operate Solutions. With Create, developers can use Unity's impressive 3D software to make good-looking video games. And in fact, many developers do use Unity. When the company went public, it shared that 53% of the top 1,000 mobile games in 2019 used Unity's software.
With Operate, game developers can publish and monetize their games with ads. And it's the digital ad market that's particularly challenged right now. The rates paid for ad slots are constantly changing and are measured with a metric called effective cost per mille (eCPM).
In the conference call to discuss financial results for the fourth quarter of 2022, CEO John Riccitiello said users are still engaging with games. But this strength was "offset by weaker eCPMs" than what the company is used to. Right now, management isn't counting on a rebound in eCPMs when giving forward financial guidance. However, Riccitiello said it's reasonable to expect the problem will go away in time.
Meanwhile, here are two incremental revenue opportunities that Unity is counting on.
Image source: Getty Images.
1. Digital twins
Digital twins are digital 3D representations of real-life objects. Increasingly, enterprises are seeing value in creating such digital twins. Specifically, with manufacturing or warehouses, items can be moved around digitally to find optimal setups for physical spaces. And many companies are turning to Unity for this.
Unity doesn't break down its revenue number for digital twins. However, industry revenue now makes up 30% of revenue for its Create segment. And digital twins falls under industry revenue. Moreover, Riccitiello told investors that revenue for digital twins was up more than 100% year over year in 2022.
Unity will compete with highly competent competitor Nvidia in the digital-twin space. But fortunately, there will likely be enough growth for both companies. According to third-party research company GlobalData, the digital-twin market could grow at a whopping 36% compound annual growth rate (CAGR) through 2030, reaching $154 billion.
MarketsandMarkets Research only projects out through 2027, but it's forecasting an even greater CAGR of nearly 61%. Therefore, there should be long-term upside for Unity here, even if it only maintains its current market share.
2. Movies?
In November 2021, Unity acquired Weta Digital for over $1.6 billion. Considering the stock market was near an all-time high, and even private-market valuations were high then, Unity likely overpaid for Weta. That aside, the company appears to have acquired some top-tier tools that will allow it to expand into movies.
Weta Digital's tools were already used in some major film franchises, including The Lord of the Rings. And right now, Unity is working on some deals with major movie studios.
Riccitiello says that deals "are in-flight to close around those products this year," but he can't comment on which studios it's in conversations with. However, he went on to say, "It's the likely suspects that you would expect," implying these are A-list entertainment companies.
Look for Unity to make announcements regarding movies at some point in 2023.
What it means for investors
Unity stock is down 85% from its all-time high, but that doesn't mean shares are dirt cheap. On the contrary, on a fully diluted market capitalization basis, it still trades at roughly 10 times trailing sales. That's a premium valuation, implying high confidence from the market regarding its long-term growth potential.
Does that mean Unity stock is a bad stock to buy? Not necessarily. But it does mean that outsized growth is imperative.
For investors deciding what to do with Unity stock, it's tempting to just look at what's happening in the video game market. And games are indeed a big part of this business. However, exclusively focusing on the video game market doesn't give a complete picture. Unity is expanding into other promising verticals, bolstering optimism that it can grow into its valuation in time.
