Unity Software (U +0.20%) is a leading provider of real-time 3D software development tools. It's mostly known in gaming circles as the software engine that is used to create video games on mobile devices and consoles. But Unity is selling its 3D software into several industries beyond just gaming, which could grow into a huge opportunity.
However, the company hasn't delivered the results to justify its previous high valuation. The market sell-off last year pulled the stock down 86% from its all-time high. Slowing revenue growth was part of the problem, but the sell-off was accentuated by the company's adjusted loss from operations widening to $90 million last year on $1.4 billion in revenue.
Let's take a closer look to determine if the stock is worth buying.
NYSE: U
Key Data Points
Revenue growth is improving
In addition to providing a software platform that is used by graphic artists in gaming, film, architecture, and other markets, Unity also provides in-game advertising services, marketing solutions, and other tools to help mobile-app developers monetize their apps.
The company reported growth across the business of 25% last year. Unity would have grown faster if not for an execution issue with its in-game advertising business. In the first quarter of last year, Unity disclosed it had ingested faulty data into its platform which led to reduced accuracy and lost revenue for its Audience Pinpointer tool. This cost the company over $100 million in revenue.
Image source: Unity Software.
Also weighing on the stock were the widening operating losses, but this seems to be turning around. Unity reported its first profitable quarter on an adjusted basis as a public company in the fourth quarter, and management guided for margins to improve throughout 2023.
What to expect in 2023
Management expects revenue to be up between 47% and 58% year over year in 2023, which includes additional revenue from last year's acquisition of ironSource, a leader in technology that helps mobile-app developers grow their business.
The expected growth is encouraging in light of Apple's privacy changes on iOS that have made it more difficult for apps to track users for advertising purposes. This has been a major headwind for social media companies, but Unity said in the first-quarter 2022 earnings call that its ad business had delivered "significant growth" before the data issue with the Audience Pinpointer.
Overall, Unity expects to outperform a down ad market this year, which speaks volumes about the value of its offering and its ability to help app developers navigate the difficult ad environment.
The ironSource acquisition is a big opportunity investors should watch. ironSource is a leader in technology that helps mobile app developers grow their business and could be a major catalyst over the next few years.
With this addition to its platform, Unity can now assist developers through every stage of building a successful mobile-app business, from software creation to distribution and generating revenue. This could be a major growth catalyst, as noted by management's guidance.
Can the stock move higher?
The stock is selling at a conservative price-to-sales (P/S) ratio of just 6.3. That seems low for a fast-growing software business. For example, cybersecurity and cloud stocks that make their money from software subscriptions like Unity are being valued at over 10 times sales.
Obviously, the market is punishing Unity for its exposure to the weakened mobile ad market, but a booming economy down the road could change the market's perception and send Unity stock higher.
It's also worth noting that Unity has a bigger opportunity beyond the gaming industry. Although gaming is a large industry valued around $200 billion, the company reported that revenue from nongaming industries grew 118% year over year last quarter, compared to just 24% with games.
Given these opportunities, it's easy to see how the stock could earn a higher valuation under the halo of more-positive sentiment in the stock market. If the P/S were to fall any lower, it would be an incredible bargain. It seems like a good time to buy at least a small position in the stock, and if Unity executes against its guidance, buy more shares.
