I was a pretty big gamer as a kid. My afternoons were often spent catching Pokémon or running away from fire-breathing dragons in Super Mario Bros. Of course, I managed to fit in my homework as well.
The thing about these games is that while they provided a great amount of entertainment, they were one-dimensional. In other words, I come from a generation of gamers that sat on the couch with a remote control and pounded a series of buttons to move characters around.
That form of gaming is quickly becoming a thing of the past. Advancements in technology, particularly the development of the metaverse, have allowed for more sophisticated experiences. Unity Software (U 2.04%) is emerging as a leader in this new gaming frontier. Let's dig into Unity's business and why some on Wall Street are bullish about it.
Image source: Getty Images.
What is Unity Software?
Generally speaking, video game companies develop all sorts of titles. Some of these are flagship titles that are only developed in house. For example, some gaming franchises are outright owned by Nintendo or Sony.
However, gaming companies also develop smaller, lesser-known titles, which tend to leverage third-party development tools. This is where Unity comes in.
Unity's software engine can work across multiple platforms and is not exclusive to one particular distributor. The beauty of this agnostic approach to game development is that Unity's software can be applied to games on mobile, desktop, and even different consoles. Furthermore, the business model allows the company to sell its software to a larger customer base, as opposed to one particular partner or distributor.
Cathie Wood loves it
Cathie Wood is the CEO of Ark Investment Management. Wood is a media darling, perhaps most well known for her bullish, albeit polarizing sentiment around technology stocks. She has appeared many times on CNBC and other outlets talking about the metaverse.
The metaverse is a term used to describe an alternate, virtual world. From a social standpoint, the metaverse could allow people to feel as if they are visiting a museum on the other side of the world right from their living room. Although the metaverse is very much in its early days, the applications seem limitless, and companies in just about every industry could have multiple use cases.
For Unity, the metaverse represents an enormous opportunity. While gaming companies will need to continue developing new consoles and franchises, it's hard to imagine that the metaverse will not be an integral component of the future of gaming.
As interest in concepts like virtual and augmented reality gain momentum, gaming companies can dedicate more internal resources to new product development and tentpole franchises, while also benefiting from Unity's flexibility. The company's software engine allows for less exclusive or sophisticated games to be developed at a faster, more cost-effective pace.
According to Wood's website, the investor owns a whopping 11.25 million shares of Unity stock across four of her exchange-traded funds. Just over the last three months, Wood has acquired nearly 1 million shares. It should be noted that since February, Unity stock has dropped from roughly $40 per share to $28 per share. Yet despite this drop, Wood has been lowering her cost basis and doubling down on her position.
Keep an eye on valuation
In late 2022 Unity merged with a company called IronSource. Mergers are often complex transactions. Upon completing a deal, companies spend massive amounts of time going through integration efforts, identifying cost reductions, and organizational structure among two executive teams. Yet in the last six months or so since the merger closed, Unity stock is up over 30% as of the time of this writing.
Valuation can be quite tricky. Unity is somewhat difficult to properly assess because the company is very much in growth mode and is not yet profitable. While I personally like to analyze price-to-earnings (P/E) and the PEG ratio, these methodologies are not an option here.
Given that Unity is still burning cash, its P/E is irrelevant, since the earnings per share are negative. Moreover, while the PEG ratio accounts for future projected earnings, research analysts likely do not yet have estimates baked in for the combined entity with IronSource. Stated differently, it's hard to know what IronSource's contribution will be to future earnings, thereby making the PEG ratio not entirely helpful in this situation.
One helpful metric to look at for Unity is price-to-sales (P/S). Unity's current trailing-12-month PS is roughly 6.9 times. To put this into perspective, its P/S was around 8.8 times this time last year. Given the company is growing its revenue base well above 20% annually, coupled with management doing a stellar job though the IronSource integration, investors should be generally pleased with the company's performance.
Even though the company has continued to grow and completed a merger, its P/S has actually decreased since last summer. While some of this stock movement is likely due to macro volatility, particularly in technology stocks as opposed to underlying business fundamentals, investors who are looking for some exposure to a growing market such as gaming should give Unity a look. Although the company needs to prove how it will turn a profit, now does appear like a good time to scoop up some shares and initiate a position in a reasonably priced stock.
