Unity Software (U 5.53%) posted its second-quarter earnings report on Aug. 2. The video game engine developer's revenue rose 11% year over year on a pro forma basis (to account for its merger with ironSource) to $533 million, which exceeded analysts' expectations by $16 million. It narrowed its net loss from $204 million to $193 million, or $0.51 per share, which also topped estimates by $0.11.
Unity's headline numbers seemed solid, but should investors still buy the stock after its year-to-date rally of more than 40%? Let's look back at Unity's struggles in 2022, the catalysts for its comeback in 2023, and where its stock might head in 2024.
What happened to Unity in 2022?
Unity's game engine is used to develop more than half of the world's mobile, console, and PC games. It also helps developers monetize their games with integrated ads, in-app purchases, and other features. The company initially dazzled the market with its rapid growth rates: Its revenue surged 43% in 2020 and 44% in 2021, and it repeatedly told investors it could grow its revenue by at least 30% annually over the long term.
But in 2022, Unity's revenue only rose 25% as it faced two major headwinds. First, Apple's privacy update on iOS, which enabled its users to opt out of data-tracking features, unexpectedly rendered Unity's advertising algorithms obsolete. Second, the broader gaming industry suffered a post-pandemic slowdown.
Meanwhile, rising interest rates popped Unity's bubbly valuations. When it closed at its all-time high of $201.12 on Nov. 18, 2021, its enterprise value hit $56 billion -- or 40 times the revenue it would generate in 2022. Today Unity's stock trades at about $41, with an enterprise value of $18.5 billion -- or 9 times the revenue it's expected to generate in 2023.
What happened to Unity in 2023?
To revive its advertising business, Unity merged with the ad tech company ironSource last November. It also continued to expand beyond its core gaming market with new tools for creating "digital twins" of physical objects, more partnerships for its Weta subsidiary (which developed the CGI effects for Game of Thrones), tools for creating virtual and augmented reality apps, and a new platform to produce mixed reality apps for Apple's Vision Pro headset.
Unity also recently launched an AI marketplace for AI tools, which can be used to accelerate the development of video games by relying on AI algorithms instead of human artists and programmers to create graphics, sound effects, and other assets.
Unity's partnership with Apple and its new AI marketplace generated a lot of hype and brought a stampede of bulls back to its stock over the past year. However, its revenue growth has also been stabilizing while its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) margins turned positive over the past three quarters.
Metric |
Q2 2022 |
Q3 2022 |
Q4 2022 |
Q1 2023 |
Q2 2023 |
---|---|---|---|---|---|
Revenue Growth (YOY) |
9% |
13% |
9%* |
2%* |
11%* |
Adjusted EBITDA Margin |
(12.7%) |
(9.7%) |
4.6% |
6.5% |
18.5% |
Unity's merger with ironSource stabilized its advertising business, and its core game engine continued to expand. It's also bundling all of its core real-time 3D tools together in its Unity Cloud platform, which is set to launch in late 2023.
Unity expects its revenue to rise 7% to 9% year over year on a pro forma basis in the third quarter, as the flat growth of the broader advertising market and its soft gaming growth in China (which remains challenging due to regulatory headwinds) offset its other strengths. It expects its adjusted EBITDA margin to land between 16.7% to 18.2%.
For the full year, it expects its revenue to grow 5% to 9% on a pro forma basis with an adjusted EBITDA margin of 15.1% to 15.5%. It boosted both of those estimates during its second-quarter earnings report to account for its "good first half execution balanced against an ongoing uncertain economic environment."
What will happen to Unity in 2024?
For 2024, analysts expect Unity's revenue to rise 20% to $2.17 billion (upon fully lapping its merger with ironSource) as its adjusted EBITDA grows 81% to $609 million. That forecast likely implies the advertising market will warm up again, the Chinese gaming market will stabilize, and its non-gaming business will continue to grow.
Unity plans to narrow its net losses on a generally accepted accounting principles (GAAP) basis and grow its free cash flow (FCF), which turned positive in the second quarter. During the conference call, CFO Luis Visoso said it was making "strong progress" toward turning profitable on a GAAP basis and that its FCF generation was now "sustainably" positive.
Based on Wall Street's expectations, Unity's stock looks reasonably valued at 6 times next year's sales and 27 times its adjusted EBITDA. It's not a screaming bargain yet, but it could still be a great long-term buy for investors who expect it to conquer the gaming market in the same way Adobe took over the digital media market.