Unity Software's (U 3.47%) stock hit its all-time high of $201.12 on Nov. 18, 2021. That represented a 287% gain from its IPO price of $52 a mere 14 months earlier. At the time, the bulls were drawn to Unity for two reasons: over half of the world's PC, console, and mobile games were developed with its game engine; and it claimed it could grow its revenue by at least 30% annually over the long term. The buying frenzy in growth and meme stocks throughout 2021 amplified its gains.
But today, Unity's stock trades at about $36. The bears stormed in as its growth cooled off in a post-pandemic market, Apple's privacy update on iOS disrupted its integrated ads, and rising interest rates popped its bubbly valuations. Unity tried to stabilize its business over the past year by expanding its non-gaming services, merging with ad-tech company ironSource to revive its advertising business, and launching a marketplace for AI-powered development tools.
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Yet Unity expects its revenue to rise only about 5% to 9% on a pro forma basis (including ironSource) in 2023. That's arguably a disappointing growth rate for a stock that trades at six times this year's sales. To make matters worse, three recent developments suggest Unity's stock could remain in the penalty box for the foreseeable future.
1. Unity's new 'runtime fees'
Unity operates a freemium business model. Its free users can use its engine to create games, but they can't access any advanced features and need to display a Unity-branded splash screen on all of their games. Its paid users can remove that splash screen and unlock a broader range of advanced tools across three paid tiers.
However, Unity recently stunned its developers with a new "runtime fee" that will be charged every time a game is installed. It will charge its Personal (free) and Plus users $0.20 per installation after they generate more than $200,000 in trailing-12-month revenue. For its higher-end Pro and Enterprise subscribers, it will start charging runtime fees once they generated over $1 million in trailing-12-month revenue.
Those fees will start at $0.15 for Pro users and $0.125 for Enterprise users, then incrementally reduced as they accumulate more installations. Unity will also charge lower runtime fees across all four tiers for its developers in emerging markets like India. Demos and charity bundles will be exempt from those fees. Those changes won't take effect until Jan. 1, but Unity plans to retroactively charge its developers based on their previous trailing-12-month revenue.
Unity claims that only about 10% of its developers will need to pay runtime fees when that change happens, but the announcement has already sparked a fierce backlash among developers. It could also narrow its own moat against fierce competitors such as Epic Games' Unreal Engine, which doesn't charge any comparable fees per installation.
For investors, this decision suggests Unity is starved for revenue growth and looking for fresh ways to squeeze more revenue from its existing users. That's a bright red flag that suggests it could miss its own modest growth targets for the full year.
2. Insider selling
Unity's management seemed to know the market would receive those fees poorly. Since the end of August, Unity CEO John Riccitiello, President of Growth Tomer Bar-Zeev, and board director Shlomo Dovrat sold nearly 108,000 shares together. Over the past three months, its insiders sold more than four times as many shares as they bought.
3. A soft market for Apple's Vision Pro
Earlier this year, Unity's stock surged after Apple said it was working with the company to develop new spatial reality apps for its upcoming Vision Pro headset. But Apple might have vastly overestimated the mainstream appeal of the $3,499 headset, which is scheduled to launch in early 2024.
According to the Financial Times, Apple initially expected to sell 1 million headsets within the first 12 months. However, it recently reduced its orders from its manufacturing partner, Luxshare, to only 400,000 units.
That reduction isn't surprising, since Microsoft (NASDAQ: MSFT) and Meta Platforms (NASDAQ: META) have both struggled to sell a meaningful number of high-end headsets. Microsoft's $3,500 HoloLens remains a niche enterprise product, and Meta discontinued its $1,000 Quest Pro earlier this year. For Unity, the lackluster sales of those high-end mixed reality devices could represent a big setback for its plans to expand its gaming platform beyond PCs, mobile devices, and consoles.
It still faces a lot of near-term challenges
Unity's growth could accelerate again next year if the macro environment improves. Unfortunately, its abrupt introduction of new fees, insider sales, and the market's weak demand for Apple's Vision Pro and other high-end mixed reality headsets all suggest it could take a long time for Unity's stock to climb above its IPO price again.
