Shares of Unity Software (U 3.47%), a maker of software for video-game and other 3D content creation, are falling again. There was some short-term hype earlier this year when Apple announced Unity would be a software partner for the upcoming Vision Pro "spatial computing" (i.e., augmented and virtual reality) headset. But that was short-lived as numerous issues at Unity continue to weigh on shareholder sentiment.
The latest problem: CEO John Riccitiello has decided to retire following controversial pricing changes for the company's developers, which Unity has since decided against fully implementing. The stock is down about 60% from its initial public offering (IPO) just over three years ago.
Unity stock doesn't appear to be all that great as a buy-the-dip candidate right now, given its financial position and with a CEO search now underway. However, a former suitor to Unity could be: AppLovin (APP 6.66%). Here's why.
Unity stalls out while AppLovin profits soar
Long before recent uproars surrounding Unity's proposed price hikes for video game developers, the company was having issues with growing its software empire in the wake of the pandemic boom. After considering a merger with ironSource last year, Unity saw its second-quarter 2023 revenue increase 11% to $533 million.
The real sticking point for many investors, though, was that Unity remains unprofitable by most metrics. Its net loss under generally accepted accounting principles (GAAP) was $193 million last quarter. Free cash flow (FCF) was a positive $33.5 million, but the cause of the big discrepancy between GAAP losses and FCF remains very high employee stock-based compensation ($158 million in the 2023 second quarter alone).
Guidance for the second half of 2023 implies a further slowdown in revenue growth and continuing net losses as Unity's digital ads business remains flat. In announcing the departure of Riccitiello, management reiterated this outlook for the balance of this year.
Meanwhile, AppLovin has been turning in an epic rebound, driven by its soaring software subscription service for app developers trying to monetize their work -- though that software growth was offset by declines in its own app development division. Nevertheless, AppLovin has done what Unity's management has failed to do up to this point: It's profitable now on all counts.
Thanks to cost controls and whittling down on stock-based compensation, GAAP net profits have swung into positive territory this year. And FCF of $844 million has helped AppLovin clean up its balance sheet and repurchase stock. Shares could still be a pretty solid long-term value right now, too, at just 15 times expected 2023 earnings per share.
Data by YCharts. TTM = trailing 12 months.
Could AppLovin love Unity?
Last year, when Unity was in the process of making its bid for ironSource, AppLovin had actually offered Unity shareholders $17.5 billion for a merger. Unity rejected the bid to pursue ironSource.
Analysts at Citigroup (NYSE: C) think AppLovin could be interested in making a purchase again with Riccitiello out. If AppLovin was interested, it might be able to get Unity for far less than last year, a deal that would now also include ironSource, too (since Unity tied up that deal late in 2022). Unity's market cap is just $10.8 billion as of this writing.
Given the current market preference for businesses that are robustly profitable, Unity's own internal issues, and the Federal Reserve indicating it will keep interest rates higher for longer to try to keep economic activity muted as it fights inflation, I'm avoiding Unity stock right now.
But AppLovin? It has become an intriguing cloud software stock in my book. If (with emphasis on the "if," because it's all speculation right now) it made another bid for Unity, that could muddy the waters for a while. Unity is a mess.
AppLovin would be a great suitor in my opinion, though. It has done a great job cleaning up its own house in the last year, and is in good shape to strengthen its position in the app development and monetization space. AppLovin is on my radar.
