Unity Software Inc - biggest opportunity for the game industry and the metaverse?

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Even though I’ve spent quite some time on the forums, I finally decided to open my first thread. I’ve been following Unity Technologies (Unity Software Inc, NYSE: U) for a long time and finally joined in with a small initial investment (just as the stock price reached ATH levels :sweat_smile:), so let’s create a thread for it. The company has been touched upon in some discussions on the forum (e.g., in QT and gaming industry threads), but I haven’t seen much discussion about it – are there other forum members investing in Unity?

Product:

  • Unity’s core product is the Unity engine – a graphics engine used especially for creating various games, but increasingly also in other professional uses such as industrial 3D design.
  • Many different software solutions (and also service businesses) have been built around the engine: e.g., the Unity Ads advertising platform, the 3D marketing and sales tool Unity Forma, and much more.
  • Additionally, Unity operates the Unity Asset Store, where designers can sell their created graphical assets to others (and Unity takes a cut from each sale).

Pricing:

  • Unity’s core product operates on annual licenses. The price depends on team size and other parameters but is in the range of several hundred dollars per month per user (based on website research, usually billed annually).
  • Free trial versions are also available for a limited time.
  • A completely free version is available for individuals and small organizations => Encourages experimentation and partly contributes to license sales.

Brief history of the company

  • Founded in 2004 in Copenhagen under the name Over the Edge Entertainment, now headquartered in San Francisco
  • 2007: The company’s name changes to Unity, and it is one of the first 3D engines to support the first iPhone
  • 2010: Unity Asset Store is launched
  • 2014: Unity acquires Finnish Applifier. Original CEO and founder David Helgason steps down, and the new (current) CEO John Riccitiello begins.
  • 2016-2018: Several funding rounds. At the end of the 2018 funding round, the company’s value is estimated at approximately 3 billion dollars. A frequent series of acquisitions begins.
  • 2020: Unity lists on the New York Stock Exchange with a valuation of approximately 13.7 billion dollars.

Growth and acquisitions:

  • Unity actively makes acquisitions: the latest acquisition announced this week is the purchase of Peter Jackson’s effects company Weta Digital for 1.6 billion dollars. This will certainly bring high-level graphics expertise to the company.
  • In the last 12 months, there have been at least 5 acquisitions or acquisition intentions, and acquisitions have also been made very actively in previous years.
  • The company also operates in Finland (where they acquired Applifier in 2014, and Unity’s advertising technology, Unity Ads, was developed based on its technology).
  • The company has grown strongly: the Q3/2021 report stated revenue growth of 43% vs. Q3/2020, and annual growth since 2018 has been approximately 40%.
  • The number of large accounts (over 100,000 USD revenue per 12 months) is also growing (Q3/21 vs. Q3/20 approximately +32%).

Stock and key figures:

  • The stock has risen approximately 165% since its listing in September 2020 (at the time of writing), and its market capitalization is already a staggering 51 billion dollars (181.94 USD per share).
  • Unity is still making a loss – and has been since its founding in 2004 (although the loss per share has decreased: Q3/21 EPS -0.41 vs. Q3/20 EPS -0.97 USD).
  • Absolutely massive growth expectations have been loaded into this. Measured by key figures, the stock is indeed very expensive due to the recent rise: P/B 26.11 and P/S 55.25 at yesterday’s closing price. For comparison, Autodesk’s P/S is 17.89, Adobe’s 20.49, QT’s 32.05, Nvidia’s 35.09, and Facebook/Meta’s 8.41 (and all of them are profitable).

Risks

  • As with other growth companies, very high expectations have been placed on Unity’s growth (which have been met so far). If these are not achieved, the ride will certainly be rough.
  • Even though the number of high-paying customers is growing, Unity still needs a very large (and constantly growing) user base to achieve its goals.
  • Technological competition (especially with Unreal) is very tough, and a lot of money has been invested in acquisitions: if Unreal (or some other smaller competitor) is capable of new innovations that Unity cannot match, even large accounts can be lost quickly.
  • In the future, a larger part of the growth may come from outside the gaming industry, where there is also more competing software (as detailed below). There are no guarantees that Unity will be as supremely dominant a technology in these sectors as it is in games. Furthermore, diversification into multiple sectors may bring additional risk of product fragmentation (when trying to be everything to everyone).

Comparisons

  • Perhaps the most direct competitor for Unity is Unreal Engine, which is owned by Epic Games (estimated to be worth approximately 30 billion dollars) and is not publicly listed, making its valuation challenging. I understand that many developers creating large-budget AAA games prefer Unreal because impressive graphics are easier to implement with it. However, Unity leads in the indie and mobile sectors, and the acquisition of Weta Digital could turn this dynamic on its head.
  • Other comparables could be industrial design software, but these have a much weaker (if any) position in the entertainment sector. Examples include AutoDesk, KeyShot, etc. In terms of graphics, Adobe could also be considered a kind of comparable.

My investment thesis:
Unity interests me particularly because I believe it has the potential to be a REALLY big player in the entertainment and gaming industry, as well as in industrial design – especially if virtual reality gains momentum, as painted by Mark Zuckerberg of Facebook, for example. The bonus here, however, is that Unity benefits regardless of who wins the VR race, as those VR objects are largely created with Unity. According to their own statement, approximately 50% of all mobile games and about 60% of all virtual reality content are built on the Unity engine.

What’s also great about Unity is that revenue comes from multiple sources: the Unity Asset Store, software licenses themselves, and the advertising network.

Useful links

So, those are the most important points. What are other forum members’ thoughts on Unity?

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Great opening!

I don’t have time to comment further now, but yesterday in the gaming company thread I touched upon Unity’s Q3 webcast and the metaverse.

I got into this in the aftermath of a gaming company podcast from over a year ago. I think it was an Atea and Verner video, where Unity was briefly mentioned for a few minutes.

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Excellent opening! What more could possibly be added to that? :slight_smile:. But I also have a small slice of this in my portfolio, and for pretty much the same reasons. I don’t have deep expertise in the industry, but I’m happy to be along for the ride with a company like this. Initially, I was looking for a gaming company for my portfolio, but then I decided I’d rather own a company whose product is used to make games, and on top of that, we get a share of the revenue from the games made.

I agree that Unity seems to be in a very strong position to grow even further if AR/VR breaks through. There also seems to be very little competition? Epic’s Unreal Engine (doesn’t even seem to be on the mobile side), what else? Furthermore, if new competitors emerge in the field, it will take a while to develop a similar level of software, and it will cost a hell of a lot of money, so I see a pretty strong moat.

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That Q3 review was good, let’s link it here as well:

https://s26.q4cdn.com/977690160/files/doc_financials/2021/q3/Q321-Earnings.mp4

The webcast mentioned that additional investments are coming for creating digital twins with both consumer products and larger entities like entire cities - so the use cases seem to be expanding more and more :smiley:

There was also this industry expansion last week, so they are heavily investing in expanding use cases now (and hopefully growth will be maintained by these).
https://venturebeat.com/2021/11/13/unity-moves-robotics-design-and-training-to-the-metaverse/

Having researched this more over the weekend, I see the biggest risk here as the valuation that has grown extremely rapidly: the multiples are now incredibly high, and there cannot be the slightest crack in growth. I will probably start a gradual, moderate buying program to increase my position because it would simply be too stressful to commit a larger sum immediately at these levels (and if the stock drops more sharply, then I will buy more significantly).

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Good opening, I’ll be following this thread with interest. I don’t (yet) have Unity in my own portfolio, but I bought some for my wife’s portfolio in the spring. I’ve been thinking about adding more, but every time I’ve found a supposedly more interesting target for my wife’s additional funds. I should make an effort to delve a little deeper.

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Small typo. Should be billion.

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True - let me fix that :sweat_smile:

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I’ve looked into this topic a bit more and found quite a lot to be hyped about :smiley:

The topic is quite new to me, so please correct me if I’ve misunderstood anything.

Riccitiello is probably referring here at least (especially?) to Facebook’s / Meta’s 10 billion investments in the metaverse this year (and growing in coming years). As a reminder, Meta decided to separate metaverse development under Reality Labs, which will now be reported as its own segment.

Labs is pretty much synonymous with Oculus, which FB acquired in 2014. The main products are VR headsets and related apps and services. I would assume that those 10 billion will be used for investments in related hardware and software. This brings us to Unity.

Oculus’s website reveals that the largest app engines for Oculus are Unity’s Unity3D and Unreal Engine’s U4E. In terms of games, the traditional division has been (as mentioned in the opening) that Unreal is strong in AAA games, while Unity is strong in indie, mobile, and 2D games. Of course, both are simultaneously moving into/investing in each other’s territory (e.g., Unity has focused on graphics).

A quick look at the Oculus forum, where both Unity and Unreal developer support can be found. On the forum, there is about 3x more discussion in the Unity thread than in Unreal’s. From this, I dare to conclude that there are more developers using Unity than Unreal (could also mean that Unity’s problems are multiplied :smiley: )

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Additionally, in Oculus’s open job positions, a search for ‘unity’ yields 75 jobs, and a search for ‘unreal’ yields 50 jobs. In many, however, a skill requirement for at least one or both tools is mentioned.

In summary, Meta is investing tens of billions in Oculus this year and in coming years, where Unity has a very strong foothold. Not bad!

Let’s return to those billion-dollar investments, an adjacent presentation linked in the FB thread.

The presentation mentions 13 different technologies (at 1:01:55) needed to reach the next level in the metaverse. Of these, avatars are highlighted as the most important, because “metaverse is about connecting people” (# Nokia). [Eye tracking is also mentioned, # SmartEye]. This brings to mind the acquisition of Weta Digital, which specifically addresses this need (3D content creation etc).

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All in all, Unity’s future is full of great opportunities. It’s not yet entirely clear to me what these opportunities could mean for cash flows. I need to delve into that more thoroughly in the future.

E: Unity and the metaverse already made it into Verner’s morning summary :partying_face:

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Great opening! I have Unity in my own portfolio, I’ve been actively following the company for the past year, and finally found a suitable buying opportunity during the October dip. Everything related to the Metaverse has been on a strong upward trend for the past month, so the recent price surge is likely mostly due to this hype. However, behind the Metaverse hype, there seems to be a very exceptional company whose platform is already very popular.

A few more points on the opening:

  • Unity acts as an engine and platform, offering the right to use it as a license. However, in terms of revenue, I see greater potential in the service business, where Unity offers usage-based services for marketing and maintaining applications developed on the platform. In practice, the more successful the applications (games and others) developed on Unity’s platform are, the more money Unity makes. For example, Shopify has very successfully utilized a similar earning logic.

  • As I understand it, losing current customers is not very likely without significant quality issues, as switching platforms is anything but easy. I would therefore see current customer retention more as a strength than a risk.

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That’s a good opening,
U also been on my radar, the price popped and that’s what happens to “these”, I wouldn’t have gone in anyway yet, maybe rather directly into Meta, which I’ve also never owned, but would be a foolproof investment.

Currency exchange rates are discussed quite little, just because of the dollar-euro exchange rate, it’s really difficult to invest in the US now, in my opinion, it’s not enough reason that the Euro continues to weaken.
I still have 6 US companies left in my portfolio, and it’s been a pleasure to follow the appreciation purely from exchange rate changes.

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Let’s update the thread after a long time. There’s interesting M&A news again!

Unity is acquiring Ziva Dynamics, a company that makes advanced 3D character modeling software. This is a company with existing software, not just conceptual stuff.

Their software makes it easier to create more realistic and credible human, animal, and other characters and to model movement (e.g., clothing). I see this as further enhancing Unity’s applicability in games and, perhaps more importantly, outside the gaming industry in various simulators or even in the film industry, challenging more traditional players in these fields. This also helps challenge the similar features of Unreal Engine that were recently announced.

The links also include some example videos, and the results are quite impressive.

The acquisition price has not been disclosed, at least as far as I can see. According to Crunchbase, they received about $10 million in seed funding in 2020, so this is probably not a huge deal financially - the benefits will be seen in the longer term.

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This is strongly related to the acquisition of Weta Digital in the autumn, the idea of which was specifically to facilitate the development of avatars with Unity’s tools.

It seems that Unity has a clear vision and this acquisition complements it very well from a technological perspective.

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Alright, the 2021 results were released last night, and they were quite good (the stock was also up about 15% in after-market trading).

Here are my thoughts and highlights - figures pasted below:

  • Even if we completely disregard the metaverse hype, Unity continues its strong performance and growth overall, while expanding the capabilities of its product.

  • The loss deepened, mainly due to additional costs from option programs, which, for example, mergers and acquisitions (M&A) certainly generate. This will likely also be reflected in next year’s results because these large acquisitions have already been made this year – and will certainly continue. This is slightly concerning, but on the other hand, it still drives impressive growth. Cash reserves decreased by about 17% compared to last year, but there is still over a billion dollars in cash. Of course, debt also increased due to acquisitions. This needs to be monitored over a few years to see how the situation develops.

  • Growth remains very impressive in both the Create (41% vs. 2020) and Operate (51%) segments. A slight slowdown is forecast for this year (34-36% annual growth), but if acquisitions and other activities continue, this could easily be exceeded. Marketing and sales have also received additional investments (sales and marketing expenses increased by about 45% vs. 2020). As a quick reminder, the Create segment primarily covers monthly subscription products (e.g., the core graphics engine), and Operate, in turn, covers content monetization (Unity Ads and software enabling in-app purchases, for example).

  • Not yet highlighted in the press release at a numerical level, but non-gaming activities and use cases are also progressing well. There is a lot of growth potential here in the future if the gaming side starts to saturate (but its share, for example, in mobile is still growing, and in my opinion, AAA titles will also become more attractive to develop, at least partially, with Unity vs. Unreal as the integration of acquisitions progresses). Especially 2D and VR/AR solutions developed for industrial/professional use (which are in the Create segment) offer, in my view, enormous growth potential.

Unity’s Create Solutions accelerated throughout the year: Create Solutions experienced a strong year across games and non-gaming. In late 2021 particularly, AAA publishers and platform providers launched made with Unity games, including Riot Games’ Ruined King: A League of Legends Story. Unity continued to expand market share within the top 1,000 mobile games in 2021.

Outside of gaming, Unity’s RT3D capabilities led to more customers across industries and use-cases to implement Unity software as part of their digital strategies. For example, Hyundai Motors and Unity partner to connect a physical factory with its digital twin to enhance plant management, drive productivity and innovate in the manufacturing process. eBay partnered with Unity to enable sellers to showcase the actual item they are selling in Unity’s proprietary, interactive 360-view.

Fourth Quarter 2021 Financial Highlights

  • Revenue was $315.9 million, an increase of 43% from the fourth quarter of 2020.
  • Create Solutions revenue was $99.9 million, an increase of 49%; Operate Solutions revenue was $194.6 million, an increase of 45%; Strategic Partnerships and Other revenue was $21.3 million, an increase of 12%, each as compared to the fourth quarter of 2020.
  • Loss from operations was $144.8 million, or 46% of revenue, compared to loss from operations of $80.8 million, or 37% of revenue, in the fourth quarter of 2020. These results were impacted by an increase in stock-based compensation expenses.
  • Non-GAAP loss from operations was $12.0 million, or 4% of revenue, compared to a non-GAAP loss from operations of $20.1 million, or 9% of revenue, in the fourth quarter of 2020.
  • Basic and diluted net loss per share was $0.56, compared to basic and diluted net loss per share of $0.31 in the fourth quarter of 2020.
  • Basic and diluted non-GAAP net loss per share was $0.05, compared to basic and diluted non-GAAP net loss per share of $0.10 in the fourth quarter of 2020.
  • 1,052 customers each generated more than $100,000 of revenue in the trailing 12 months as of December 31, 2021, compared to 793 as of December 31, 2020.
  • Dollar-based net expansion rate as of December 31, 2021 was 140% as compared to 138% as of December 31, 2020.

Full Year 2021 Financial Highlights

  • Revenue was $1.1 billion, an increase of 44% from 2020.
  • Create Solutions revenue was $326.6 million, an increase of 41%; Operate Solutions revenue was $709.1 million, an increase of 51%; Strategic Partnerships and Other revenue was $74.8 million, an increase of 7%, each as compared to 2020.
  • Loss from operations was $531.7 million, or 48% of revenue, compared to loss from operations of $274.8 million, or 36% of revenue, in 2020. The 2021 full-year GAAP results were impacted by an increase in stock-based compensation expense, as well as a charge of $49.8 million related to the termination of a lease agreement.
  • Non-GAAP loss from operations was $50.7 million, or 5% of revenue, compared to a non-GAAP loss from operations of $50.6, or 7% of revenue, in 2020.
  • Basic and diluted net loss per share was $1.89, compared to basic and diluted net loss per share of $1.66 in 2020.
  • Basic and diluted non-GAAP net loss per share was $0.22, compared to basic and diluted non-GAAP net loss per share of $0.39 in 2020.
  • Net cash used by operating activities was $111.4 million for 2021, compared to net cash provided by operating activities of $19.9 million for the same period last year. Free cash flow in 2021 was USD (153.4) million, compared to USD (20.2) million for the same period last year.

EDIT: Off-topic, but ping @Yu_Gong for some reason “math” formatting appears in the last sentence that I can’t remove even by pasting as plain text, so is this some kind of forum style code bug or something? :thinking: Edited and problem solved

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Off-topic: This is indeed due to the dollar signs, things between them are in math syntax. I’ll look into whether this can be changed or even removed. :slight_smile: But if you change the $ signs to, say, (dollar), then the format changes, for example.

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It’s hard to see how Unity can turn the business profitable. The only truly scalable component is ads. The only way I can think of is massive price increases for licenses. But does Unity have pricing power?

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You clearly didn’t read the announcement. Most of that loss was due to stock-based compensation; without it, there would have been a few percentage points of negative profit (see below). Unity could turn profitable as early as today if they gave up their significant growth investments.

Unity doesn’t have a long stock market history, but based on last year’s guidance, they are cautious guidemakers like Pekka Lundmark. The guidance a year ago was 23-26%, but they ended up with 43%.

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Yes, I read that. I just don’t see any value in such Non-GAAP figures. It also says this:

Non-GAAP net loss and non-GAAP net loss per share have limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:

  • they exclude expense associated with our equity compensation plan, although equity compensation has been, and will continue to be, an important part of our compensation strategy;

I work in the industry, and almost all employees receive stock-based compensation as an extension of their salary. Why should these just be removed from the figures? Could salaries also be cleaned out of the figures to make the results look better? Perhaps I chose my words a bit too harshly when I said profitable, but how does Unity more softly turn its cash flow around to justify its current valuation?

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I don’t believe there will be an issue if revenue growth can be kept on track, and profitability should also gradually improve.

However, equity-based compensation often includes performance targets, so it’s not usually automatic, and this component can be modified over time (especially for senior management, who often have a significant amount of it). Equity-based compensation also likely becomes more prominent during major acquisitions, where, as I understand it, larger one-time items may arise when securing the management of the acquired company, etc., so this is not necessarily a permanent state of affairs.

I’ll have to investigate further to see if these were explained in more detail somewhere (possibly need to wait for the actual annual report to be published).

Additionally, especially outside the gaming sector, I also see the potential for scalable revenue growth (with low costs). Currently, in many cases, these applications are probably still in the experimental phase with a few users, but if you get an entire design department of a larger company to use Unity, revenue will increase quite significantly. Of course, there is a lot of competition in this area, but I don’t see this as impossible.

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My argument against Unity as an investment case is that this business scales only with the number of users, but not at all with the success of the end products. Growth will certainly come, but so will costs. There is fierce competition for developers and salaries are rising. The product is good but the numbers are not convincing at all.

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Unity already has, for example, the Gaming Services package, which end products (games) can utilize for multiplayer, voice chat, advertising, content delivery, etc. And that specifically scales with the number of players/users. Or did I misunderstand your argument?

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