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Summary
Unity is a platform for creating and operating interactive, real-time 3D (RT3D) content. It allows creators ranging from game developers and architects to automotive designers, filmmakers and more, to create, deploy, and monetize interactive, real-time 2D and 3D content to more than 20 different platforms like mobile phones, consoles like XBox and Playstation, and AR + VR devices. For example, the popular game Pokemon Go is built using Unity.
Founded in 2004 in Copenhagen, Unity initially started as a gaming company that developed its own games. After the game failed commercially, the three founders decided to instead commercialize the tools they created to simplify game development, and so sell them to other game developers.
Today, Unity’s platform touches many industries and applications, with more than 5B downloads of applications per month built with Unity in the first 9 months of 2020. Since the company’s IPO in September 2020, the stock price has doubled, from $75 to $150. In this post, we’ll look at Unity’s business model, competitive position and market opportunity.
Did you know?
Facebook reportedly considered buying Unity to build out their expertise in VR/AR and integrate Unity with the rest of the Facebook applications in 2019. Zuckerberg felt that losing Unity might risk slowing down their VR/AR strategy and allow others to cut off their access to the Unity platform in the future.
Fundamentals (Q3 2020)
Revenue: $201M, +53% YoY
EV: 23B
EV/Sales (LTM): 36.9x
Gross Margin: 79%
How Unity makes money
Create Solutions (Tools for content creation) ~31% of Total Q3 2020 Revenue
These are the tools and services creators can use to create 2D or 3D content. The core platform itself has different subscription plans ranging from free to 3 year paid plans for varying advanced features. This category also includes Engine extensions, a growing portfolio of industry-specific extensions like MARS for VR development and Cinemachine for virtual production of films.
Operate Solutions (Tools for managing + monetizing content): ~60% of Total Q3 2020 Revenue
These are the tools that help creators manage, optimize and monetize their content through advertisements or in-app purchases. In fact, Unity runs one of the largest mobile ad networks, serving 23B ads per month. It also has a portfolio of live services developers can use to manage and optimize their user acquisition, player matchmaking, server hosting and identification of bugs. Overall, Unity does a revenue-share model from the ads (cost per impression) or in-app purchase (cost per install) revenue generated from content monetization.
Strategic Partnerships + Other: ~9% of Total Q3 2020 revenue
Unity has a large and diverse customer base consisting of amateur game designers and some of the largest global game development companies like Electronic Arts, Nintendo, Take-Two Interactive, Niantic, Zynga, and more. As of Q3 2020, Unity had 739 customers contributing over $100K in annual revenue of the company. These companies pay Unity a mix of structures (flat-fee, revenue-share and royalties) for Unity to create and maintain integrations with their software and/or hardware. For example, ensuring Unity integrates well with Oculus or with the Play Store is very important to Facebook and Google. This bucket of “Other” also includes revenue from Unity’s Asset Store, Unity’s marketplace for artists and developers to buy and sell digital assets like a spooky forest or the physics to guide characters’ joint movements for use in their content.
Picture of Unity’s Asset Store (below)
Growth opportunities
Existing Customers. Unity currently has a take-rate of 0.4%, according to the CEO, and can grow to 2% or more in the overall gaming space by increasing adoption of new tools like cloud content delivery, hosting and monetization. The land-and-expand seems to be working, with dollar-based expansion rate at ~130% pre-COVID. By providing these tools, Unity is aligned with customers for their long-term success.The whole market is growing quickly and is $140 billion today.
Non-Gaming Sectors. Unity is looking to expand their solutions to new industries such as architecture, engineering, construction, automotive, transportation, manufacturing, film, television and retail. All together, the market size is $17 billion today. Unity plans to tackle these opportunities by building industry-specific workflows, features, and go-to-market strategies.
Acquisitions. Unity has made several tuck-in acquisitions to expand their product offerings and deepen technological expertise. Their most recent acquisition is Vivox for $123 million, which provides in-game voice and text chats. The CEO said in the Q3 earnings call that they would consider using acquisitions to improve their Operate services, including the underlying data and AI engines.
Competitors / Risks
Game Engines. Epic, the company behind the other leading game engine, Unreal, is one competitor to Unity. Other competitors include Cocos2d by Chukong Technologies. Some large studios have their in-house game engine, which could limit Unity from entering into this customer segment. Furthermore, some of the game engines such as Roblox are offered for free or are simpler to use, attracting greater developer interest. Facebook might also integrate their advertising technology into the Oculus platform, allowing VR and AR creators to monetize their games.
COVID-19 Tailwinds. Operate was 60% of Q3 revenue, which grew 70% year-over-year. This was driven by higher engagement and utilization of monetization tools in Unity-based games and apps as people stay at home. Post COVID-19, as people return to offices and kids return to schools, time spent on games is likely to slow, which will cause Operate growth to normalize.
Lockup Expiration. Unity is expected to announce Q4 earnings on February 4th. Two trading days post the announcement, shares held by employees and former employees are no longer subject to the lockup. There might be short term pressure from new shares employees releasing shares into the market.
Key Questions to Ask Yourself (before we think you should buy...)
What might the growth rates look like post COVID-19? And can Unity expand beyond their core gaming creators?
Our Take
We think that Unity is worthy of further consideration if the investor is confident about Unity’s future prospect in gaming, VR and AR, non-gaming sectors.
Note this is not investment advice. Please consider doing your own research before making any investments!
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