Unity Software (U), a real-time 3D platform used by creators to develop interactive experiences, has recently reported financial results that outperformed expectations. As a professional investor, my initial pessimism regarding the company’s performance has been reassessed, prompting a revision of my sell rating on the stock.
Unity’s Business Divisions
Unity operates through two main divisions, Create Solutions and Grow Solutions. Grow Solutions, bolstered by the acquisition of IronSource, now dominates Unity’s operations, providing tools for creators to monetize their content. On the other hand, Create Solutions focuses on empowering developers to design applications.
Near-Term Prospects
Heading into the earnings result, there were concerns about Unity’s dollar-based net expansion rates continuing to drop. However, the pace of decline appears to be flattening out, suggesting some stabilization in this aspect. Nevertheless, challenges remain, and the underlying revenue growth rates have been obscured by the impact of the IronSource acquisition.
Profit Potential and Outlook
Despite its impressive rhetoric as a disruptor in the gaming industry, Unity’s growth is projected to be around 10% CAGR, making it a modestly growing company at best. This raises concerns for investors, who would want to see stronger profitability emerging to justify the company’s $15 billion market valuation.
Financial Performance and Market Reaction
Unity’s second-quarter financial results have exceeded expectations, with a 79.6% YoY revenue surge to $533.48 million. The company outperformed estimates on both revenue and net loss per share. The growth was driven by gains in Create Solutions and Grow Solutions across various geographic regions. However, the soft advertising market and gaming industry restrictions in China have affected Unity’s performance.
Analyst Opinions
Following the strong showing in a challenging macro environment, Goldman Sachs’ Kash Rangan has reiterated a Hold rating on Unity, accompanied by a $45 price target. The rating for Unity among analysts is a “BUY”, with a price target of $41.88.
The Bottom Line
In light of Unity Software’s recent performance, I have reconsidered my earlier pessimism and withdrawn my sell rating on the stock. While there are still concerns about the near-term prospects, signs of stabilization in dollar-based net expansion rates offer some optimism. However, investors should be cautious about interpreting revenue growth rates due to the influence of the IronSource acquisition. Unity’s profit potential seems modest, and its market attractiveness remains limited.
