Unity Software (U +1.57%) attracted a stampede of bulls when it went public in September of 2020. The video-game engine developer priced its initial public offering (IPO) at $52, and opened at $75 before soaring above $200 last November.
But today, Unity's stock trades at less than $30. The former market darling lost its luster as investors fretted over its slowing growth, steep losses, and high valuation. Rising interest rates also exacerbated that selling pressure.
Could the stock recover from that ugly drawdown over the next three years? Let's review its current challenges and future catalysts.
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Why did Unity's stock drop below its IPO price?
Unity's game engine is used to develop more than half of the world's mobile, console, and PC games. It simplifies the development process by bundling tools for creating graphics, sounds, and other assets.
It's a freemium platform that unlocks more features for its paid users, and it enables developers to monetize their games with digital ads, in-app purchases, and other paid services. At the time of its IPO, the bulls believed that the "one-stop shop" approach would enable Unity to benefit from the long-term expansion of the gaming market.
CEO John Riccitiello also proclaimed the company could maintain more than 30% annual revenue growth "over the long term."
That forecast initially seemed realistic: Unity's revenue rose 43% to $772 million in 2020 and grew 44% to $1.1 billion in 2021. Its two core businesses -- its namesake game engine and the Unity Ads division -- were firing on all cylinders as the pandemic lit a fire under the gaming market.
In Deceber of 2021, it also acquired Weta Digital -- which created the special effects for Game of Thrones, Avatar, and Lord of the Rings -- to expand its reach beyond the gaming market.
But in 2022, the growth of Unity's game engine cooled off in the post-pandemic market as people played fewer video games. Unity Ads also stopped working properly after Apple (AAPL +0.54%) updated its privacy settings on iOS. That sudden malfunction forced Unity to buy the ad tech company ironSource in November to reboot its entire advertising business.
Even after acquiring ironSource, Unity only expects its revenue to rise by 23% to 25% to just under $1.4 billion in 2022. Riccitiello still believes Unity can achieve a compound annual growth rate of 30% over the long term, but the company remains unprofitable by both generally accepted accounting principles (GAAP) and non-GAAP measures.
That combination of slowing growth and red ink made Unity an unappealing stock as interest rates continued to rise. And even after its steep decline, Unity still doesn't look extremely cheap at five times next year's sales.
NYSE: U
Key Data Points
Can Unity rise back above its IPO price in three years?
In 2023, Unity's top-line growth will be significantly inflated by its $4.4 billion acquisition of ironSource. Its main challenge will be to integrate that business into Unity Ads to overcome Apple's iOS changes.
IronSource is profitable, so the acquisition won't squeeze Unity's long-term margins, but the all-stock deal will dilute its shares. On the bright side, Unity expects its operating cash flow to turn positive in the fourth quarter of 2022 as it integrates ironSource and implements other cost-cutting measures. The company's gaming business could also stabilize as the industry laps its post-pandemic slowdown.
Based on those factors, analysts believe revenue will rise 59% to $2.2 billion in 2023 as its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) improve from a $22 million loss to a positive $219 million. In 2024, they expect its revenue to rise 19% to $2.6 billion as its adjusted EBITDA more than doubles to $509 million.
Unity is even more optimistic: It expects its adjusted EBITDA to exceed an annual run rate of $1 billion by the end of 2024 as it generates more synergies from its merger with ironSource. But during the company's latest conference call in November, chief financial officer Luis Visoso warned that "as long as the ads market sentiment remains one of recession, we expect to guide revenue growth lower than our sustainable growth target" of 30%.
Assuming Unity matches analysts' expectations and grows its revenue by another 19% to $3.1 billion in 2025, it would still have more than doubled its revenue from 2022. If it still trades at a similar price-to-sales ratio by then, it could potentially rise to about $60 a share by the end of that year. That would be a decent return from its current price, but it would be far below its all-time high.
That said, Unity could still evolve into a much larger company over the next few decades as its platform locks in more developers and it expands more deeply into the augmented-reality, virtual-reality, and nongaming markets.
