Unity (U 2.75%) should be in an enviable position. The company's game engine is wildly popular, powering a long list of high-profile and niche games. Unity and Unreal Engine from Epic Games are often the two choices game developers seriously consider for their next game.
A string of bad decisions
Unfortunately, Unity has made a series of missteps. The company paid $4.4 billion in 2022 for ironSource, an app monetization platform, in a deal that hasn't delivered results. At the time, Unity predicted that the transaction would drive adjusted EBITDA to a run rate of $1 billion by the end of 2024. The company's latest guidance calls for an adjusted EBITDA of $425 million at most this year.
Unity also got too big and became too unfocused, leading to massive losses. The company laid off 25% of its workforce earlier this year as it reeled in its ambitions. This was part of a "company reset" initiated by interim CEO Jim Whitehurst in November, which also involved shuttering offices around the world. Unity will now focus on its "strategic portfolio" as it winds down non-strategic lines of business.
The biggest blunder of all, and the thing that forced Unity to take these actions, was the poorly communicated "runtime fee" announced last October. Unity planned to charge developers every time an app using Unity technology was installed, including games that had already been released. Developers revolted, and the company mostly backed off the plan. This hubbub led to the ouster of former CEO John Riccitiello.
Righting the ship
Unity now has a new permanent CEO, Matthew Bromberg, who has held high-level positions at Zynga and Electronic Arts. Bromberg faces the difficult task of winning back the trust of developers while turning Unity into a sustainable business.
The company has a long way to go. While the announced layoffs will improve the situation, Unity's costs were out of control in the first quarter. Sales and marketing spending ate up half of revenue, while research and development spending consumed more than half of revenue. Despite this heavy spending, revenue from Unity's strategic portfolio grew by just 2% year over year. Excluding some one-time items, Unity's net loss was $141 million on $460 million in revenue.
What remains of the runtime fee will begin generating additional revenue once games are released using the next major version of Unity's engine. Unity will collect either a fee per install or a 2.5% revenue share once certain thresholds are met, allowing the company to benefit from the success of games made using its platform. However, it may take years for this source of revenue to become meaningful.
Is Unity stock a buy?
Based on Unity's current results, it's hard to justify buying the stock. Revenue from the strategic portfolio is barely growing, losses remain enormous, and any turnaround will likely be a multi-year affair.
However, at the core of Unity is a product that fills a critical need in the video game industry. Unity's platform is relatively easy to use, comes with a wide variety of tools and features, and is free for developers just getting started. It provides ways to monetize mobile apps with ads, making the platform a good choice for free-to-play games.
Unity stock has tumbled more than 90% from its pandemic-era high, with the company valued at roughly $6.3 billion today. That works out to a price-to-sales ratio of 3.5 based on the company's guidance for full-year revenue from the strategic portfolio.
Whether this is cheap or expensive depends on Unity's ability to get its act together. The company needs to find a way to grow revenue without upsetting its developer base, all the while slashing costs. That's a tall order, and change won't happen overnight. The good news is that Unity the platform is deeply ingrained in the video game industry and is often the first choice for developers.
Turnarounds are inherently risky, and Unity is certainly a risky stock. For long-term investors willing to hold on through volatility over the next few years, Unity looks like a reasonable turnaround play.
