Unity Software's (U +0.00%) stock has declined more than 60% over the past 12 months. The game engine provider repeatedly disappointed investors with its decelerating growth, persistent losses, and murky plans for the future.
But after that steep decline, Unity trades at just 4 times this year's sales and 17 times its adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). Should you buy this out-of-favor growth stock as a turnaround play?
Image source: Getty Images.
What happened to Unity?
When Unity went public in September 2020, it attracted a lot of attention for three reasons. First, its freemium game engine was already used to develop more than half of the world's mobile, console, and PC games.
Second, Unity helped its developers monetize their games with integrated ads, microtransactions, and other paid features. The stickiness of that ecosystem locked in its customers and widened its moat against its competitors.
Finally, the company claimed it could grow its revenue by at least 30% annually over the long term.
Unity initially stayed on track by boosting its revenue 43% in 2020 and 44% in 2021. That rapid expansion, along with the buying frenzy in growth stocks, propelled its shares from their IPO price of $52 to a record high of $201.12 on Nov. 18, 2021. At its peak, its market cap hit $57.5 billion, which was 41 times the revenue it would actually generate in 2022.
NYSE: U
Key Data Points
Yet that sky-high valuation set Unity up for a steep decline after its growth decelerated. In 2022, its revenue only rose 25% as the gaming market cooled off and Apple's privacy-oriented iOS update disrupted its advertising services.
That abrupt slowdown drove Unity to merge with adtech company ironSource to reboot its advertising business; roll out more tools for creating AR, VR, and digital twin applications; and expand Weta Digital (which it had acquired from Peter Jackson's special effects studio Weta FX in 2021) to develop more tools for theatrical special effects. But at the end of 2023, Unity shut down Weta Digital to cut costs and focus on its core gaming and advertising businesses.
Unity's revenue rose 57% to $2.19 billion in 2023, but most of that growth was inorganically driven by its merger with ironSource. On a pro forma basis, which normalizes the year-over-year comparisons for both companies, Unity's revenue actually stalled out over the past year. However, its adjusted EBITDA margin improved as it laid off thousands of employees, shuttered Weta Digital's lower-margin business, and trimmed its other expenses.
|
Metric |
Q1 2023 |
Q2 2023 |
Q3 2023 |
Q4 2023 |
Q1 2024 |
|---|---|---|---|---|---|
|
Revenue growth* (YOY) |
(2%) |
11% |
8% |
(2%) |
(8%) |
|
Adjusted EBITDA margin |
6% |
19% |
24% |
30% |
17% |
Data source: Unity Software. YOY = year over year. *Pro forma basis in 2023.
But for the full year, analysts still expect Unity's revenue to decline 16% to $1.84 billion as its adjusted EBITDA dips 8% to $413 million. Unity declined to provide an exact top-line outlook, but it claims its "strategic portfolio" of game engine, cloud, and monetization products can still generate 2%-4% sales growth for the full year.
Unity still has a murky future
Unity made some questionable business decisions as its expansion slowed. First, its merger with ironSource was controversial for three reasons: It was done right after the company laid off its own staff, it diluted its existing investors with a $4.4 billion all-stock deal, and the adtech company had previously been accused of malware issues.
Last year, Unity unexpectedly rolled out new "runtime fees" that would be charged every time a game was installed after a developer surpassed certain revenue levels. However, the backlash from its developers was so fierce that it hastily backtracked on most of those fees. CEO John Riccitiello resigned a month after that brand-tarnishing fiasco.
Unity's new CEO, Matt Bromberg, is trying to reset its business by downsizing its workforce, expanding its strategic portfolio, and trimming its non-strategic segments. But those cost-cutting strategies could narrow its moat against Epic Games' Unreal Engine and other game development platforms, and analysts don't expect it to come anywhere close to breaking even on a generally accepted accounting principles (GAAP) basis over the next few years.
It's not the right stock to buy right now
I bought some shares of Unity back in early 2022, but I liquidated that stake at a loss this past February because it wasn't the same business I originally invested in. Its stock might seem cheap, but it faces too many macro and competitive headwinds. Its odd business moves and abrupt management changes over the past year also suggest it's struggling to find fresh ways to reignite its sales growth. So for now, I'd stay far away from Unity and invest in more promising tech stocks instead.
