Stock Pitch: Unity

Brief Write-Up on $U

November 16, 2021

Hello All,

As some of you already know, I entered “The Market Stock Pitch” competition on Saturday and my stock pick was Unity. I didn’t win but, it was such a great experience and I’m excited to go back on, in a couple of months.

I have to say though, all the pitches were so great and I feel bad for the people who had to choose one over the other. And honestly it didn’t feel like a competition but, more a friendly discussion among familiar faces. 😍

But since, I did the DD anyway, I thought I’d post my slides and write up my pitch here. The pitch was only 3 min long, so we had to keep it short. I’m filling in the rest in this post. I hope you find it useful!

Please Note: I’ve used a number of different sources that are in linked in the footnote1

Most of you probably know Unity better than I do because of their background in gaming. In fact, I had to have quick lesson with my daughter for this.

And then one day I saw an ad on Twitter that Unity was being used for Building Information Systems… this really caught my attention. That’s when I realized that Unity had potential beyond the world of gaming and I started digging in.

The Company

Unity is a 3D Creator Engine. But what makes them really special is that they are interactive and real time. This helps large-scale teams develop creative solutions while collaborating in real time.

The company has two basic lines of business:

  • Create is their creator engine and is a SaaS. YTD 9 months revenue grew 38% to close at $227m.

  • Operate is their monetization service which is a revenue share model. This works through Unity Ads for Gaming and In-App Purchases. This is their largest revenue stream growing 53% YTD 9 months with revenues of $515m.

Strategic Partnerships is their third revenue stream growing 5% YTD to close at $53m. Total YTD 9 months Revenue was $795m, a 44% growth year on year.

The Market

The Market is going 3D through AR & VR, and Unity is partnering with the likes of Audi, VW and Nike. They’ve partnered with the architectural firm, Mortenson. AutoCAD designs can be projected onto a building surface in 3D, and they even helped design the most efficient layout for a hospital operating room.

The Numbers

A quick look at the numbers.

QoQ revenue is growing, with a solid average Gross Profit Margin. R&D spending is the largest expense, as expected. Unity’s been beating EPS estimates consistently for the last few quarters, and as the date of this presentation, they’ve busted all analyst price estimates. Institutional ownership remains strong.

The two charts below weren’t used in the presentation but I’ve added them here for good measure. The first one shows the yearly growth in revenues & gross profits. But you see Gross Margins coming down a bit.

The second chart below shows items from the balance sheet, on the asset side. Unity’s assets are mainly composed of Cash & Goodwill. I speak about Goodwill under the risks. I don’t like Goodwill on the balance sheet. Here’s an article I wrote a while back, explaining why.

The $639m shown here is before the Weta acquisition deal. So, goodwill is likely to increase further. One thing to point out before we move on - Unity paid down $125m of debt on their balance sheet. So now they’re debt-free.

Unity is guiding below analyst estimates for Y2021. I did a rough estimate for a price target: 30% growth in revenue and 45x EV/Revenue to arrive at a 1-year target of $225.40/share, which was a 15% upside from the time I presented.

Risks

No company is without risks and of course, Unity has a few. The point about Stock Compensation below - YE 2020 Stock Comp was $134m, almost half of their net losses!

One thing to add here is their issue with the IDFA. CEO, John Riccitiello, explained it really well:

I'm going to introduce something that I think -- probably most of you think it's pretty obvious, but I want to emphasize it again. Most ad networks, their business is based on the identity -- the specific identity of the user interacting with the application.

Ours is not.

Ours is based on understanding contextually, where they are and what they're doing and what they've done before, and what they're going to do next, using predictive models based on AI, on the 50 billion-plus data as we adjust per day. And as we intimated in the call, nearly a year ago, when we were talking about the early innings of IDFA, we felt that that would lead to a relative competitive advantage for us as 1 advantage for the alternative way of driving modernization. It came in weaker, relatively weaker. And that's exactly what's happened.

So I would argue that the puts and takes, it comes down to a really simple thesis.

Ours is a better way to monetize even absent the changes that were introduced by Apple with IDFA and choice are on privacy. And on a relative basis, we gained advantaged all those -- over all those, who use identity, individual identity, they know you and your brother, whose birthday it is. That became relatively weaker and we became relatively stronger and have the single largest data insight based on the largest MAU count for anybody in our world. More or less it played out to a script almost exactly as we'd hoped, but better than we were willing to forecast given how cloudy it was a year ago.

To sum up:

My Bull Thesis for Unity is also 3D…

  • Democracy - anyone can be a creator and Unity is focused on getting more artists onboard

  • Distribution - the platforms are already there and Unity will benefit from the rising tide of the metaverse

  • Dominate - they’re investing in the right partnerships, be it on the creator side or the customer side. The new TAMs that will come off of these partnerships is explosive.

I like to say there’s always a story behind the numbers and the story is strong with Unity!!

Thank you!

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