Unit software‘S (NYSE: U) shares have fallen more than 60% in the past 12 months as the game engine provider repeatedly disappointed investors with its slowing growth, persistent losses and murky plans for the future.
But after that steep drop, Unity trades at just 4 times this year’s revenue and 17 times 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 powering more than half of the world’s mobile, console, and PC games.
Second, Unity helped its developers monetize their games with embedded ads, microtransactions, and other paid features. The stickiness of that ecosystem locked in its customers and widened its moat relative to its competitors.
Finally, the company claimed that revenue could grow by at least 30% per year in the long term.
Unity initially stayed the course by growing its revenue 43% in 2020 and 44% in 2021. That rapid expansion, coupled with a buying frenzy in growth stocks, propelled its shares from their IPO price of $52 to an all-time high of $201.12 on Nov. 18, 2021. At its peak, its market cap hit $57.5 billion, or 41 times the revenue it would actually generate in 2022.
Yet that sky-high valuation led Unity to a steep decline after growth slowed. Revenue rose just 25% in 2022 as the gaming market cooled and AppleThe privacy-focused iOS update disrupted ad services.
That abrupt slowdown prompted Unity to merge with ad tech 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 acquired from Peter Jackson’s special effects studio Weta FX in 2021) to develop more tools for theatrical special effects. But Unity shuttered Weta Digital in late 2023 to cut costs and focus on its core gaming and advertising businesses.
Unity’s revenue grew 57% to $2.19 billion in 2023, but most of that growth was driven inorganically by its merger with ironSource. On a pro forma basis, which normalizes year-over-year comparisons for both companies, Unity’s revenue was flat last year. However, its adjusted EBITDA margin improved as it laid off thousands of employees, closed its lower-margin Weta Digital business and trimmed other expenses.
Metric |
Q1 2023 |
Q2 2023 |
Q3 2023 |
Q4 2023 |
Q1 2024 |
---|---|---|---|---|---|
Sales growth* (Annual) |
(2%) |
11% |
8% |
(2%) |
(8%) |
Adjusted EBITDA margin |
6% |
19% |
24% |
30% |
17% |
Data source: Unity Software. YOY = Year-on-Year. *Pro forma basis in 2023.
But for the full year, analysts still expect Unity’s revenue to fall 16% to $1.84 billion, while adjusted EBITDA will fall 8% to $413 million. Unity declined to provide an exact topline forecast, but says its “strategic portfolio” of game engine, cloud and monetization products can still generate 2%-4% revenue growth for the year.
Unity still has a dark future
Unity made some questionable business decisions as its expansion slowed. First, its merger with ironSource was controversial for three reasons: It came just after the company had laid off its own staff, it diluted its existing investors with a $4.4 billion all-stock deal, and the ad tech company had previously been accused of malware problems.
Last year, Unity unexpectedly introduced new ‘runtime fees’ that would be charged every time a game was installed after a developer exceeded certain revenue levels. The backlash from developers was so intense, however, that the company hastily walked back most of those fees. CEO John Riccitiello resigned a month after that brand-sullying fiasco.
Unity’s new CEO Matt Bromberg is trying to reset his company by trimming his workforce, expanding his strategic portfolio and shrinking his nonstrategic segments. But those cost-cutting strategies could shrink his moat against Epic Games’ Unreal Engine and other game development platforms, and analysts don’t expect the company to come close to breaking even under generally accepted accounting principles (GAAP) for several years.
It is not the right stock to buy now
I bought some Unity stock in early 2022, but sold that stake at a loss last February because it wasn’t the same company I originally invested in. The stock may seem cheap, but the company is facing too many macro and competitive headwinds. Its strange corporate moves and abrupt management changes over the past year also suggest it’s struggling to find new ways to revive revenue growth. So for now, I’d stay away from Unity and invest in promising tech stocks instead.
Should You Invest $1,000 in Unity Software Now?
Before you buy shares in Unity Software, you should consider the following:
The Motley Fool Stock Advisor team of analysts has just identified what they think is the 10 best stocks for investors to buy now… and Unity Software wasn’t one of them. The 10 stocks that made the cut could deliver monster returns in the years to come.
Think about when Nvidia made this list on April 15, 2005… if you had $1,000 invested at the time of our recommendation, you would have $751,670!*
Stock Advisor offers investors an easy-to-follow blueprint for success, including portfolio building guidance, regular analyst updates, and two new stock picks each month. The Stock Advisor has service more than quadrupled the return of the S&P 500 since 2002*.
View the 10 stocks »
*Stock Advisor returns as of July 2, 2024
Leo Sun has positions in Apple. The Motley Fool has positions in and recommends Apple and Unity Software. The Motley Fool has a disclosure policy.