Part 2: Deep dive on Unity Software ($U)
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Company: Unity Software
Ticker: (U)
Website: Unity.com
IPO date: September 18, 2020 (traditional IPO)
IPO price: $52
Current stock price: $36.32
Outstanding shares: 378.6 million
52 week high: $58.62 on August 12, 2022
52 week low: $21.22 on November 09, 2022
ATH: $210.00 on November 18, 2021
Market cap: $13.750 billion
Net cash/debt: -$1.500 billion
Enterprise value: $15.250 billion
Headquarters: San Francisco, California, United States
Number of employees: 7,700+
Average price target from analysts: $39.29 based on 14 analysts
Next earnings call (Q2 2023): N/A
Investor Relations [click here]
Q1 2023 Earnings Report [click here]
Q1 2023 Earnings Call Transcript [click here]
Outline
Introduction [part 1]
Company Background [part 1]
Opportunity [part 1]
Business Model [part 1]
Competitive Advantages [part 1]
Risks [part 1]
Valuation [part 2]
Investment Model [part 2]
Analysts [part 2]
Technicals [part 2]
Conclusion [part 2]
Additional Sources [part 1 & 2]
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Introduction #2
For the past few days I’m been thinking about Unity and what the Apple announcement on Monday regarding VisionPro means for Unity and their platform, to be honest I’m still not sure. I was hoping some of the 14+ analysts that cover the company would come up with some commentary, raise their estimates and increase their price targets but that didn’t happen. According to TheFly.com (where I get my analyst commentary & changes), the only analyst that put out a note this week was Piper Sandler who remains bullish, says the Vision Pro is another catalyst for U and he reaffirmed this $43 price target. I’ll put the full note in the “Analysts” section below.
Personally I think the Vision Pro has the potential to be a game changer for Unity especially after buying IronSource.
Just a reminder that Unity acquired IronSource at the end of 2022 which is why Unity’s 2023 revenue growth looks so impressive. You can read about the deal [here]
Just to be clear, I was going to send out the Unity writeup this week but I was planning on starting a position until we got the news on Monday at the Apple event. That changed everything for me including my longer term investment thesis, my financial forecasts and what the think the upside might be for the stock price. If U pulled back I’d be willing to increase my position from 2.4% (current) up to 4.0%
We already know there are 2+ billion active iOS devices in the world however many households have 2+ devices (phone, iPad, MacBook, etc) so it’s hard to know exactly what the household number is that might buy a Vision Pro but I’ll guess 1 billion. Assuming Vision Pro comes out in 2024, I think at least 4-5 out of 1,000 iOS device households will buy a Vision Pro. Using 1 billion households this would equate to 4.5 million Vision Pros per year — this might even be conservative especially if the price comes down. Once Apple starts selling a leaned down version for $1500-$2000 then they’ll probably sell 10+ million per year. These are the kinds of numbers that will get developers excited to build/monetize new apps/products for Vision Pro and many of those developers will need to use Unity’s suite of products/services.
As I mentioned in part 1 of the writeup, I think this news about Vision Pro gives Unity a shot at beating the current estimates by a wide margin however there’s still alot of unanswered questions with any new product so much of this is wait and see. For instance I think it’s easier to forecast revenues and earnings for a company like CrowdStrike, Shopify or Meta compared to a Unity given this Apple news. So what I’m going to do investment model section is provide two forecasts using current estimates and then my “more bullish” estimates.
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Valuation
I’m going to be using Non-GAAP numbers in this section but let’s be clear, in terms of GAAP numbers, Unity is still unprofitable and will be for another few years but the non-GAAP and FCF numbers look very decent.
I’m going to use the enterprise value from part 1 of this writeup which was $15.25 billion when the stock was $36.32 which is almost exactly where it closed today ($36.28)
Based on the $15.25B EV, Unity is now trading at…
7.1x 2023 EV/REVS and 5.9x 2024 EV/EBITDA
56.7x 2023 EV/EBITDA and 25.8x 2024 EV/EBITDA
85.1x 2023 EV/NI and 37.9x 2024 EV/NI
132.9x 2023 EV/FCF and 45.5x 2024 EV/FCF
Using non-GAAP numbers, U looks pretty good especially the 2024 numbers considering triple digit growth rates for EBITDA, net income (NI) and free cash flow (FCF). Not to mention with the announcement of Apple Vision Pro, I think these 2024 estimates will end up being low which means the real multiples are actually lower and the stock is even cheaper than it looks right now.
Just doing some basic math, if U only does $636M in 2025, throw a 40x P/E on that and you have a $25B company not including cash. I have no idea what the analysts are forecasting a dip in net income margins (NIMs) for 2026 but seems strange and very unlikely. It’s more likely that NIMs will increase by 1-3% per year for the next 5-6 years — this is true for most young tech companies as they become profitable and increase operational efficiencies.
It’s good to look at current multiples but my investment models are still more valuation if you’re a longer term investor because it shows you what a stock might be worth in 3-5 years based on specific financials.
Investment Model
As promised, I provided two different investment models. The first one are my estimates through 2027 (which might still be too conservative) assuming Unity becomes a major beneficiary of the VisionPro and leverages their platform for developers as expected. In this scenario, if Unity hits $6B of revenues in 2027 with 24% NIMs, you could be looking at a $135 stock in 2016 which is 272% upside from the current price.
If you look at the second investment model, it’s based off the current consensus estimates which forecast $4.2B of revenues in 2027 with 23% NIMs however in this scenario I’m only getting a price target in 2026 of $68 which is only 88% upside form the current price. If I believed these were the likely numbers going forward then I would not own the stock because 88% over the next 3 years is good but not good enough for me plus it doesn’t leave me any room for mistakes versus a stock that is super undervalued and even if they miss my estimates by 5-10% there’s still plenty of upside.
Analysts
Overall the 14 analysts that cover Unity are definitely bullish but for whatever reason they are not very active in terms of updating their ratings and price targets. I’m still surprised we have not gotten more commentary this week from them regarding VisionPro — perhaps they are on vacation or perhaps they are waiting to speak with management or perhaps they’re just waiting until Q2 earnings to see what U management does with guidance and says on the earnings call. I’m definitely excited to hear their comments/thoughts — my concern is that U isn’t going to see a big uptick in revenues from VisionPro until later this year so management might sound more conservative and we won’t see a big guidance increase in which case the market might overreact and sell off the stock because investors are so damn short term focused.
If I scrolled back to late 2021 you’d see price targets in the $200 range which is just insane (in hindsight). That means investors were paying 50x NTM EV/SALES as you can see from this chart below, big difference compared to 6.5x or 7.0x EV/Sales at the current price.
Here’s what the analysts are saying:
June 6th: Piper Sandler says Apple's (AAPL) new spatial computer launch, Vision Pro, could help reinforce the longer-term Unity Software (U) vision and strategy to become a developer platform of choice for 3D applications. The firm sees support for Apple Vision Pro and other next-generation computing devices to be further proof-points on Unity's "differentiated platform." Besides Apple, Unity developer job openings at TikTok, Meta, Samsung, Snap, and Microsoft hint at broader appeal in augmented reality/virtual reality applications, the analyst tells investors in a research note. Piper keeps an Overweight rating on Unity with a $43 price target.
May 11th: Morgan Stanley analyst Matthew Cost raised the firm's price target on Unity to $28 from $27.50 and keeps an Equal Weight rating on the shares after the company reported "strong" Q1 results and gave guidance ahead of expectations. The firm raised its FY23 and FY24 revenue estimates by 1% each to reflect the modestly higher guidance for year, though it raised its FY23 margin targets "more meaningfully" given the strong Q1 EBITDA performance and Q2 guidance.
April 4th: Oppenheimer analyst Martin Yang notes Unity announced that Unity Industrial Collection, a collection of tools for industry customers, will be replaced by Unity Industry starting April 3, 2023. On the same day, Unity also announced Terms of Service changes for industry customers. New ToS requires industry customers making more than $1M per year to use Unity Industry to access Unity Editor. After a brief discussion with the company, the firm believes the latest announcement is consistent with management's strategy to raise prices to premium customers as Unity invests more and incorporates more products and services into its product bundles. Oppenheimer expects recent changes to lift incremental revenue and margin by Q4 2024. The firm has a Perform rating on the shares.
February 23rd: Piper Sandler raised the firm's price target on Unity to $43 from $33 and keeps an Overweight rating on the shares. Tight cost controls coupled with the ironSource merger helped swing the model to profitability for the first time during Q4, the analyst tells investors in a research note. The firm says Unity's 2023 outlook calling for 53% growth implies "not much has to go right" considering the $2.125B revenue mid-point appears achievable even if the standalone Unity business declines year-over-year.
February 23rd: DA Davidson analyst Franco Granda raised the firm's price target on Unity to $45 from $35 and keeps a Buy rating on the shares. The company's Q4 results were "solid", and it made up for a "disappointing" Q1 guide with a 20% EBITDA beat on the full year outlook, the analyst tells investors in a research note. The firm adds that Unity's accelerated path to profitability is "encouraging" despite top line softness, though it also expects the stock reaction to be muted due to the 30% rally year-to-date.
February 23rd: Oppenheimer analyst Martin Yang downgraded Unity to Perform from Outperform without a price target post the Q4 results. The company's fiscal 2023 revenue outlook fell short of estimates due to weaker in-game advertising market and macro factors, the analyst tells investors in a research note. While management's more conservative outlook further de-risks 2023 expectations, Unity's valuation multiple sufficiently accounted for updated revenue growth and margin profiles, the analyst tells investors in a research note. The firm wants to see more evidence of a mobile ad market recovery and Unity's expansion among nongaming enterprise customers before recommending the shares.
Technicals
In terms of technicals it’s been an interesting week for Unity, the announcement on Monday pushed the stock through the 200d sma and up to the 200d ema although it was unable to hold on. Now we’re getting a “high tight” flag while the moving averages catchup — basically bounced off the 5d ema today. I actually have Unity in both of my portfolios, in my trading portfolio I have a stop loss below the 5d ema with no stop loss in my investment portfolio because I’ll be adding on any pullbacks.
Since I’m now bullish on Unity for the next few years I honestly don’t care what the stock does in the short term, I’d be more than fine with a 10-15% pullback so I could average down into a bigger position. If the stock rips higher from here it will be harder for me to add.
If you’re an investor and like Unity for the next 3-5 years then you should probably be buying at these prices and average down on pullbacks.
If you’re an investor I think you can buy here but I’d rather wait for another pullback into the moving averages or wait for a breakout above the 200d ema at $37.40
Conclusion
Clearly the benefit from a revenue beat over the next few years has massive implications for Unity’s stock price. In reality none of us know what’s “already baked in” meaning we don’t really know if the market has already priced in the VisionPro announcement or is the market still in a “show me” mode which means Unity has a nice opportunity to beat estimates, raise guidance and get the stock ripping higher. We like to say the markets are efficient but that’s bullshit, there’s a million situations where the market is not efficient otherwise CELH would not be up 1,000% over the past few years. There are always misunderstood stocks and undervalued stocks, just have to look for them and come up with an investment thesis that lays out a scenario which the market has not priced in yet. I did this with ONON running earlier this week and I’ve done it many many times over the past few years with CELH, SWAV, UPST, CROX, SDGR, NU and dozens more. The goal is to find companies that can beat the current estimates because that’s what moves a stock higher. I love a good beat & raise quarter plus it forces the analysts to move up their estimates and price targets. However the most important part of beat & raise is bringing in the big institutional money because they’re the ones that can move a stock and they’re the ones that can support the stock on pullbacks. I’ll be paying attention to how many funds are adding Unity to their portfolios when we get the 13F’s at the end of Q2. If the big hedge funds are buying Unity then we know this story has legs.
I’m not sure how many of you follow my investment portfolio but I’m up 70% YTD and many of my biggest winners are stocks that I did deep dives on the past 12 months. In some of those cases I did a deep dive because I already owned the stock and wanted to write about it to explain to my subscribers why I was bullish but in some cases I started a position after doing a writeup which ended up giving me the conviction to start a position. I think this Unity writeup falls into the second group, hopefully I’ll end up being right but as you can probably tell if Unity is going to be a huge winner over the next few years (200% return or better) than it’s going to be because the VisionPro was a blockbuster success
I’ll also mention this… several people have already asked me if I think Apple would ever buy Unity. Personally I think it’s unlikely because that would cost Apple at least $20 billion and that’s not their style however it’s certainly possible and I would not be shocked if it did happen (would be good for AAPL and U shareholders). TBH, it makes a ton of sense but it’s just not part of Apple’s DNA to do be acquisitions.
Additional Sources
Management – https://unity.com/our-company#our-leadership
Board of Directors – https://unity.com/our-company#board-directors
Ownership – https://www.sec.gov/ix?doc=/Archives/edgar/data/0001810806/000181080623000037/unity-20230418.htm#ib5fd52273c00478bb2b940e23227c5d8_82 (page 36)
Key Metrics – https://www.sec.gov/Archives/edgar/data/1810806/000181080623000059/unity-20230331.htm#i8231058b7d3944318ea08e6e9b1a5fab_25 (page 17)
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Enjoy the rest of your week.
~Jonah
Disclaimer: The stocks mentioned in this newsletter are not intended to be construed as buy recommendations and should not be interpreted as investment advice. Many of the stocks mentioned in my newsletter have smaller market capitalizations and therefore can be more volatile and should be considered more risky. I encourage everyone to do their own research and due diligence before buying any stocks mentioned in my newsletters. Please manage your portfolio and position sizes in accordance with your own risk tolerance and investment objectives.