Is Unity Software Stock a Buy Now? – The Motley Fool

Unity Software‘s (U 7.78%) stock price surged 10% on Aug. 10 after the video game engine developer posted its second-quarter report. Its revenue rose 9% year over year to $297 million, missing analysts’ estimates by $2 million. Its adjusted net loss widened from $1.3 million to $53.1 million, or $0.18 per share, but still cleared Wall Street’s expectations by $0.03.

Unity expects its revenue to rise 10%-17% year over year in the third quarter, missing analysts’ expectations for 21% growth. For the full year, it expects its revenue to increase 18%-23%, compared to its prior outlook for 23%-30% growth and the consensus forecast for 24% growth.

A person plays a smartphone game at home.

Image source: Getty Images.

Those headline numbers were weak, but they indicated Unity was still growing year over year. Unity also reaffirmed its plans to acquire ironSource (IS -5.20%) to stabilize its advertising business. That announcement indicates Unity will likely reject AppLovin‘s (APP 5.40%) unsolicited bid for a merger, which is contingent on Unity walking away from ironSource. So, is Unity’s stock finally safe to buy after plummeting more than 70% from its all-time high last November?

What were Unity’s biggest problems?

Last year, Unity generated 30% of its revenue from its Create Solutions business, which houses its eponymous game development engine. Another 64% came from its Operate Solutions business, which provides additional multiplayer, monetization, and advertising features for developers. The rest of its revenue came from its Strategic Partnerships and Other division. The Create Solutions segment continues to grow like a weed, but the growth of its Operate Solutions business hit a brick wall this year.

Period

2020

2021

Q1 2022

Q2 2022

Create Solutions Revenue Growth (YOY)

37%

41%

65%

66%

Operate Solutions Revenue Growth (YOY)

61%

51%

26%

(13%)

Strategic Partnerships and Other Revenue Growth (YOY)

(12%)

7%

11%

(2%)

Total Revenue Growth (YOY)

43%

44%

36%

9%

Data source: Unity. Chart by author. YOY = year over year.

That slowdown was caused by problems with Unity Ads’ algorithms, which started ingesting “bad data from a large customer” in the first quarter. That setback, likely caused by Apple‘s privacy update on iOS, forced Unity to rebuild its entire advertising algorithm and reduce its estimates for the year. The weakness of the broader advertising market exacerbated that pain.

Unity subsequently laid off some of its artificial intelligence (AI) and software engineers and agreed to buy ironSource — an Israeli ad tech company with a controversial past — to strengthen Unity Ads. That planned acquisition caught the attention of ironSource’s rival AppLovin, which offered to merge with Unity instead. Unity CEO John Riccitiello refused to comment on AppLovin’s offer during the conference call. However, investor relations chief Richard Davis said the ironSource deal was still on track to close by the fourth quarter.

As for Unity Ads, Operate Solutions chief Ingrid Lestiyo said the platform had successfully “removed the bad data that was inadvertently ingested from interacting with any of our models.” Lestiyo also said it had “fortified” its monitoring and machine learning observability capabilities to mitigate these “rare types of events” in the future and that its acquisition of ironSource would enable it to “leapfrog” its own road map and accelerate its long-term growth.

Brighter days could be ahead

Unity’s guidance suggests the storm has passed. In addition to its midpoint target of 14% year-over-year revenue growth in the third quarter, CFO Luis Visoso expects its revenue growth to “accelerate to 21%” in the fourth quarter as the Operate Solutions business recovers.

Unlike previous quarters, Unity didn’t reiterate its long-term target for more than 30% revenue growth. However, it reiterated its target of achieving profitability on a non-GAAP (generally accepted accounting principles) basis by the fourth quarter of 2022. Its planned spin-off of its Chinese business into a new joint venture — in which it will retain a majority stake — could also help it achieve that goal by reducing its operating expenses.

It could finally be time to buy Unity again

The first half of 2022 was challenging for Unity, and it was tough to recommend the stock as the storm clouds gathered over Unity Ads. However, Unity has finally cleared the air with its second-quarter report — and its guidance suggests that its business will stabilize by the end of the year.

Unity’s stock still isn’t cheap at 13 times this year’s sales, but I believe it’s finally worth nibbling on again. Its stock will remain volatile for the foreseeable future, but it could head higher over the long term as its core game engine continues to grow, it rolls into more non-gaming markets (like AR, virtual reality, and movies), and it expands its toolkit of advertising and monetization tools for developers.

Leo Sun has positions in Apple and Unity Software Inc. The Motley Fool has positions in and recommends Apple and Unity Software Inc. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.

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