Is Unity Software's Growth Slowdown a Permanent Problem?

Is Unity Software’s Growth Slowdown a Permanent Problem?

Unity stock is out of favor and that could persist for a while, but the company isn’t in trouble.

The honeymoon phase between investors and Unity Software ( U -0.79%) is done and gone. After the first-quarter 2022 earnings update, shares have crashed over 80% from all-time highs and trade below where the stock made its debut in public trade in 2020. Q1 earnings were great, but revenue guidance for full-year 2022 was downgraded as much as $135 million compared to the outlook provided at the start of the year.

But is the slowdown in growth permanent? Unity doesn’t think so. In fact, excluding a one-time impact to sales primarily surrounding one particular product, management says its 3D creation platform is quite healthy and can sustain 30% annual growth for many years. Here’s why. Image source: Getty Images. Don’t blame Apple for this problem

To better understand the big decrease in Unity’s expected revenue, let’s break down the primary sales segments the software outfit reports. Unity Create provides all the tools developers need to build and manage a video game, or alternatively, the tools creators use in various design applications (construction, manufacturing, commerce, advanced simulation, etc.). Then there’s Unity Operate, a dashboard of various items that enable developers to monitor and monetize their creations (primarily via advertising). The final and smallest segment comes from “strategic partnerships and other” revenue. Unity Create $116 million 65% Unity Operate $184 million 26% Strategic Partnerships and Other $19.7 million 11% Total $320 million 36% Unity had been forecasting 36% sales growth for full-year 2022 but downgraded that to 22% to 28% growth. Revenue is now expected to be in a range of $1.35 billion to $1.425 billion, reduced by as much as $135 million at the low end compared to the prior outlook. The culprit is one specific segment: Unity Operate.

One product within Operate, Unity Monetization, was the issue. This helps game developers place ads within their games. As you may have heard, Apple ( AAPL 0.17%) has thrown a wrench in the gears of the online ad industry by cracking down on user activity tracking, with Meta Platforms ‘ Facebook, in particular, getting blasted. But Unity said Apple isn’t the cause of their Monetization blues.

According to CEO John Riccitiello on the earnings call, the issues can be summed up as follows: Following years of rapid growth and working through the challenges of Apple’s privacy changes, we got hit hard by two issues. The first was a fault in our platform that resulted in reduced accuracy for our Audience Pinpointer tool, a revenue-expensive issue given that our Pinpointer tool experienced significant growth post the [Apple] IDFA (Identifier for Advertisers) changes. The second is that we lost the value of a portion of our data — training data, due in part to us ingesting bad data from a large customer. OK, so Apple’s not to blame, but rather some internal issues causing a temporary pause in Unity Monetization’s pace of revenue realization. The good news is Riccitiello and company think this will be temporary. Most of the $100 million-plus revenue reduction will take place in the second and third quarters before getting back to where it was early in 2022. Unity says there should be no carryover impact in 2023. 30% is still reasonable

The short story is that Unity thinks at least 30% revenue growth is still a reasonable expectation, just not in 2022 as it works through its problems with ad monetization for its customers. Given the torrid pace of the Unity Create segment, I agree with this renewed call for sustained long-term expansion. Of course, if Unity does get back to 30% growth in 2023, it will be growing off of a smaller revenue base than previously expected ($1.35 billion to $1.425 billion, versus the prior guidance of $1.485 billion to $1.505 billion) — unless of course, it sees more rapid acceleration in the Monetization product next year.

Nevertheless, the temporary drop in sales and how that will impact Unity’s longer-term trajectory is now priced in after another steep drop in share price after the Q1 update. The stock currently trades for just under eight times enterprise value to current year expected sales . I still believe in Unity’s long-term potential, so will likely add some more shares to my position in the coming weeks. Should you invest $1,000 in Unity Software Inc. right now?

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