Unity Software: After Another Smackdown On Earnings, Time To Speculate
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Summary:
- Unity Software Inc.’s total revenue decreased by 8% from last year, but exceeded estimates by $26.9 million.
- The company’s core strategic portfolio showed a 2% increase, driven by growth in subscriptions and partnerships.
- Unity Software’s guidance for Q2 fell below consensus, but adjusted EBITDA is a reason to be positive.
- A speculative bet on a return to growth following this transition.
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We previously traded Unity Software Inc. (NYSE:U) during its heyday a few years ago, before rates started rising, and unprofitable or barely profitable, revenue growth tech type companies fell out of favor. With today’s decline following just reported Q1 earnings, we see operations shifting focus, and think the revenue declines are temporary. However, the company and management must execute. We view Unity Software stock as a speculative buy here for a turnaround. The chart is broken, and the fundamentals are mixed, but we like to consider betting on companies like this for a tradable turnaround. Let us discuss the just reported earnings.
Unity Software revenues fall, but portfolio focus is shifting
In the just-reported quarter, total company revenue reached $460.4 million, reflecting an 8% year-over-year decrease. A decrease was, of course, expected due to portfolio adjustments that were being made. It is worth noting that this result was a pretty sizable revenue beat, surpassing estimates by $26.9 million. That is a strong result. However, the so-called strategic portfolio, which represents Unity’s core business focus, showed a 2% year-over-year increase to $426 million, exceeding initial guidance from management of $415-$420 million. This is good news.
Now within the so-called core strategic portfolio, the Create Solutions line drove revenue through increased subscriptions and partnerships. Create solution saw a notable 17% year-over-year growth to $133 million. Core subscriptions, excluding China, also grew by 13%, which we see as positive. However, the Grow Solutions line, which is focused on monetization through the company’s mediation platform and ad networks, saw declines. In fact, sales were down 4% year-over-year to $294 million. This is a focus of improvement for management moving forward.
With the decline in the stock, the Street is not convinced. These lines will be of focus moving forward, and the non-strategic business lines saw revenues drop 59% to $34 million, so well less than 10% of total revenue here. You can expect further declines here as this part of the business is wound down.
Unity Software moving toward consistent profits, EBITDA is up
Keep in mind that Unity was long a money loser, like many other up-and-coming tech names. However, in 2023, the company started to turn a profit consistently, and it is odd to see the stock give back more and more as earnings go up. In Q1, there was a GAAP net loss of $291 million. Adjusted losses were $141 million, which was much better than the previous year’s $254 million net loss. Adjusted EBITDA hit $79 million, a solid improvement of $50 million year-over-year. This is noteworthy, and positive.
Unity Software guidance left something to be desired
The quarter itself was quite strong, but the guidance was softer than expected for Q2. In outlining both revenue expectations and strategic priorities for Q2 and the year, the sales expectations were below consensus. This is why the stock is down again, but we think at these levels, it is one to consider speculating in for a trade.
For Q2, Unity anticipates revenue for the so-called strategic portfolio to fall within the range of $420 million to $425 million, which would be a year-over-year decline of 6% to 7%. This was below the consensus of $443 million. Adjusted EBITDA, however, was respectable and should be between $75 million and $80 million as a whole. For the year, Unity reaffirmed its full-year revenue guidance for the strategic portfolio of $1.76 billion to $1.80 billion. That would be a 2-4% increase, but was also slightly below consensus. What we like is Adjusted EBITDA of $400-$425 million for the year, with EBITDA margin of 25%.
Looking ahead
Unity helps developers and improves the gaming experience in many ways, and there is an opportunity for growth. Presently, the company is in a transition as it winds down its non-strategic business and focuses on the strategic portfolio. We will be looking for revenue growth within the Create segment to outpace expectations. More game subscriptions and more multiplayer game development are possible catalysts here.
Additionally, in the shareholder letter management cited ongoing progress in LiveOps, which is a suite of services facilitating ongoing engagement with game players, and collaboration tools catering to development teams. Growth within the Grow segment will come from further product enhancements.
In the letter, management highlighted the importance of “rich data utilization,” so expect them to leverage data more effectively to refine their advertising models and deliver a stronger return on ad spend.
Take home
Shares have been crushed. At an all-time low here under $22, the valuation has reset. This is also because growth has declined, but profitability power is up. On an adjusted basis, EPS looks to come in somewhere in the $0.55 to $0.95 for the year. That means we are trading at less than 30X FWD earnings for a once exciting growth tech company that is going through a transition.
We think this is a good price to speculate on Unity Software Inc., regardless of the chart. However, it is speculation, as it is a bet that management can execute on its transition and return to much more meaningful growth.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in U over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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