Unity Software: Bizarre Outlook

Summary:

• Unity Software Inc.’s Q2 revenues fell 16% year-over-year, but beat estimates by $7.5 million.
• Core strategic portfolio revenue increased by 6% year-over-year to $426 million, exceeding initial guidance.
• Adjusted EBITDA for Q2 rose to $113 million, beating guidance and showing improvement.
• A guidance change was a head scratcher, but stocks tend to bottom on bad news.

We previously traded Unity Software Inc. (NYSE:U) a few years ago, before rates started rising. When rates started rising, many unprofitable or barely profitable, revenue growth tech type companies fell out of favor in a bad way. A few months ago, we labeled Unity a speculative buy after it got beaten down following Q1 earnings. However, shares have continued to face pressure. We continue to assert that the revenue declines are temporary, but it is now a “show me” story. The just reported Q2 earnings were mixed, and in this column we check back in on performance.

Unity Software revenues fall again, but better than expected

In the just-reported quarter, total company revenue was $449.3 million, reflecting a 16% year-over-year decline. A decrease was, of course, once again expected due to portfolio adjustments that have been made. It is worth noting that this result was a beat, surpassing estimates by $7.5 million. That is a strong result. However, the so-called strategic portfolio, which represents Unity’s core business focus, showed a 6% year-over-year increase to $426 million, exceeding initial guidance from management of $420-$425 million. This is good news, and was flat from the sequential Q1.

Now within the so-called core strategic portfolio, the Create Solutions line drove revenue through increased subscriptions and partnerships. Create Solutions saw 4% year-over-year growth to $129 million, but this was down 2% from the sequential Q1’s $133 million. Core subscriptions also grew by 14%, which we see as positive, and the company is benefiting from price increases and higher level subscriptions being chosen by customers. 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 9% year-over-year to $296 million. This is a focus of improvement for management moving forward, but we do note that this was a small increase from $294 million in Q1.

These lines will be of focus moving forward, and the non-strategic business lines saw revenues drop 71% to $23 million, so just 5% 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 revenue growth type tech companies. So much has changed, including revenue declines, and the major portfolio shifts. 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 Q2, there was a GAAP net loss of $126 million, much improved from the loss of $193 million a year ago. Adjusted EBITDA hit $113 million, rising from $88 million a year ago, and rising from $79 million in the sequential quarter, a solid improvement of $50 million year-over-year. This blew away guidance for $75 to $80 million, and a reason why shares are in rally mode today.

Forward view

The quarter itself was strong, with better gross and operating margins, but the guidance was somewhat mixed. For Q3, management sees revenue for the strategic portfolio to $415 to $420 million, down 4% to 6% year-over-year, and down from the strong Q2 print. Once again, management guided the same adjusted EBITDA levels of $75 to $80 million for the total company.

Now, here is where there is some confusion. While EBITDA and revenues were strong for Q2, the company reduced its full-year revenue outlook. Guidance for the strategic portfolio is now $1.68 to $1.69 billion compared to $1.76 to $1.80 billion previously, or a decrease of 2% to 3% year-over-year. Why? Management is getting cautious, and today’s rally is a bit of a surprise, as the recovery in the Grow Solutions business is in question. However, the company is making significant investments in product enhancements, and these will take some time to generate returns.

Now, the company also reduced its outlook for EBITDA, despite the huge Q2 print. They now see $340 to $350 million, compared to $400 to $425 million in the previous guidance. And all this time, the current shareholder base is being diluted, though a small silver lining is that the dilution is projected to be lower than expected. The company expects 488 million fully diluted shares at the end of H2, which is a reduction from the prior view of 492 million. All told, this is a 2% dilution from 2023.

Looking ahead

Unity helps developers and improves the gaming experience in many ways, and there is an opportunity for growth. The company remains in the midst of a transition. Shares have been crushed. With today’s Unity Software Inc. rally despite a guidance reduction, one could argue that a bottom may be starting to form. While the quarter was mixed, the guidance revision was painful. However, stocks tend to bottom on bad news, and we would argue the guidance was bad news, yet we are in rally mode. We believe this remains a speculative buy.

---

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within 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.

---

We make winners. Come make money with us

Like our thought process? Stop wasting time and join the traders at BAD BEAT Investing at a 60% off sale annually!

Our hedge fund analysts are available all day during market hours to answer questions, and help you learn and grow. Learn how to best position yourself to catch rapid-return trades, while finding deep value for the long-term.

• Available all day during market hours with a vibrant chat.
• Rapid-return trade ideas each week from our hedge fund analysts
• Crystal clear entries, profit taking, and stop levels
• Deep value situations
• Stocks, options, trades, dividends and one-on-one attention