Unity Vs. Roblox: One Winner And One Loser

Summary:

• Apple’s Vision Pro headset is expected to drive customer adoption of VR/AR technology, benefiting companies like Unity and Roblox.
• Unity’s shares have risen 37% since June 2nd, while Roblox’s shares increased by only 4% in the same period, possibly due to differences in their business models and future growth prospects.
• Valuations are similar but one company has far superior prospects for growth.

Introduction

The announcement of the Apple (AAPL) Vision Pro headset will help usher in a new era of computing, moving us from a world of 2D applications to 3D… At least that’s my view.

While Apple is not the first company to launch a VR headset, just as they were not the first to launch a smartphone, if history is any guide (as it was with the iPhone) the Apple Vision Pro will set the benchmark for VR/AR and drive customer adoption of the new technology. Sorry Meta (META).

The launch price of $3,500 likely gave sticker shock to many, it’s best not to give the price alone all too much weight. Over time, it’s reasonable to expect the price to come down as Apple moves to take market share, perhaps through the launch of a separate, lower spec, “standard” non-Pro line.

At the $3.5k price point, most people won’t be able to experience the first generation of Apple’s Vision Pro, but that’s not important for now.

Prior to Apple’s announcement, VR likely felt to many like a niche product made strictly for gamers. Maybe it conjured memories of Meta’s Mii-esque social media online world, “Horizons” where people can hang out in a digital environment and socialize with other strangers online and play small mini games.

Where Apple Vision Pro differs is its target market, based on the announcement trailer this is not a gaming-first machine. While it can play games, its other features, like an ultra high definition display, eye tracking cameras, and external facing display make it useful for so much more than just gaming.

The Apple Vision Pro may one day replace laptops as we know them, as well as TV screens. After all, who needs a TV when the Apple Vision Pro can make you feel as if you are looking at a jumbo movie theater-style screen?

Beyond Apple, there are many other companies who are likely to be impacted by this technology. Despite the many non-gaming applications of Apple Vision Pro, the two companies I’d like to highlight today are Unity (NYSE:U) and Roblox (NYSE:RBLX).

Some Context

Before I dive deeper into these companies, let me first set the stage with some context.

Both Unity and Roblox hit the public markets during the euphoric 2020-2021 time period when tech stocks were roaring, capitalizing on strong investor appetite as interest rates plunged close to zero.

As a result, they were able to come to the market with robust valuations (great for raising capital) but were subsequently punished when rates began to rise.

As you are probably aware, in November 2021 the market flipped, almost as if by a switch, and the stock prices of high growth, low/no profit companies like Unity and Roblox took an absolute beating. From their 2021 highs, both companies fell 80-90% as investors threw out these out-of-style stocks in favor of companies with a stronger track record of profitability.

Of course, hindsight is 20/20, and looking back the valuations of these companies were rich, but given the long-term trend of declining interest rates a person back then could be forgiven for making an argument that the only thing that truly mattered was future earnings, no matter how far out they were projected.

Obviously, things changed, and that thesis did not pan out. The unprecedented stimulus, shocks to the global supply chain, and volatility of commodities resulted in some of the worst inflation many of us have ever experienced.

And with that, the Federal Reserve, and other monetary authorities, reacted by increasing interest rates. For example, in the US, the benchmark rate was increased from roughly 0% to over 5% in just a few months. That rapid increase devastated high growth stocks.

Just take a look at the infamous ARK Innovation ETF (ARKK).

The Next Chapter?

While the jury is still out on where inflation will go from here, and if the Fed has been able to put that genie back in the bottle, during the last FOMC meeting, the Fed did not increase rates, perhaps indicating we may be near the end of the rate hiking cycle.

This is where things start to get good, roughly at the same time the Fed chose to slow its rate hikes, Apple chose to announce its Vision Pro headset.

For Unity, these events couldn’t have been lined up any better, its shares skyrocketed up 37% since June 2nd (the Friday of the week prior to the announcement). While lower rates are positive for Roblox too, they reacted notably less positively as shares only increased by ~4% in the same time period.

So what gives, why was Roblox left in the dust?

Well, I do have a theory why… but before I get to that, let’s take a look at the financial performance of these companies, so we can understand why I am comparing the two.

I want to highlight two metrics, in particular, revenue growth and EBITDA margin.

Revenue Growth

First let’s talk about their revenue growth, up until 2022, Unity had consistently grown their revenues in the 40%+ range and Roblox had been growing even faster (upwards of 80%).

In 2022 a number of things happened, as I already mentioned the rate hiking regime was in full force, but there were other impactful events beyond just the rate cycle.

Impacting both Unity and Roblox was the end, or winding down, of Covid era restrictions which had been a tailwind for video game makers worldwide. More time at home, simply meant more time to play video games, the inverse also proved to be true.

For Unity specifically, 2022 marked a rapid slowdown of advertisement spending that was only exacerbated by the challenges they had with their own advertisement model.

So Unity was hit with a triple whammy in 2022, reduced ad spend globally, losing ad share to competitors, and reduced time spent gaming (less consumers to see ads, and slowed game development).

For Roblox, the story is a bit more straightforward in my view: as children went back into the classroom they spent less time playing online and purchasing Roblox’s online currency.

EBITDA Margin

From a profitability perspective both companies are unique, throughout 2022 Roblox had much better margins than Unity, albeit still negative.

From my perspective, this just comes down to a fundamentally different business model. Roblox relies on its customers to make elaborate mini-games within its own video game whereby they can sell access to other users for a fee using the in-game currency, Roblox then takes a cut. You can think of this model as being similar to Apple’s app store model.

Unity on the other hand makes far more elaborate software made for people who want to build a game from the ground up, not just create a mini-game within a video game.

There are tradeoffs here, for one, Unity’s model may be a bit more difficult to monetize, as the game development cycles for Unity games take much longer than most Roblox games. Additionally, many of Unity’s games are built for the mobile phone and rely on advertisement spend, which can often be quite fickle.

The different approach to monetization has resulted in different margin profiles, as ad spend slowed Unity was hit almost immediately, whereas Roblox was hit when demand slowed for its core game offering.

Valuation

To briefly touch on valuation in terms of price to forward sales, both companies trade at around the same level, 7.5x. Similarly, the forward sales looking out one year are similar at 6.3-6.5x, with Unity trading at the lower valuation. These levels are relatively in line with where they were last year, despite an improving macroeconomic outlook and potentially increased demand driven from new apps being built for Apple Vision Pro using Unity.

Conclusion

So why was Roblox left in the dust following the Apple Vision announcement?

It all has to do with the future.

You see, in the past, Unity’s revenue growth stalled out due to problems with its advertisement model and slowing ad spend across the board. These temporary challenges crushed revenue, earnings, and the stock price.

On the other hand, I believe Roblox’s revenue growth is slowing as the underlying demand for its game is showing signs of stalling.

Further supporting Unity, going forward, many are expecting ad spend to reaccelerate, though not many are expecting a new pandemic which could boost demand for Roblox in a similar fashion to 2020 and 2021.

In short, the Apple Vision Pro should be great for gaming in general, though it may not be as great for Roblox. Unity has positioned itself as the number one seller of picks and shovels for the VR gold rush, whereas Roblox is just one chunk of gold that is starting to lose its shine in my opinion.

I rate Unity a Buy and Roblox a Sell.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of U either through stock ownership, options, or other derivatives. 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.

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