Why Could the ironSource Acquisition Change the Outlook for Unity Software Stock?

TL;DR

ironSource is the company Unity acquired mainly to address problems in its Operate Solutions division, bringing capabilities in publishing, user acquisition, monetization and ads. Unity’s revenue rose 13% in the third quarter, but Operate recorded zero percent growth through the first nine months, adjusted operating income was negative $35 million, and free cash flow fell to negative $81 million. Read on for the investor’s two main warning signs.

Transcript

I like to think of myself as a long-term investor and when 2022 started there were few companies I was as excited about as I was about Unity software the company makes the platform where games and and new tools in the metaverse can be created and it helps people monetize them there was a lot to like about it and yet quarter after quarter the compan... Read More

Key Insights

• ➗ Unity Software's operate solutions division has struggled with zero percent growth, prompting the company's acquisition of iron Source to address these challenges.
• 👷 The broader adoption of Unity's create tools outside of gaming, such as in sectors like entertainment and construction, presents significant growth opportunities.
• ✋ Concerns regarding Unity's high level of stock-based compensation, particularly during a period of underperformance, have raised questions about its management practices.
• 🖤 The company's lack of transparency and failure to disclose iron Source's financial performance contribute to investor unease and uncertainty.
• 🤩 Unity's focus on improving monetization and addressing operational issues will be key to restoring investor confidence.
• 😮 The decline in Unity's cost per impression due to cautious advertisers highlights the impact of rising interest rates on its business.
• 😀 The company's financials, including negative operating income and declining net margins, indicate the challenges it faces in achieving profitability.

Questions & Answers

Q: What is ironSource, and why did Unity acquire it?

ironSource provides capabilities related to publishing, user acquisition, monetization and ads. Unity acquired the company mainly to address serious problems in its Operate Solutions division, which monetizes games built on Unity’s platform.

Q: How could ironSource affect Unity stock?

The acquisition could help Unity repair its struggling Operate business and improve monetization. However, the investor remains uncertain because Unity first appeared to believe it could solve the problems internally before turning to ironSource.

Q: How did Unity Software perform in the third quarter?

Revenue increased 13%, slightly ahead of Wall Street’s estimates and within management’s guidance. Non-GAAP loss per share was 14 cents, while adjusted operating income was negative $35 million.

Q: Why was Unity’s Operate Solutions division struggling?

Operate Solutions recorded zero percent growth through the first nine months after previously growing 57% per year over four years. Management also said mobile cost per impression was declining because rising interest rates made advertisers cautious about aggressive campaigns.

Q: What explanation does the investor give for Unity’s monetization problems?

The investor speculates that Unity believed it had a workaround for Apple’s privacy changes, but later discovered it was not working. Unity then discussed bad data in Operate, attempted to clean and reprocess it, and subsequently pursued ironSource, though the investor explicitly says this interpretation may be wrong.

Q: What was driving growth in Unity’s Create Solutions business?

Create Solutions was growing at a 60% annualized rate during the first nine months. The transcript attributes part of that growth to adoption outside gaming, citing HBO Max, Tilbury Douglas and Orlando as users of Unity tools.

Q: What financial trends worried the Unity shareholder?

Adjusted gross margins declined but remained healthy, while adjusted operating and net margins fell further. Free cash flow changed from positive $34 million to negative $81 million, and the balance sheet moved to a net neutral cash position.

Q: Why was Unity’s stock-based compensation a major concern?

Stock-based compensation equaled 40% of revenue during the first nine months and about half of revenue in the latest quarter. The investor considered that level excessive because it coincided with poor company performance.

Summary & Key Takeaways

• Unity Software reported third-quarter results with a 13% increase in revenue, slightly surpassing expectations. However, operating income remains negative, and the company's cost per impression has declined due to advertiser caution amid rising interest rates.

• The acquisition of iron Source indicates Unity's focus on improving its operate solutions division, which experienced flat growth this year. The use of Unity's create tools outside of gaming, such as in entertainment and construction, offers promising growth opportunities.

• Concerns arise regarding Unity's high level of stock-based compensation, which accounts for a significant portion of revenue, especially in a period of underperformance. The company's opaque approach to reporting and lack of clarity on the impact of the iron Source merger further exacerbates investor uncertainty.