Unity

The 1 AR/VR Stock I’m Investing In Right Now

With the AR and VR market set to expand at a 46% CAGR in the next five years, Unity is the one stock I’m buying to benefit from this trend.

Unity Software Inc. (NYSE: U) is a cross-platform game engine that operates as a development platform and facilitates video games’ creation, operation, and monetization in 190 countries. The company was founded in Denmark in 2004 and has a mission to “enable more people to be creators”. Despite a volatile ride since going public in September 2020, these are the reasons I am buying Unity today. 

A look at Unity’s financials:

Unity’s two key revenue generators are its Create and Operate solutions. Create solutions enables developers to develop real-time 2D and 3D games and applications, while Operate allows developers to grow and monetize users. 

In Q1 2021, Unity reported revenue growth of 41% year-over-year (YoY), which exceeded expectations and has high gross margins of 75%. The company also has a strong balance sheet with cash and cash equivalents of roughly $1.1 billion and no long-term debt. Management also raised its full-year guidance to between $1billion and $1.015 billion, which would equate to roughly 29%-31% growth along with previously guiding for 30% revenue growth over the long term. 

What I like about Unity: 

Unity is the leading platform for creating interactive real-time 3D content for apps and games and has approximately 2.7 billion monthly active users. Management believes that it is “inevitable” that developers will continue to shift to 3D content. Being a leader in this space will allow it to tap into the growing augmented reality (AR) and virtual reality (VR) markets and provide the tools for developing the ‘metaverse’. It estimates that its total addressable market is currently in the region of $29 billion across gaming and other industries, increasing significantly over the coming years as it benefits from secular tailwinds. 

Due to its business model operating as a development platform, it is also not reliant on hit releases. However, it still benefits from popular games built on its platform, such as the AR game ‘Pokémon Go’. Unity estimates that upwards of 50% of mobile and PC games are made using its platform, and in 2020, 94 of the top 100 game development studios by revenue were on the platform. 

Unity also has optionality outside of what has historically been its core gaming market. It is has expanded into architecture, construction, film, and more, and is being used by Fortune and Global 500 companies such as Disney, Toyota, and others. Earlier this year, it also acquired VisualLive, an AR construction platform for engineering and architecture, which will complement its existing offerings and partnership with Autodesk.

Unity also continues to expand its customer base across a wide range of industries and saw new customers in areas such as household appliances and healthcare. The number of customers generating more than $100,000 of revenue increased to 837 compared to 668 a year prior. Its dollar-based net expansion rate also expanded to 140%, demonstrating the stickiness of its platform. 

Risks to Unity’s share price:

Unity is operating at a loss which expanded from $166 million to $234.7 million in 2021. The company has a history of net losses, which may be a cause for concern. It is also trading at a rich valuation of almost 37x price to sales which will require management to continue to execute. 

Another headwind that Unity is facing is related to Apple IDFA, which was implemented in the last quarter. Management had previously stated that this would cause a 3% hit to revenue for the year. 

Unity’s Create solutions faces competition from other companies such as the Unreal Engine developed by Epic Games, which created ‘Fortnite’, or in-house game development studios. Its Operate solution generates the majority of its revenue and operates in a more fragmented category. It competes against other public and private companies such as Amazon, Google, and Facebook. However, it is essential to note that most of its listed competitors are also its customers. 

Unity’s growth potential: 

Unity is well-positioned to benefit from secular tailwinds in the coming years as a leading platform in the development of real-time 3D content and should prosper with the continued development of AR and VR. Importantly, it also has optionality outside of gaming, which will allow the business to grow. The stock is also trading significantly below its all-time high, which could provide investors with a good opportunity to invest despite the lofty valuation.

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