In its fourth-quarter report, Unity, a video game engine company, revealed a significant drop in its financial performance, which is likely to cause concern among investors. The company’s total revenue decreased by 25% compared to the previous year, with the Create Solutions segment experiencing a 47% decline. Even after excluding the impact of ending a deal with Wētā FX, the Create Solutions revenue still fell by 20%. Meanwhile, Unity’s advertising-focused Grow Solutions had a smaller revenue decrease of 5%.
The decline in revenue is largely attributed to Unity’s strategic shift in its business portfolio, involving business exits and streamlined operations. Despite these expectations, Unity surpassed analyst forecasts. However, the company’s first-quarter revenue guidance indicated a notable drop, failing to meet analyst predictions.
Despite the disappointing guidance, Unity’s stock experienced a notable surge on Thursday. It’s unclear if this increase will persist, but some elements within Unity’s performance suggest an emerging turnaround.
Unity recently eliminated its Runtime Fee, previously aimed at charging developers by game installs, replacing it with higher subscription pricing for major clients. Even with the increased rates, Unity has accelerated new deals and subscription renewals, leading to a 15% uptick in subscription revenue year over year in the fourth quarter, partly due to launching Unity 6.
Beyond gaming, Unity is expanding into other industries requiring advanced 3D visualization software. The company reported a 50% revenue increase within its industry segment, acquiring notable clients such as Toyota and RTX. Though the revenue from this sector remains undisclosed, entering the non-gaming market presents significant long-term growth potential.
In the advertising sector, Unity is intensively revamping its technology and enhancing its platform for customers. The company plans to transition its ad network to Unity Vector, an artificial intelligence (AI) platform, at the end of the first quarter. Vector utilizes self-learning AI models and data from across Unity’s operations to enhance ad performance and outcomes for advertisers.
Unity’s CEO, Matthew Bromberg, indicated that the benefits of the Vector platform would not immediately reflect in the company’s results, emphasizing a cautious outlook for the first quarter as the advertising business undergoes restructuring.
Despite the declining revenue and negative net income, Unity is managing to generate positive free cash flow. Stock-based compensation and the amortization of intangible assets from acquisitions mainly explain the disparity between earnings and cash flow. Although the cash flow’s quality may not be optimal, it bolsters the company’s financial position, providing more time for turnaround efforts. By the end of 2024, Unity reported having slightly over $1.5 billion in cash.
Unity is a prominent player in the gaming industry, alongside Epic Games’ Unreal Engine. By discontinuing the Runtime Fee and working to rebuild trust with developers, Unity is taking steps to prevent a departure to competitors.
Given the current results, an $11 billion market capitalization for Unity appears unreasonable. However, in a few years, this valuation might be advantageous. Unity’s leading role in the video game engine sector, combined with the potential growth in its underperforming advertising business, positions it as an intriguing stock for a turnaround.
Significant positive developments are necessary for Unity, and unforeseen difficulties could impede its recovery. Unity remains a high-risk stock, yet one offering the potential for substantial returns. For investors willing to persist through a challenging period, Unity presents an investment opportunity worth considering.
