Spatial Computing And AR Will Drive Digital Transformation

Key Takeaways

• Step-change improvements in AI-powered advertising and widespread platform upgrades could drive substantial outperformance in revenue growth and margin expansion beyond analyst expectations.
  
• Unity's data advantage and expanding enterprise reach position it for long-term recurring revenues, with digital transformation trends unlocking markets far beyond gaming.
  
• Rising competition from proprietary and open-source engines, profitability challenges, industry cyclicality, platform fragmentation, and regulatory pressures all threaten Unity's long-term growth and margins.

Catalysts

Operates a platform to create and grow games and interactive experiences for mobile phones, PCs, consoles, and extended reality devices in the United States, China, Hong Kong, Taiwan, Europe, the Middle East, Africa, the Asia Pacific, Canada, and Latin America.

• Analyst consensus expects a moderate revenue lift from Unity Vector, but given that Vector is already delivering 15 to 20 percent improvements in installs and in-app purchases at this very early stage, there is a high likelihood that step-function improvements in AI-powered ad performance will generate significant outperformance relative to consensus expectations for both revenue acceleration and margin expansion as advertisers increase spend well above historical levels.
  
• While analysts broadly anticipate revenue growth from Unity 6 adoption and price increases, the real upside could be substantially larger as over 80 percent of active users are expected to upgrade and with nearly all of Create revenues now coming from high-margin subscriptions, accelerating platform migration and price optimization could drive sustained double-digit subscription growth and gross margin expansion far beyond current forecasts.
  
• Unity's unique ability to aggregate behavioral and performance data from billions of real-time interactions across its Create and Grow platforms gives it a defensible data advantage, setting the stage for the company to introduce entirely new analytics, live-services, and audience segmentation products for developers-unlocking long-term recurring revenue streams and improving net margins.
  
• As real-time 3D and interactive content become foundational to industries from automotive design to healthcare and manufacturing, Unity is positioned to be the mission-critical infrastructure powering digital transformation, which can drive multi-year compounded revenue growth as enterprise contracts scale, expanding the company's total addressable market well beyond gaming.
  
• The proliferation of spatial computing and the rise in mobile device adoption globally will accelerate the demand for AR/VR and cross-platform interactive experiences, reinforcing Unity's leadership in these segments and laying the groundwork for exponential growth in both user base and usage-based licensing revenues over the next decade.

Unity Software Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more optimistic perspective on Unity Software compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts.
• The bullish analysts are assuming Unity Software's revenue will grow by 10.7% annually over the next 3 years.
• Even the bullish analysts are not forecasting that Unity Software will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate Unity Software's profit margin will increase from -25.2% to the average US Software industry of 13.2% in 3 years.
• If Unity Software's profit margin were to converge on the industry average, you could expect earnings to reach $321.1 million (and earnings per share of $0.67) by about August 2028, up from $-450.7 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 75.4x on those 2028 earnings, up from -29.4x today. This future PE is greater than the current PE for the US Software industry at 39.7x.
• Analysts expect the number of shares outstanding to grow by 4.75% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.35%, as per the Simply Wall St company report.

Unity Software Future Earnings Per Share Growth

Risks

• The increasing trend of proprietary game engines and open-source alternatives such as Godot threatens Unity's core business as major publishers move away from third-party engines, which could shrink Unity's addressable market and place long-term downward pressure on revenues and margins.
  
• Despite recent improvements, Unity's longstanding struggle to achieve consistent profitability, combined with ongoing high R&D and cloud costs associated with rapid innovation and acquisitions, could continue to depress net margins and earnings over the long term.
  
• The company's heavy reliance on gaming-with the majority of customers being game developers and publishers-exposes it to the cyclical nature of the gaming industry, which increases revenue volatility and limits Unity's ability to diversify income streams and smooth earnings across business cycles.
  
• Platform fragmentation and technical complexity from supporting multiple new hardware ecosystems (such as AR/VR, foldable devices, and proprietary platforms like Nintendo Switch 2) risks escalating Unity's technical debt and integration costs, likely placing ongoing pressure on gross margin and slowing top-line growth as resources are stretched.
  
• The secular trend toward increased regulation, including antitrust scrutiny and evolving data privacy laws, could constrain Unity's ability to monetize user data and advertising, resulting in higher compliance costs and potentially reducing future advertising revenues and net profits.

Valuation

• The assumed bullish price target for Unity Software is $39.91, which represents two standard deviations above the consensus price target of $27.57. This valuation is based on what can be assumed as the expectations of Unity Software's future earnings growth, profit margins and other risk factors from analysts on the bullish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $44.0, and the most bearish reporting a price target of just $15.0.
  
• In order for you to agree with the bullish analysts, you'd need to believe that by 2028, revenues will be $2.4 billion, earnings will come to $321.1 million, and it would be trading on a PE ratio of 75.4x, assuming you use a discount rate of 8.3%.
  
• Given the current share price of $31.83, the bullish analyst price target of $39.91 is 20.3% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.