Partnership With Google In XR Will Strengthen Future Competitive Position

Key Takeaways

• Enhanced AI and expanded XR partnerships could boost revenue, margins, and competitive position in both gaming and non-gaming markets.
  
• Successful diversification and cost efficiency strategies support revenue growth and improved financial health for Unity Software.
  
• Competitive pressures, reliance on price increases, and transition disruptions could threaten Unity's market share, revenue growth, and shareholder value.

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.

• The integration of Unity Vector, an AI platform for the Unity Ad Network, is expected to enhance targeting precision and performance, potentially leading to increased future revenue growth and improved net margins by providing better ROI for advertisers.
  
• The widespread adoption of Unity 6, with upgrades and increased subscriptions, is projected to drive revenue growth, especially as pending price increases for Pro and Enterprise tiers begin to take effect over 2025 and 2026.
  
• Unity's growing presence in XR (extended reality) through partnerships, like the one with Google for Android XR, could strengthen its competitive position and open new revenue streams, benefiting both top-line growth and net margins.
  
• Expansion in non-gaming industries, evidenced by significant customer wins such as Toyota and Raytheon, and a 50% growth in the industry segment revenue could substantially boost revenue and diversify Unity’s earnings base.
  
• Operational efficiencies and cost management initiatives are poised to enhance Unity’s adjusted EBITDA and free cash flow, driving shareholder value through increased earnings and gradual deleveraging of its balance sheet.

Unity Software Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Unity Software's revenue will grow by 6.3% annually over the next 3 years.
• 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 -36.6% to the average US Software industry of 12.1% in 3 years.
• If Unity Software's profit margin were to converge on the industry average, you could expect earnings to reach $262.5 million (and earnings per share of $0.56) by about April 2028, up from $-664.1 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 65.7x on those 2028 earnings, up from -12.5x today. This future PE is greater than the current PE for the US Software industry at 30.2x.
• Analysts expect the number of shares outstanding to grow by 4.81% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.11%, as per the Simply Wall St company report.

Unity Software Future Earnings Per Share Growth

Risks

• The iterative nature of the Unity Vector transition could delay the full realization of its benefits, which may result in short-term disruptions and impact revenue growth, particularly in the advertising segment.
  
• Competitive pressures in the environment, such as new entrants and technological advancements like Microsoft's gaming development offering and AI applications by competitors, could threaten Unity’s market share and future revenues.
  
• While Unity experienced growth in subscription revenue, the reliance on price increases for growth in 2025 and 2026 could affect customer retention and acquisition if perceived as uncompetitive, impacting revenue and net margins.
  
• The transformation in Unity's Ad business, combined with the cautious guidance due to seasonality and disruptions, indicates revenue volatility as they transition, posing risks to consistent earnings.
  
• The potential dilution from stock-based compensation, despite efforts to minimize it, could affect shareholder value if growth does not meet expectations, impacting the EPS and shareholders' returns.

Valuation

• The analysts have a consensus price target of $28.954 for Unity Software based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $35.0, and the most bearish reporting a price target of just $20.5.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $2.2 billion, earnings will come to $262.5 million, and it would be trading on a PE ratio of 65.7x, assuming you use a discount rate of 8.1%.
• Given the current share price of $20.19, the analyst price target of $28.95 is 30.3% 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.