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Unity (U) Stock | NYSE: U

Covered by Stratosphere

The Gaming Engine: Zero to 60

Unity Software Inc. ("Unity") provides a software platform for creating and operating interactive, real-time 3D content.

The platform can be used to create, run, and monetize interactive, real-time 2D and 3D content for mobile phones, tablets, PCs, consoles, and augmented and virtual reality devices.

Unity has two main business segments: Create Solutions and Operate Solutions. Create Solutions is essentially the Unity platform used by creators to create real-time 2D and 3D content. Operate Solutions empowers creators to monetize content using content delivery solutions and advertising.

Unity's versatile products are primarily used in the gaming industry. However, it is also used in the architecture and construction, animation, and designing sectors, among others.

Unity's gaming engine can let creators and professionals bring an idea to life from the ability to build, deploy and monetize, just like a vehicle going from zero to 60.

Stratosphere Score

9

Growth

10

Valuation

5

Quality

8

Margins

6

Dividend

0

Balance Sheet

7
Adrian Iwanicki

Author

Adrian Iwanicki

Equity Analyst

Investment Thesis

  1. Unity is a gaming engine that allows game developers, hobbyists, and other industry professionals to build, deploy, and monetize interactive real-time content. Unity has significant market share of the total gaming engine market and huge market share in mobile gaming.

  2. The most exciting upside about Unity may be the application of the gaming engine outside of gaming with endless optionality. The platform has applications used in non-gaming industries such as Architecture, Engineering & Construction ("AEC"), film, marketing, automative, educational technology, and more.

  3. The ability to bring an idea to life on Unity Create Solutions and then monetize, gain users, and conduct cloud delivery and analytics using Unity's Operate Solutions provides a full turnkey solution for creators. Unity benefits from the high switching costs users face once on the platform.

  4. Operate Solutions provides game developers and other creators a compelling offering to deploy their creations. This segment has strong recurring revenues with high margin and high dollar-based net expansion rates (i.e., existing customers tend to spend more money on the platform every year).

  5. Unity's growth is impressive and we believe it is still early in the growth story as the gaming engine witnesses secular growth from both gaming and other industry applications.

Key Company Metrics

A set of metrics we constantly keep updated to monitor the investment thesis.

Competitive Advantages

Platform & Community

Unity's main design platform, Asset Store, and the Creator Community are excellent value propositions that engage users and keep them on the platform.

Unreal arguably hosts a better platform for 3D graphics, but Unity’s track record should not be ignored. Pokemon Go, Temple Run, and Escape From Tarkov were created on Unity. Each of these games are immersive, engaging, and frankly, addictive. 

Temple Run, probably the most widely known mobile experience created on Unity, was downloaded over one billion times when this TIME article was written in 2014. This short compilation of games showcases other impressive, high-resolution games created by developers of all sizes on Unity.

Pokemon GO VisualSource: The Verge
Pokemon GO OutdoorsSource: The Verge

The Asset Store and Creator Community are valuable supplements to Unity's user experience.

The former equips developers with the tools to create incredible content using other developers' work. Assets can be sold to other Unity members, which becomes a lucrative incentive and positive reinforcement to the original developer, platform, and the community in its entirety.

The Creator Community is large and active - approximately 1.5 million active monthly creators develop thousands of games and applications each month. The sheer scale of the community offers outstanding reach to third-party platforms that can strategically partner with Unity to expand their own business, and allows creators to collaborate with, and learn from each other within the Unity realm.

Unity has everything it needs to equip developers with the right tools and community to build and monetize games and other creations.

Data Footprint

As a technology company, Unity possesses the ability to garner mass amounts of data from its users. The continuous capture and analysis of end-user behaviour and application performance allows Unity to see how end users interact with games and content.

By tracking this behaviour, Unity can optimize content performance, user acquisition and engagement, and monetization based on predicted lifetime value of each customer.

This creates value for all involved - stickiness of the platform increases as end users consume Unity-sourced content and developers and creators come back to create more content and monetize it as consumer demand grows.

Market Presence

Unity sees almost 3 billion monthly active end users consume or create content each month. The vast amount of "input" and "output" users creates a strong network effect – increasing usage on both ends of the spectrum cascades into more content creation from existing users and attracts new creators and end consumers.

Guided onboarding, access to learning resources, intuitive content creation, and partnerships with high schools and universities ensure all developers, especially the young and relatively inexperienced, enjoy and benefit from using Unity. The combination of running an easy-to-use platform and working with students at no cost to them boosts knowledge of how to create and use RT3D software and content prior to graduation.

The former is an inherent low barrier to entry that allows newer and / or younger creators to learn the platform and iterate content quicker. In turn, Unity is more likely to generate a lifetime user through ease of use.

The latter is clever in that Unity is aware of the high switching costs associated with game engines – as one learns and continues to accumulate knowledge and real experience on one game engine, switching costs (i.e. re-training, re-coding, and opportunity costs) rise.

Unity's moat can be demonstrated through its market presence – 71% of the top 1,000 mobile games were made with Unity and 94% of the top 100 game development studios were customers of Unity.

Opportunities Ahead

  • Unity sees a total addressable market ("TAM") of $29 billion. The platform has inherent optionality due to the many use cases it has been able to tackle. Despite being referred to as a "gaming" platform, Unity serves the gaming, (consoles, PC, AR, VR), architecture, engineering, construction, automotive, transportation, manufacturing, film, animation, cinema, and education industries. With the proposed acquisition of Peter Jackson's Weta Digital 3D tech segment - best known for creating stunning VFX for The Lord of the Rings, Game of Thrones, The Planet of the Apes, and many Marvel movies - some of the world's most advanced visual effects tools will be made available to Unity creators to make even better content. We think Unity will find its way into more use cases over time, whether that will be within the same industries it serves today or in new industries as well.

  • Unity is placed at the foundation of a high-growth industry. Global mobile gaming revenues are expected to grow faster than the global games market, which is already expected to grow around 10% per year through 2023. COVID-19 accelerated mobile gameplay around the world, but this effect may subside when economies re-open in a post-pandemic world. Growing global smartphone penetration, increasing mobile game consumer spend, and Unity maintaining its top position in the mobile and AR / VR game development space should provide ample opportunities for growth within the areas Unity currently operates in. 

  • Tim Sweeney, CEO of Epic Games, said, "[t]his Metaverse is going to be far more pervasive and powerful than anything else. If one central company gains control of this, they will become more powerful than any government, and be god on Earth". Although we think this is a far-fetched statement considering nobody "owns" the internet today, Sweeney expresses the opportunity of the metaverse well. The metaverse can single-handedly blow Unity's $29 billion TAM estimate out of the water to a number substantially higher than we can imagine. The changes we may see in digital marketing, pop culture, economies, shopping, entertainment, and many others could be beyond our imagination (see this Adobe MAX 2019 video (view 2:01 to 3:52) for an interesting depiction of what the metaverse might look like). Therein lies the massive opportunity for Unity to capitalize on a gigantic new wave of computing through its AR and VR investments and capabilities.

Risks

The Competition is Unreal

Unity faces intense competition from one other major organization: Unreal Games ("Unreal").

Unreal has several advantages over Unity that make it a more compelling option for some developers and creators. For example:

  • Unreal produces "high-fidelity" 3D visuals from the moment of creation; Unity also produces great graphics but to a lesser extent and with more work required than Unreal;

  • Visual artists tend to prefer Unity due to Unreal's better graphics vs. Unity;

  • Unreal is completely free, offering a no-barrier entry to begin using the platform. The only kicker is that Unreal collects royalties from any of your published games. Unity offers a free version of its platform, but it is much more limited than Unreal;

  • Unreal offers Blueprint (Figure 3), a visual scripting method, as an alternative to using C++ on Unreal. The developer does not need to know how to code in Unreal – they can simply use Blueprints;

  • Unreal is most popular amongst the AAA-game industry due to its more powerful platform and graphics capabilities; and

  • Unreal also creates its own games, the most notable being Fortnite and Gears of War. Unity does not create its own games.

However, we think Unity is still a highly compelling platform for most creators and developers. We have found Unity has advantages over Unreal in the following areas:

  • Unity is better suited for lower-powered devices, such as mobile; Unreal hosts a bulky platform that is not necessarily suited for lower-powered devices;

  • Unity is a more intuitive platform than Unity, making it the perfect choice for small(er) developers; larger development teams working with Unreal typically require "specialists" to dedicate their time focusing on subsets of the development process, whereas less-experienced, lone developers or small teams on Unity benefit from the easy-to-use platform;

  • Related to the point above, Unity is simpler to use mainly because of its larger and more robust Asset Store. Developers can tap into this resource to pre-populate their games with a wide variety of stored assets to get their game to look, feel, and perform as closely to what the developer had imagined without creating code from scratch;

  • Although Unity does not offer a visual scripting method like Unreal’s Blueprints, the platform identifies problematic or incorrect strings of code for the developer. This is a great feature as C# has slightly more complicated syntax than other languages;

  • Unity's 2D focus and toolset make it the better choice over Unreal 2D development;

  • Unity is more versatile in the realms of AR and VR – Unity has more experience with AR and VR and contains flexible plugins.

Target Market

Unreal Gaming Engine is programmed with C++, which requires extensive programming, but in turn allows for more customization and higher performance. Because of this, the engine is primarily used for bigger and higher performance projects for console, PC, and AR / VR platforms.

Unity, on the other hand, is programmed with C# and the engine is catered more towards mobile games. The engine dominates the mobile game industry, holding over 50% of market share. This is in comparison to Unreal Gaming Engine having little to none.

The Learning Curve

As mentioned before, both engines require a fair bit of expertise and months to master, but in terms of learning game development, Unity is more welcoming to newcomers.

As an organization, Unity has always been pushing to democratize game development, giving anyone the ability to create games given the right tools. This is what has allowed Unity to be the common choice for education environments and casual games.

From an entry point perspective, the Unity platform does a lot of work for the developer and locks certain aspects to ensure there are no catastrophic mistakes that could ruin the functionality of the game.

Unreal Gaming Engine on the other hand is much harder to master because of the more detailed programming language and technical skill needed.

In terms of development, since the engine uses open source code, every aspect is customizable. This is a much harder task for beginners but is needed when developers want full creative freedom.

Pricing

Unity's engine runs on a freemium subscription model in which certain features are locked. You are required to pay more in order to unlock more features.

Unreal Gaming Engine, on the other hand, runs on a revenue share model. All features are unlocked and Unreal takes 5% of the game's revenue, regardless of how much is generated.

Unreal's payment structure is less restrictive and might be more favourable to creative and development teams, especially smaller ones.

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