Unity Software is best known for its game engine, which was used for over 50% of all video games in 2020. But Unity is also used to create over 60% of all VR/AR applications, and is starting to expand into other industries such as automotive, architecture, manufacturing, film, and retail. It’s not just about Pokemon Go!
In this week’s pod, we take a deep dive into Unity, and have a fantastic discussion with Karle Kane, the founder of Rainfall Games. Karle is an experienced software developer with over fifteen years’ experience in the financial technology space. He founded Rainfall Games to pursue his passion for game development and has been a Unity developer since 2010. Rainfall have released several mobile games and are currently working on their first major PC title Corrupted Spirits. They have recently branched out to create bespoke data visualization apps, leveraging their knowledge of the Unity real-time development platform.
- Unity is one of the largest development platforms for gaming and was used to create over 50% of video games across 20 platforms in 2020. It is even more dominant in mobile gaming where 71% of the top 1,000 mobile games in 2020 used Unity. 93 of the top 100 game studios by revenue are Unity customers, and on average there were 2.7B people each month who consumed content created with Unity in 2020. Unity estimates their addressable market in gaming at $12B growing to $16B by 2025
- Over 60% of all VR/AR experiences are created with Unity, and this platform was used to create 90% of all Microsoft HoloLens and Samsung Gear VR experiences. AR/VR is seeing increased adoption, not just in gaming but also in other industries including healthcare, manufacturing, architecture and design and the VR/AR market is projected to grow by 63% per year through 2025. Unity estimates their current opportunity in VR/AR at $17B
- They have three main business segments: Create Solutions, a subscription-based business providing access to Unity’s development tools; Operate Solutions, a usage-based business helping game developers to run and monetise their games; and Strategic Partnerships, where tech partners such as Apple, Microsoft, Nintendo and Sony pay Unity to support their hardware and software. These three segments contributed 30%, 61% and 9% of revenue respectively in 2020, with Operate Solutions growing the fastest
- Unity acquired Applifier and launched their in-game advertising network in 2014, and this is now one of the world’s largest mobile ad networks serving 23B ads per month. Unity does not break-out advertising revenue from their Operate Solutions segment, but the whole segment had revenues of $471M in 2020, an increase of 61% from the previous year. However, recent changes in iOS to prevent app tracking is estimated to reduce revenues by $30M in 2021, which represents 3% of total revenue
- With recent acquisitions of Finger Food Studios and RestAR, Unity is accelerating its move beyond gaming and into other industries, including architecture, engineering, construction, marketing, retail, and scientific research. The top ten automakers in the world are using the Unity VR platform for design and simulation. At the end of 2020, 13% of their enterprise customers were outside of gaming, up from 8% just six months prior
- Total revenue for 2020 was $772M, an increase of 43% from the previous year. Existing customers are buying more each year, with DBNERs of 138%, 133% and 124% for 2020, 2019 and 2018 respectively. The business is reinvesting in growth and has not shown a consistent profit as yet, having just become free cashflow positive in Q4 2020. They ended 2020 with $1.3B in cash with a further $480M in marketable securities and zero debt
- Unity currently has a market cap of $23B with a P/S ratio of 24. Despite the huge 50% drop from its all-time high in January, the stock remains relatively expensive and will need to maintain continued high revenue growth to justify the valuation
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Transcript
Albert: Hi, this is Albert.
Luke: And this is Luke.
Albert: Today is Monday the 10th of May.
Luke: Welcome to the Telescope Investing podcast.
Intro
Albert: This week on the podcast, we’re going to have a look at a company that’s been on my watch list for a while now, Unity Software.
Luke: I know a bit about this space, but I haven’t really thought about it or researched it. So when you suggested we take a look at it, Albert, interesting and I’ve learned quite a bit just doing the research, but I’ve got to say, you and I are not experts on game development. We’re not experts on Unity and that whole space. So we are delighted today to invite one of our close friends on, Karle from Rainfall Games, as our resident expert on Unity.
Karle: Hello there.
Albert: Thanks for joining us on the podcast, Karle, and we have loads of questions for you. But before we get there, let’s just give a quick background on Unity. So Unity is a software development framework that’s best known for its game engine, but actually, it can be used to create many types of interactive real-time applications.
Luke: Yeah, I definitely came to this thinking it was just games, but in the prep, Karle’s told me about a number of other use cases that are quite exciting. Unity are one of the biggest platforms. Last year, they were used to develop over 50% of all video games across 20 platforms. These guys are massive.
Albert: Yeah, and they’re particularly strong in mobile games and actually, about 71% of the top 1,000 mobile games in 2020 were made using Unity.
Luke: Everyone likes to track monthly active users and Unity’s numbers are great. Apparently 2.7 billion users per month in Q4. That seems like a crazy big number, up from 63% the year prior.
Albert: Well, Unity was actually founded in Copenhagen in Denmark in 2004 as Over the Edge Entertainment, but they changed their name around 2007 to Unity.
Luke: Over the Edge is a bit of a mouthful. I like Unity.
Albert: Yeah, and they’re based in San Francisco now and they actually IPO’d in September last year, quite recently, and it was quite a hot IPO. The share price jumped around 30% on the first day, continued rising to a high of $175 in January, but along with the overall tech market, it has since dropped to about $89.
Luke: I’m pretty sceptical about the valuation even after that drop, but we’re going to pick that up in the financials at the end. And as ever, Albert and I are both making investment decisions as part of today’s discussion. I think we’re both sitting in slightly different places in terms of our commitment right now, so let’s see if that moves as we have the chat.
Albert: So do you think listeners will know who’s in favour and who’s not?
Luke: Well, I think this episode you are wearing the Unity bull horns and I’ve got the bear teeth.
Albert: Okay. Well, let’s get Karle’s opinion on this.
About Karle
Luke: So Karle, let’s kick it off. Why don’t you tell us a little bit about yourself and about Rainfall Games?
Karle: Hi, certainly. So my name’s Karle Kane. I previously worked for 15 years in financial technology before deciding to take a chance and jumping into game development. I founded Rainfall Games three years ago. We’re currently working on our first major PC title, developed in Unity, and have previously developed a few small mobile apps as a means to cut our teeth and learn game development.
Albert: What were the names of the games that you’ve released before, Karle?
Karle: You might be able to find them in the App Store and Android Google Play Store. They’re called Snork which was a 3D snake game; you might be familiar with Snake from the old Nokia phones.
Luke: Many a happy hour sat on the toilet playing snake.
Karle: For me, it was math class. And then also, I created a puzzle game called Chemistry and another puzzle game called Rock Crash. And one thing you don’t want to do if you’re making mobile games is make puzzle games because it’s massively oversaturated and it’s almost impossible to make any money in the segment, but it was a good learning experience.
Albert: Actually, we covered Gravity a few weeks ago and it was shocking how many games there are out there. It’s very hard to get yourself known in that space, right?
Karle: Yeah. So I think when I released my mobile games, the numbers were something like 800 games released every day on each app store. So without any marketing, it’s virtually impossible to get noticed.
Luke: Bloody hell, that’s ridiculous. 800 games a day!
Karle: Yeah. Really any kind of organic discovery is very difficult to achieve.
Luke: So you’ve pivoted more from mobile games to PC games have you with your latest project?
Karle: Yes, exactly. The theory being that it’s easier to reach your target audience on the PC indie gaming segment. You can create a lot of different types of games there, whereas mobile’s a little bit more restrictive.
Game engines
Albert: So Karle, you mentioned that you’re using Unity for your latest game. I believe there’s one other main development framework called Unreal Engine. Have you used that before?
Karle: For a lot of developers, one of the first choices they’re making is whether to use Unreal Engine or Unity. There are a lot of other frameworks you can use, but they’re the main two contenders. As each year goes by, there’s less that separates them. I think in the past if you were going for very high visual quality or very high performance, you’d be looking at Unreal Engine, but Unity has really stepped up their game in the last few years. For any developer, you can achieve a similar result on either engine.
Albert: So why did you choose Unity over Unreal Engine?
Karle: I’ve been working with Unity since I think it was version 3 or 4 back around 2010. So there’s a lot of familiarity for me there.
Luke: That’s interesting because I think there’s a key part of the bull case is once the developer builds a familiarity with the framework and with the software, they’re very unlikely to move away. Would you agree with that?
Karle: There’s definitely a cost in switching. I guess at the start of any new project, you have to make the decision of which engine you’re going to use. One of the things you have to consider is the skill set of your team. And then also, any assets you’ve built up. So for instance, source code that you can reuse. If you switch engine, obviously, there’s work involved in porting this.
Albert: Does Unity have a strong developer following? Do they work closely with developers to add new features and products?
Karle: I’d say yes, there’s a lot of people using Unity and so there’s a very powerful networking effect. If you need any support, you can go to the forums and ask a question, and often it’ll be other users of Unity that actually help you solve your problem.
Luke: That’s really powerful when a community reaches that point and the users become such advocates that they’re pulling in other colleagues and other users onto the platform at the same time. A few years ago, I had a venture capital stake in a company called Play Canvas who were in exactly the same space and they got acquired pretty quickly; they were bought out by Snap in 2018-19.
One of the key benefits that we used to promote on Play Canvas was building this whole collaboration between designers, coders, artists, audio engineers; everyone kind of came together around the asset store and almost building libraries of content that they could sell. Is that any part of the Unity model?
Karle: So the asset store is very popular with Unity users. If you can go to the asset store and grab 3D models, animation, even code [that] forms the functionality of your game, then you get a very good head start on developing your game. You could almost build a game entirely out of assets you pull from the store without writing a single line of code.
Albert: Is that what you’re doing, Karle? Are you stealing all people’s assets?
Karle: You know, I wish I’d used assets earlier. I think one of the mistakes I’ve made in my game development career is trying to do lots of things from scratch. In reality, if you release a mobile game and the artwork isn’t unique, the end user is unlikely to notice that. Unless you are copying a really major game like Fortnite, you know, no one will have seen it before, and it saves a lot of time and it’s often very recently priced. So it’s a very good strategy.
Luke: Do Unity monetize that platform, the asset store for developers, to sort of generate revenue by creating reusable assets?
Karle: Yes. So the developers of the assets can sell them on the store. You’re also free to go to pretty much any other asset store, and as long as the license is compatible with what you’re doing, then you can do that.
Albert: I believe that Unity also has features that allow you to monetize your content by displaying ads within the game. Have you used those features?
Karle: Yes, it was actually very useful when developing my first mobile app. You could very quickly integrate the Unity services, such as analytics, adverts, monetization, with very little work. There’s probably more work configuring these features on the individual stores, like the App Store and Google Play.
Having talked to other developers though, they recommend, for instance, with ads to go with multiple providers, because you’re often at the mercy of the ad provider. And if you aren’t having much success with them, you want to be able to switch out to someone who’s going to pay you more.
Luke: Alb I guess it’s a lot like the supply-side advertising space we looked at a few episodes ago with Magnite. I guess, as a developer, you are creating a channel that’s going to attract eyeballs and you want auctions to take place to sell your advertising space at the best possible revenue.
Albert: Yeah, absolutely.
Beyond gaming
Luke: So Karle, tell us a bit about some of the other use cases you’ve used Unity for beyond game development.
Karle: So recently, I’ve worked with members of the scientific research community. They have a requirement to present the data from their research and often the people they’re presenting to aren’t scientifically literate, so clear visualizations are very important. There’s various solutions online already. However, you’re often very limited in what you can do with them. Unity gives you ultimate freedom in the way you present the data, but obviously, you have to do some work to build up those visualizations yourself.
Luke: Can you tell us a bit about one of the projects you’ve done?
Karle: A hot topic at the moment is digital twins, where you have a virtual representation of the real world. By putting your data into this virtual world, other scientists can look at your data, incorporate it into their own models, and then hopefully, come to some new conclusions or get better results. I’ve worked with one company to model ice melts in Antarctica. It’s a way to explore the data set so you may look back in history or play back through a certain time range, and it’s a way to visualize your data for communication.
So often, if you’re talking to politicians, you want to be able to present the data in a more easily understood format. So if you can import your data into a model and then create a presentation from it, it’s one avenue to get more funding for your research.
Luke: Karle, that’s pretty awesome. Like you’re using Unity to save the world. If only Al Gore had access to your technology, he wouldn’t have needed that crazy crane in his big graph. He could have showed the ice melting in real-time.
Albert: One of the things we look at when we look at companies, Karle, is competition. Do you see anything coming up that could challenge Unity in the future?
Karle: It’s a good question. There’s certainly lots of other game engines. There’s probably few that offer the wide array of features that Unity does. I think one of the big benefits that I see personally is that Unity can target any platform. So I can write my game once, or my application or my visualization, and I can target it at mobile; I can target it at consoles, at PC, Mac, even web. Now, there’s not many other game engines that do that.
Luke: That’s also especially when you’re struggling early days with monetization. The more platforms you can deploy to, I guess the faster you can ramp that up.
Karle: Yes, exactly. And often, it’s a lot harder to get onto consoles. So one route a lot of people take is to release on PC first. And then if the game is popular, they’re in a much stronger negotiating position to then go to Nintendo, Sony, etc. to get onto their platform.
There’s lots of competitors [at] different stages of maturity. Unity is tried and tested. Every major platform has a big game written with Unity, and it has such a large community that you can find people to help you achieve what you want to. If you go with another platform, you’re taking quite a big risk there, unless you have all the skills in-house that you need.
Luke: That community stickiness is pretty powerful. Maybe just as we wrap things up, have you found any downsides in using Unity? Any regrets about adopting this platform?
Karle: So I think where Unity is successful is that it gives people a very quick way to get up and running. When I go to meetups in London, probably only 50% of the people there are developing games; the other 50%, people from all sorts of other industries. We see a lot of architects for instance. These are very skilled people who don’t have the time to learn how to program a game engine from scratch, and they can jump straight into Unity and put something together which is useful for them as a company.
Going back to the architect’s example, you see lots of people who will create a model in Unity to demonstrate the environmental features of the building or to show the effectiveness of solar panels on the roof. That’s one of the strengths of Unity is that you can get started very quickly. As you progress deeper into Unity, building more complicated games, you start to kind of find the edges.
So there’s lots of systems which are good to get you going but then need quite a lot of work to get to the production standard that you require. This is one of the differences between Unity and Unreal in that Unreal is a game engine built by a company that makes triple-A games and Unity is a game engine built by software engineers, I guess.
The metaverse
Luke: Have you heard of this concept of the metaverse?
Karle: I haven’t, no.
Luke: As I was doing my Unity research, a number of other investors, particularly Chris Seifel, talk about the metaverse and how Unity might be the enabler for that. Basically, the Matrix or any other Neuromancer William Gibson vision of the future. Being able to enable, as you say, architects and artists and totally non-technical people to be able to create assets and build a rich online experience. That might be the kind of thing that accelerates our transition to almost, you know, living in a virtual world for some parts of our existence. Maybe, you know, some parts of socializing, some parts of actually working.
Karle: I’m sure you’ve heard of VRChat, which is a very popular chat platform now.
Luke: I’ve got my Oculus sat next to me. What am I missing out on?
Karle: Well, I still think it may be aimed at younger people at the moment, but it is a way to pop into a virtual world and chat with other people.
Albert: Is it like a VR version of Zoom?
Karle: I guess it’s very reminiscent of something like Fortnite where everyone has very interesting avatars to represent themselves.
Luke: I did hear about a company that adopted Red Dead Redemption 2 for their team meetings. They’d all sit around a campfire and engage that way.
Karle: I think one strength of Unity is how quickly they adopted VR support. I’ve been to lots of meetups where AR companies have been presenting to Unity developers because they want Unity developers to integrate their APIs.
Albert: I think VR and AR is a big part of our investment thesis. If Unity can get into that market, it presents a huge addressable market for them.
More about Karle
Luke: Karle, that’s been really fascinating. Thanks so much for coming on the show and giving us some of your insight. So what have you got planned for the future?
Karle: Well, since we’ve dipped our toe into building applications in Unity for other purposes than games, I think there’s a lot of opportunity in this space. So I’ll be pursuing that further, working with more companies, probably in the scientific community to help them visualize their data.
Luke: And if you can keep saving the world for us, we’ll all be grateful.
Karle: Well, I’m not sure I’m saving the world, but helping the scientists save the world for us.
Luke: Every little bit helps.
Albert: Yeah, thanks for joining us, Karle, it was really useful.
Luke: So I think we’re going to say a goodbye to Karle here, and Albert and I are going to dive into the nitty-gritty of the company, but again, thanks, Karle, thanks for joining the podcast today.
Karle: That’s great. Thanks for having me.
Tailwinds
Luke: So, Albert, we wanted to deep dive Unity today because we think this is a really interesting sector right now. Why don’t you pick up a conversation on a couple of the tailwinds that we see?
Albert: I guess the main tailwind for Unity would be gaming, especially in mobile gaming. I saw a chart recently that says in 2020, the global games market was valued at around $160 billion and mobile gaming took up $77 billion of that. Unity themselves value their addressable market in gaming at $12 billion, growing to $16 billion by 2023. It’s not a huge market but it is growing. And Unity had revenues of around $770 million last year, so there’s still quite a lot of market for them to capture.
Luke: Yeah, and it’s definitely the pandemic effect all over again, right? It’s been such a driver of so many of our growth stocks, but particularly last year during national lockdowns. In some ways, games became a bit of a social lifeline for many kids and actually, let’s face it, many adults as well. Almost the only way to socialize with your buddies while you were stuck in your home.
Albert: Actually, the last time I saw the Unity splash screen was in a game called Overcooked and also its sequel Overcooked 2. Me and my girlfriend completed those games during the Coronavirus lockdowns last year, and I don’t think we would’ve done that if it wasn’t for the lockdown.
Luke: Who is the Overcooked champion in your household?
Albert: It’s a team game, Luke. There’s no overall champion. We worked together.
Luke: Katrina and I had to go for one afternoon and we just ended up fighting with each other about letting the burgers burn.
Albert: Yeah, and I would say that if your relationship can survive Overcooked, it can survive almost anything.
Luke: Games are massive, but Karle picked up on the topic of AR and VR. There’s definitely very interesting applications of this stuff into the commercial environment, particularly, as he was saying, with architects and other folks starting to model real-world situations using Unity.
Albert: Yeah, a very popular AR game called Pokemon Go was actually built using Unity. And I’ve read that Unity is used to create around 60% of all AR and VR experiences.
Luke: And if they’re building out that asset store and getting developers and non-developers used to a platform, that’s going to be incredibly sticky, and we would definitely expect Unity to dominate the market as it continues to grow.
Albert: Yeah, this reminds me we actually considered Unity for the 2021 model portfolio as an investment in the AR and VR megatrend, but I think we decided that AR and VR just wasn’t ready and other stocks were better for 2021. But I’m starting to think that augmented reality and virtual reality could become mainstream earlier and companies in this space are seeing increased tailwinds.
Luke: Yeah, that whole AR/VR market is estimated to be another $17 billion of revenue potentially out there.
Albert: Yeah, and I’ve read that the AR and VR market is expected to grow around 63% a year and reach $571 billion by 2025. To be honest, that figure sounds way too high to me, but even if that market was a tenth of that size, that’s a sizeable opportunity for Unity.
Leadership
Luke: Should we talk about the people a little bit? Let’s focus on the leadership of Unity. So they were founded by three guys, David Helgason, Joachim Ante, and Nicholas Francis.
Albert: So I had a quick look at where these guys are now. And David Helgason was CEO until around 2014 and is now on the board, and I think he owns around 7% of the company. You said Joachim Ante but I thought it was pronounced Joachim Ante. Regardless, he is the CTO of Unity, and he owns around 10% of the company. And when I looked at Nicholas Francis, I don’t believe he’s at Unity anymore. I saw he left around 2013 to found a game studio called Frame Bunker. This is a wild guess, Luke, but I’m guessing that Frame Bunker uses Unity.
Luke: I guess so, and that’s good to see that two of the founders are still there with a really significant 17% of the company between them and they’re still on the board. So that’s really good insider ownership. They brought in an external CEO. They brought in a guy called John Riccitiello in 2014. John was previously the CEO and president of Electronic Arts.
Albert: But if you look at the history, he didn’t do a great job at Electronic Arts, and he left after delivering pretty terrible results.
Luke: Well, it looks like he’s doing a better job at Unity. He’s got a 93% CEO rating and overall the company has 4.4 stars out of five on Glassdoor. Employees cite strong values and a really good culture as some of the positive points. And the negatives are kind of things you’d expect with a rapidly growing company, growing pains and it’s just a bit chaotic.
Customers
Albert: Moving on to their customers. As of June last year, there were around 1.5 million monthly active creators all over the world using Unity, and they ended 2020 with 794 customers generating over a hundred thousand dollars in revenue, and this is up from 600 at the end of 2019.
Luke: And that’s an interesting number, isn’t it? So let’s reflect on their pricing model for developers. You only actually have to pay to use Unity if you’re generating over a hundred thousand dollars a year. As Karle was saying, if there are 800 games being launched every day, a ton of developers out there working on stuff are not paying Unity a penny. The majority of those will probably generate zero revenue, let alone a hundred grand. So for Unity to only have about 800 customers who are paying to use the platform, there’s an unrealized revenue there for that huge number, 99% plus of their customers, who are using the free tier.
Albert: Actually, I think this is some cause for concern because Unity is the market leader for mobile games, and around 93 of the top 100 game studios by revenue are already using Unity, so the gaming market might be nearing saturation.
Luke: But I guess Unity do have multiple revenue streams. So that whole cost to developers, I think they bundle that under their Create Solutions business segment, but they also have an Operate Solutions revenue stream where they generate in-app or in-game revenue from monetizing content and advertising.
Albert: Just to give a bit more detail about the Create Solutions and Operate Solutions, Create Solutions is a subscription-based business where companies pay a monthly subscription and these contracts typically run for two to three years, and they are multiple tiers of membership ranging from a free tier up to an enterprise tier, which costs $2,400 per year per seat.
And Operate Solutions has a more usage-based business model, and here, it’s a revenue-sharing model. When the games are used more and Unity’s features are used more, Unity will earn more revenue from those features.
Luke: That’s where they make the majority of their money. We’ll pick it up in the financial section at the end of the episode, but Operate Solutions is the bulk of their revenue. I think they’ve got a third smaller revenue stream as well though with strategic partnerships with some big tech companies, companies like Apple, Google, Microsoft, Samsung, et cetera.
Albert: This is really important because Unity is the most popular platform to build games on and developers want to know that they can use Unity on a platform before they start developing on it.
Luke: One of the key revenue sources in Operate Solutions is their ability to do in-app advertising. Apparently, Unity is now one of the world’s largest mobile ad networks serving 23 billion ads per month.
Albert: Yeah, they don’t break out how much money they make from advertising but an interesting thing in the last call was that they said Apple’s recent iOS 14 changes regarding privacy might have an effect on their business. And they expect that these changes will reduce their revenue from the advertising business by approximately $30 million, or 3% of their revenue, in 2021.
You know, Luke, advertising is absolutely everywhere. I read an article recently that said a company is now able to insert advertising into old movies. For example, you could be watching a scene in an old movie set in the street and in the background, there would be an advert or something like Coke. I’m not sure if this is done in real-time and it’s customized for each viewer, but this seems to be just a matter of time now.
Luke: It’s horrifying, isn’t it? I’ve been rewatching the Star Wars original trilogy. So actually, I just caught the most recent versions on Disney+. I hadn’t seen George Lucas’ edits until now. It’s horrific. The music is totally different. He’s inserted all these crazy CGI characters. It’s horrible. There’s even a scene at the very end of Return of the Jedi where Jar Jar Binks is dancing around and shouting, “We’s a free!” when the second death star blows up. It’s a travesty messing with art in this way. I really hope that this in-movie advertising doesn’t become a big thing.
Albert: I’m sure there’s a hotline you can call at Disney to complain. Another interesting product from Unity is something called Unity Simulation, which is something that developers can use to train AI models. From their website, they say it is used to harness the power of the cloud to run millions of instances of parameterized Unity builds to generate training data for machine learning, test and validate AI algorithms, or evaluate and optimize model systems. This sounds like a tool that is applicable to a wide range of applications, not just games.
Luke: Brings to mind that Google Deep Mind video from a few years ago. They’re trying to train AI agents to play hide and seek and then they could manipulate the environment in different. And it was really fascinating seeing how the behaviours evolved over millions of iterations.
Albert: Yeah, I saw that and it’s absolutely fascinating. The thing that these AI agents were doing, you would never think of yourself, but they were ingenious.
Luke: So that’s interesting they were using Unity as part of that environment. I guess it’s just leaning on the frameworks and the toolkits for simulating real-world physics perhaps.
Albert: In our chat with Karle, he mentioned network effects. Having a large pool of developer talent is a huge advantage for Unity. Unity has a freemium model and developers are able to start using Unity at very low cost. And I’ve read that it’s actually less programming-intensive than Unreal Engine, and it is the preferred engine among students and amateur professionals.
Optionality
Luke: We also like to look at optionality. I think we picked up a lot of that in the conversation with Karle as well, but they have made a couple of key acquisitions. In April last year, they acquired Finger Food Studios, who create interactive media projects for corporate clients. And just a few months ago in December, they acquired Rest AR, a Tel Aviv-based computer vision and deep learning company that enables fashion brands, online retailers and marketers to scan and render physical consumer products in high-quality 3D using only a mobile device.
Albert: And at the end of 2020, only about 13% of their enterprise clients were outside of gaming, and this is from 8% just a few months earlier. They’re clearly branching out of gaming and into other industries, which is really exciting.
Luke: Yeah, we talked about AR and VR being a key use case for Unity if they’re helping with the build of environments, and today across all platforms, Unity is used to create 60% of all AR/VR experiences.
Albert: I believe we mentioned in our episode on hype cycles that Unity is the most widely used VR platform, and 90% of Microsoft’s Hololens experiences are made using Unity. It’s also used to build over 90% of Samsung Gear VR content as well.
Well, you know what smart guy saw this coming? It was Zuckerberg at Facebook. I think he tried to make a bid internally to acquire Unity back in 2015. He was quoted as saying VR/AR will be the next major computing platform after mobile.
But thankfully, they didn’t succeed in acquiring this company. The last thing I want is Facebook knowing how badly I suck at games.
Luke: Or what kind of reality you are trying to augment.
Albert: Actually, Luke, I don’t think VR will become something that is in every home. I remember playing a PlayStation VR game at a friend’s home a few years ago. It was a Star Wars game and I was flying around in an X-wing. It was really immersive but as soon as I moved the ship, I just felt instantly dizzy and wanted to throw up. My friend did tell me it takes a while to get used to, but I’m not sure I would want to go through that. I’m much more optimistic about AR though.
Luke: I totally agree. I think we mentioned it a few weeks ago as well, but there’s so many applications of AR in the real world. There’s a number of companies already delivering solutions for things like remote expertise. If a more junior doctor perhaps is wearing AR glasses, he could have a remote expert supporting him and helping him figure out where to make an incision or how to conduct that surgery.
Albert: Yeah, that’s really interesting, Luke. I listened to one of the episodes of ARK Invest podcast and they had the CEO of Vuzix on, and Vuzix makes AR glasses, and he’s seeing increased usage of AR in fields such as healthcare and manufacturing. And I’ve read recently that the healthcare VR market is expected to grow at 38% annually until 2025.
Luke: Yeah, that was a really interesting interview. I was fascinated to hear that they’ve basically solved the hardware, it’s expensive but I guess the price will come down, and they were already deploying real use cases with this remote expertise in lots of different fields.
Competition
Luke: Well, let’s talk about competition a little bit. You already mentioned Unreal, and it does sound like they’re big competing platforms, perhaps for different types of applications, but definitely big in the games world. Unreal is owned by Epic Games and Epic are in a pretty big legal case with Apple right now around monetization of their own content. Basically, Apple are trying to take their usual 30% cut of all the revenue generated on the Unreal platform and Epic think that’s unfair.
Albert: I’m not sure if Epic has shot themselves in the foot here, but Apple have blocked their games, especially their really popular game Fortnite, from their iOS devices. And in fact, Apple tried to block Epic from their Mac platform as well, and that is really important because that would block the Unreal Engine from developers. And if you are a developer, would you choose a framework that could potentially lose support on macOS or iOS?
Luke: We don’t want Apple to win this court case even though it could be doom for Unreal because then Apple are going to be able to stake that same 30% claim on Unity-provided games as well. We want these platforms to unhook their tight control over revenues in that way.
Albert: I saw what you did there Luke with doom, but we should add that the courts decided that it was unfair for Apple to block Epic from macOS, so that decision has been reversed. Epic Games is still private and in the latest funding round, they had a valuation of around $28 billion, which is quite similar to Unity.
Luke: I can’t see Apple winning this court case. They’re facing antitrust allegations on many fronts.
Albert: As you know, Luke, I’m a big fan of Apple. I have an iPhone, an iPad, and a MacBook. Well, I have to say that Apple is one greedy company. Taking 30% of all in-app purchases is extortionate and now they want 30% of the money that podcasters make. Don’t they know that most podcasters make jack?
Luke: Well, there are lots of options. We’re not monetizing Telescope Investing and we’ve got no plans to, but if we were to, I wouldn’t want to give 30% of that away to a platform.
Albert: That’s news to me, Luke, no plans?
Luke: You need to plan your retirement around something other than selling ads on here, buddy.
Albert: Alright. I’m off!
Financials
Albert: Well, let’s move on from our financials and into Unity’s. They had their fourth quarter and full-year earnings in February this year, and their revenues were more or less in-line with expectations. Their full-year revenue for 2020 was around $772 million, an increase of 43% from the previous year.
Luke: That breaks down as $230 million for Create Solutions, $470 million for Operate, and then those strategic partnerships are the last piece of $70 million.
Albert: They’re still ploughing a lot of money into growing the business so they’re not profitable yet, but they did turn free cash flow positive in the fourth quarter of last year.
Luke: That’s great, that’s really powerful, and if they can continue to churn out 43% annual growth, they’re going to be a profitable company before long.
Albert: One of the figures we’d like to look at is the dollar-based net expansion rate, which is how much existing customers pay from previous years, and in 2020, the DBNER was 138% and this compares to 133% in 2019 and 124% in 2018. It’s only three years but it’s consistently high and seems to be growing.
Luke: Yeah, it’s consistently really high. I guess that’s what’s driving that 43% year-over-year revenue growth. These are really good revenue numbers. I know that they finished last year over [with] a billion dollars in cash and cash equivalents, so that gives them a lot of money to play with if they’re thinking about other acquisitions.
Albert: And as we mentioned earlier, Unity’s share price did take a dip at the start of this year. I think the main reason for this dip is the overall decline in tech stocks, but another reason is that their guidance for this year was a little bit lower than expected. Their guidance for 2021 for revenue of between $950 million and $970 million, which is a growth of between 23 and 26% year-over-year. This is a bit below their target of 30% growth year-over-year going forward.
Luke: I guess this episode’s going out on the 11th of May. I can’t help but notice that is earnings day for Unity, so it’s going to be really interesting to see if they deliver on their Q1 guidance of 210 to 220 million dollars revenue.
Albert: Yeah, that was a complete coincidence. We did not plan that in any way.
Luke: Well, maybe we’ll check in in the news segment next week and see if they did pull off those numbers.
Key takeaways
Albert: Let’s look at the key takeaways for this episode, Luke. Unity is the leading engine for gaming, especially mobile gaming.
Luke: They’re also the leading engine for AR and VR experiences, and that’s a market that’s going to grow significantly over the coming decade.
Albert: Whether you invest or not is up to you to decide. The valuation today is much more attractive than it was three months ago. The price is almost 50% lower than it was in January. Still, at 26 times sales, it’s not cheap and it will need to maintain high rates of revenue growth to justify its valuation.
Luke: So should we bring it around to the real key takeaway, what are we gonna do? What’s your thoughts on whether you’re going to add Unity to your own portfolio?
Albert: Yeah, I expect Unity to maintain its lead in gaming and increase its revenues from that segment. However, with 70% of the top 1,000 mobile games already using Unity, the gaming market does seem to be nearing saturation. If I were to invest, Luke, the primary reason would be its optionality to move into other industries, especially in VR and AR applications. As you said, it’s already the leading platform for developing AR and VR, and if those things take off, it’s likely to take Unity with it.
Luke: So come on, Albert, I’m going to hold you to an answer. Are you gonna buy Unity or not?
Albert: As I said, it’s been on my watch list for a while now. Now that we’ve done this deep dive, I think I will take a starter position in Unity. What about you, Luke?
Luke: Yeah, I think I’m not just yet. I really like the company. I like the whole future they potentially have, and I totally buy that they’re the dominant platform and the whole optionality around AR, but maybe their revenue’s going to get hit by this privacy case that’s happening right now. As Apple start to allow their customers to control much more carefully the data that they share with advertisers, and I wonder if that does hit advertising revenues. And that whole Operate segment, they don’t break out the numbers, but you can’t help but think that the lion’s share of their revenues is going to be related to advertising in some way.
Albert: Well, they did say that they believe that this change in iOS will impact their revenues by $30 million. That’s only 3% of their revenues, but for a company of their size, that’s quite significant. But I think companies like Unity and for example, Magnite and The Trade Desk, they will find ways around these restrictions and work out other ways to target customers, maybe not so precisely using personal data, but they will find a way and these revenues will recover.
Luke: I think they will, but maybe a new normal gets established. I think nobody knows what’s going to happen in that space. My Magnite position has taken quite a hit more recently and maybe Unity’s going to correlate without quite closely. I buy your argument of taking a starter position. I think I’m just going to let that story play out a little bit longer before I take that same decision myself.
Albert: My main investment thesis is VR and AR, and that might not happen. If AR and VR turn out to be fads then I think Unity’s growth prospects are going to be severely hampered.
Luke: I don’t think AR is a fad. I definitely think that’s the way the world is moving in so many different industries. I would agree that Unity are going to be a key platform there, but it’d be interesting to see how they monetize that. Like, you couldn’t see adverts popping up mid-surgery for a doctor, right?
Albert: You never know, Luke. As we said, advertising is everywhere.
Luke: You cut an incision into the patient and you see a bunch of sausages being advertised alongside the intestines. I think I would pay the premium to my doctor so he can remove the in-surgery advertising.
Wrap
Albert: Before we go, Luke, I want to say happy birthday to one of our good friends, Shree in London. Happy birthday, Shree.
Luke: Is it really Shree’s birthday already? Good grief. Happy birthday, old man.
Albert: Well, that’s all this week. Thanks for listening.
Luke: If there’s a future topic you’d like us to cover, you can message us on Twitter. I’m @LukeTelescope.
Albert: And I’m @AlbertTelescope, or you can email us at feedback@telescopeinvesting.com.
Luke: If you enjoyed today’s episode, you can find more content at our website, telescopeinvesting.com, where you can leave us a comment or a review.
Albert: And if this is your first time tuning in, perhaps consider subscribing to the website so that you are the first to hear about new articles and episodes as they drop.
Luke: Thanks, Albert.
Albert: Thanks, Luke.
Luke: Big thanks to Karle for helping bring some of today’s episode to life.
Albert: Yes, thanks, Karle.
