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Unity (U) Stock | NYSE: U

The Gaming Engine: Zero to 60

Unity Software Inc 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.

The products are used in gaming industry, architecture and construction sector, animation industry, and designing sector.

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.

Growth

87

Valuation

33

Quality

85
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Where Are We Now

Updated on: 11/15/2021

Conviction Score

9

Unity’s gaming engine is used by developers and industry professionals within and outside gaming to create interactive real-time 3D content. We think Unity could be one of the most important companies over the next few decades as the count of use cases for real-time 3D content shoots through the roof. Shares today are certainly not cheap, though. Proceed with caution.

  • Unity today is already working with non-gaming industries like architecture, engineering, construction, film, marketing, automotive, and more. Sales are growing around the 50% mark per year and the company is currently on pace to earn more than $1 billion in revenue each year.

  • Unity is scoring strong, big customer accounts. It has almost 900 customers that pay Unity more than $100,000 per year for its services, up from just over 700 the year prior.

  • The acquisition of Peter Jackson's Weta Digital's 3D tech segment to boost its gaming development portfolio and help it expand into movies and film. We like this deal and think it aligns with Unity's long-term vision.

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 a 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 business has optionality for the gaming engine to be used in other 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, cloud delivery and analytics using Unity’s Operate Solutions provides a full turn key solution for creators and high switching costs.

  4. Operate Solutions provides game developers and other creators a compelling offering to deploy their game. This segment has strong recurring revenues with high margin and high net expansion rate meaning customers spend more on the platform every year.

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

The Basics

Unity Software provides solutions for developers to create and monetize real-time 2D and 3D content for mobile phones, tablets, PCs, consoles, and AR/VR devices.

The platform is mainly used by content creators to develop video games with other industries slowly beginning to embrace the 3D content creation world.

Some industries include: Architecture, Engineering, Construction (AEC), Workplace Safety, and Augmented Simulations.

In terms of the business, Unity generates its revenue from three different segments:

  • Create Solutions

  • Operate Solutions

  • Strategic Partnerships and Other

Unity Revenue Mix (Q3 2021)

Source: Unity Investor Relations

Pioneering Mobile Gaming

The year is 2005 and Unity launched their gaming engine exclusively on Apple’s Mac OS X. This was a strange choice considering that Unity was written in C# which is a Microsoft programming language.

Regardless, Unity’s engine was extremely powerful about to hit the big time with what would happen next.

With the launch of the Apple App store in 2008, Unity was in a fantastic position to take advantage of grabbing almost all of the game development in the iOS ecosystem.

Fast forward to today, Unity has a significant market share in the whole gaming industry being in pretty much a duopoly with Tencent's Unreal Engine.

The Engine to Create, Build, Monetize Zero to 60

Create Solutions

Unity provides a variety of tools and software for content creators and artists to create real-time 2D and 3D content.

ArtEngine and Granite are the main tools used for content creation.

These systems work together to create "ultra-realistic digital artwork" and depth of field graphics to give a truly immersive experience.

Non-gaming industries are also seeing the value of Unity’s Real Time 3D (RT3D) content creation tools.

Unity has put in place specific Create Solutions tailored to these industries such as:

  • Unity Reflect – This platform helps to create RT3D experiences for architecture, engineering, construction, and AR/VR environments.

  • Unity MARS – This service provides professional-grade workflows for AR and VR development.

  • Unity Forma – This product configuration toolkit allows content creators to make visually appealing content for product and service commercialization.

Operate Solutions

Operate Solutions is a suite of solutions provided by Unity to operate the content created using Unity’s Create Solutions, as well as external content outside of the Unity platform.

The set of tools provided allow subscribers to monetize their work through advertisements, maximize the lifetime value of end-users, optimize the cost of acquiring and engaging end users, and manage downtime needed to service games.

Operate Solutions contain the following functions:

User Acquisition and Monetization

  • Unity Ads – allows creators to leverage Unified Auction to earn the highest value for each impression by an end user on their content. Each time an end user views or uses a creator’s content, Unified Auction identifies and shows the best advertisement to show the customer.

  • Unity IAP – IAP refers to In-App Purchases. These micro-transactions allow creators to sell add-ons to amplify one's current gaming experience.

End-User Engagement

  • deltaDNA – This analytics tool enables developers gain insight into behaviours of end users within their game to improve end-user engagement.

  • GameTune – “DSaaS” – data science as a service. Customers use data from end users compiled by Unity to optimize end-user engagement based on a variety of game elements

Cloud Operations

  • A group of services – Multiplay, Build Server, Vivox, Cloud Content Delivery, Furioos, and Simulation designed to maximize the end-user experience by reducing and suppressing technical challenges, delays, downtimes, and unpredictable costs when content is launched.

The ability to bring an idea to life on Unity Create Solutions and then monetize, gain users, use cloud delivery and analytics through Unity’s Operate Solutions provides a full turn key solution.

Not to mention that Unity’s game development life cycle is extremely fast compared to other gaming engines. It has this advantage over the Unreal Engine. That being said both engines serve their purpose and have pros and cons. The Unreal Engine from Epic Games (a Tencent company) is also incredibly powerful and has unmatched graphics.

Unity has a huge ecosystem of developers with tons of resources to reduce the learning curve and to build out games in virtual environments.

The Unity Business Model graphic

Beyond the Create Solutions software offerings, Unity’s Operate solutions make the business very attractive with recurring revenues.

Not only is revenue recurring in nature with the SaaS (Software as a Service) model, customers are typically spending more on the platform every single year.

This is demonstrated in Unity’s monstrous 100%-plus Dollar-Based Net Expansion Rate.

TL;DR: customers are spending more money every year.

Additionally, Unity is continually adding large customer accounts that spend more than $100,000 every year. The exciting part is that a decent chunk of them are in industries outside of gaming.

Customers >$100k of Trailing 12-month Revenue

Source: Unity Investor Relations

The Future of the Gaming Engine Extends Beyond Gamers

The most exciting upside about Unity may be the application of the gaming engine outside of gaming.

Gaming is a huge Total Addressable Market (TAM) to begin. The TAM if you include the potential in the following industry becomes gigantic:

  • Architecture, Engineering & Construction (AEC)

  • Automative, Transportation & Manufacturing

  • Film, Animation and Cinematics

  • Branding and Creative Agencies

  • Gambling

  • Educational Technology

Industry Applications of Unity

Autodesk, a global leader in 3D product design, recently announced a partnership with Unity to bring 3D Augmented Reality and Virtual Reality solutions for specific industries.

This is a clever move by Unity as it will allow the engine to penetrate a massive industry outside of gaming. Autodesk is well known among those in the Architecture, Engineering, and Construction (AEC) industry. Unity can use this brand power to their advantage and bring new solutions that consumers in other industries can use.

Unity's Partnership with AutodeskThis snapshot encapsulates Unity's Engine with Autodesk's Revit to create a spectacular car model

The Competition is Unreal

When it comes to competition, there is only one other gaming engine that stands in the way: Unreal Gaming Engine.

Looking at the industry as a whole, what makes these companies perform well is the moat they have created. The learning curve for both Unity and Unreal Gaming Engine is very steep. Developers take months to specialize in a specific engine due to their differences in programming and interface. This also means switching costs are higher.

Now it comes down to, which gaming engine is better? Why would a team prefer one over the other?

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.

Bottom Line

Unity can benefit from the tailwinds of both gaming and the industry applications outside of gaming.

The company has a significant market share in gaming and will continue to benefit from the growth of the industry. Unity’s revenue growth is impressive and we believe it to still be early innings of this growth story.

Unity has some impressive case studies demonstrating the success of various clients in and out of gaming.

Game Studio, Kefir, generated $125M in revenue in 62 days post-launch with their Zombie killing game, Last Day on Earth. Last Day on Earth has 83 million downloads and millions of daily active users. The studio, Kefir creates, builds and monetizes completely on Unity.

Like many business to business (B2B) software companies, Unity has extremely sticky recurring revenues with high gross margins of 80%.

We believe the upside that both gaming engines owned by Unity and Unreal have huge total addressable markets with capabilities of being highly disruptive in industries such as architecture, engineering and construction (AEC), manufacturing, transportation, film and other virtual environments.

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