Is Epic Games a Threat to Unity Software Stock?

Once upon a time, but not so long ago, Nanalyze covered tons of tech startups. We published dozens of lists, from the top AI startups in the United Arab Emirates (of all places) to some of the first synthetic biology startups making fake food (and now being sold in fast-food places). Starting around 2017, some of these emerging technology companies grew big enough to start disrupting their respective industries. An ensuing flood of IPOs meant retail investors could finally get a piece of the action, as some of the most exciting private tech companies went public. It all peaked in 2021 with more than 900 new public companies, driven largely by SPACtacular speculation

Number of U.S. IPOs since 1999.
The IPO boom and bust cycle for the last two decades. This year, private companies are mostly staying private, with IPOs down more than 80% compared to last year. Credit: Statista

We naturally shifted our focus to covering these companies, now only occasionally analyzing startups when it becomes relevant to retail investors. That doesn’t mean there aren’t a lot of cool private companies to still discover, but what’s the point if the average person can’t get skin in the game? We recently told you about how ARK Invest opened a sort of hybrid venture fund for retail investors to get some limited exposure to private companies. The investment firm is still cobbling together the ARK Venture Fund (ARKVX), with just seven private companies on the list. The heavy exposure (nearly 12% of the portfolio) to Twitter alone may come as a bit of a surprise, but there are some more interesting names in the portfolio. 

About Epic Games

For instance, sitting at No. 3 at 8% of the portfolio is Epic Games, a 30-year-old video game company that has raised at least $6.4 billion in funding. Its most recent fund-raising round came in April of this year – a $2 billion infusion from Sony, which has invested across multiple rounds, and a private Danish holding company that owns the LEGO brand. Nearly 40 investors have jumped onboard since 2012, with Fidelity, Baillie Gifford, Franklin Templeton, T. Rowe Price, BlackRock, Lightspeed Venture, Kleiner Perkins, and Disney among the marquee names. 

Topping the list is Chinese tech giant Tencent (0700.HK), which bought into the company 10 years ago for $330 million. Reportedly the world’s largest company in the video game industry based on investments, Tencent owns 40% of Epic Games. Not a bad investment based on the North Carolina company’s $31.5 billion valuation, enough to make it one of the top 10 most valuable unicorns on the planet. CEO Tim Sweeney remains the controlling shareholder with an estimated 28% equity, according to Forbes. 

Screenshot of Unreal Engine
Epic Games released Unreal Engine 5.1 this month. Credit: Epic Games

Sweeney originally founded the company as a computer consulting business under the name Potomac Computer Systems in 1991. He switched gears after he used his nascent firm to publish his first commercial video game, ZZT. The game designer changed the name to Epic MegaGames before toning it down a bit with just Epic Games. There’s a ton more to the history of the company, but things really took off after 2012 when Epic Games shifted with the industry and adopted the games-as-a-service model, a riff on the software-as-a-service model where recurring revenues revolve around customers paying for access to the online platform in perpetuity. And, of course, there was a little video game that came out in 2017 that even Shakespeare scholars have heard about.

How Does Epic Games Make Money?

Today, Epic Games is primarily known for three things. 

  • Unreal Engine. This is the company’s powerful gaming engine that was originally developed for PC first-person shooter games. It is one of the most popular gaming platforms around and supports content on desktop, mobile, and even virtual reality. Special effects wizards also use it in movies like the Star Wars franchise.
  • Fortnite. Far and away the company’s most popular video game. Don’t ask us what it’s about. We don’t care, except that a large demographic is addicted to it like a country doctor to OxyContin. 
  • An epic lawsuit with Apple. In 2020, Epic sued Apple, which countersued, over the business practices in the Apple app store. Epic also sued Google for a similar reason. Apple emerged victorious but Epic earned some street cred for taking on tech’s most powerful companies.

The last bullet point is particularly relevant for us because Epic released financial figures as part of the lawsuit – information that private companies normally don’t reveal. That’s how we know that it made more than $9 billion between 2018 and 2019. The company also reported more than $5.5 billion in profit from the two-year period, according to an article in Verge. Some of these numbers are likely behind this chart from Statista showing past, current, and future revenue for Epic Games.

Epic Games revenue
Epic Games revenue. Credit: Statista

It’s rather amazing that Epic has pulled in that much money given how much product it gives out for nothing. Fortnite is free to download but users pay real money to buy fake stuff in the virtual worlds in which they create and compete. Unreal Engine operates under a royalty model where it is free to use, but Epic collects 5% on gross revenues after the first $1 million. It actually waives its royalty fee if developers using Unreal Engine offer their games on its Epic Games Store (EGS), which launched in 2018 and only takes a 12% cut versus the standard 30%. Unreal Engine accounted for $221 million in revenue during the 2018-19 timeframe, and EGS brought in about $235 million over those two years. Other games not named Fortnite made $108 million, meaning the online game phenom accounted for most of the company’s revenue – nearly 90%.

Epic Games vs Steam

In fact, it would seem that Epic is milking the Fortnite cash cow to prop up its other business ventures, especially over at its storefront. Ars Technica had a nice breakdown of how much money Epic is bleeding, based on the court filings from both Epic and Apple, as it tries to build up business at EGS. We’ll give you the Cliff’s Notes here with numbers released about 2020 revenue and losses: EGS lost $635 million between 2019 and 2021, based on documents and testimony associated with the lawsuit. Here’s the thing: The online store itself is reportedly self-sustaining. The problem circles back to all the free stuff. Epic Games should be called Epic Giveaways. It reportedly doled out nearly 750 million free games in 2020, probably representing tens of millions of dollars in revenue. That same year, Ars Technica further reported, Epic also paid $444 million in minimum guarantees to developers for exclusive publishing rights. 

Number of games added to Steam since 2004.
Steam has gained steam by adding thousands of video game titles in recent years. Credit: Statista

All of this isn’t just to grab market share from Apple and Google, but to tackle an online games store monopoly that probably isn’t as well known outside of gaming culture. By most metrics, a service called Steam is the leading distributor of online video games. It was developed by Valve, a private video game developer, publisher, and digital distributor out of Bellevue, Washington that a couple of OGs from Microsoft started in 1996. Earlier this year, Steam had nearly 28 million concurrent players on its platform, which apparently is an all-time record for online game distributors, and boasts 120 million active users. For comparison, Epic peaked at 13.2 million concurrent users and 31 million daily active users in 2021– so it is definitely making inroads and cutting into Valve’s dominant market share. The chart below is from a 2019 survey of nearly 4,000 game developers, so only about a year after EGS launched.

Most popular PC video game stores.
Epic Games Store wasn’t even on the radar as recently as 2019. Credit: Game Developers Conference

Steam has something like 50,000 game titles versus just 917 at the Epic Games Store, but the bar for entry is much higher if cheaper at EGS. In fact, third-party games represented just 36% of the $840 million spent through the store in 2021. Sounds like it’s going to cost Epic a lot more freebies to win more market share.

Epic Games vs Unity

The battle that we’re really interested in is the one with Unity Software (U). As we described in a previous article on Unity, the company has a very different business model compared to Epic Games, with all of its revenue revolving around its gaming engine. Developers pay a subscription to create games and content on its platform, though most revenue actually comes from post-creation activities, especially marketing. However, both companies represent long-term plays on the metaverse. That’s because the near term doesn’t look so great: The metaverse play is bleeding companies like Facebook Meta (META) dry, as it tries to convince consumers life is better inside a half-built Matrix. 

Screenshot from Unity Engine.
The Unity gaming engine. Credit: Unity

If you Google Epic Games vs Unity, you’ll end up with about 32 million hits comparing which gaming engine is better. The consensus seems to be that Unity is easier to use and optimized for mobile, while Unreal from Epic is more robust and built for full-on video games. Market share has been hard to peg down, but the consensus is that Unity has a commanding lead overall. The numbers seem to range somewhere like 40% to 50% for Unity and 10% to 20% for Epic’s Unreal Engine. Here’s a snapshot of game developers in the UK, for instance:

Game engine of choice by developers in the UK.
Game engine of choice by developers in the UK. Credit: Statista

That might seem counterintuitive given Epic’s much greater 2021 revenues than Unity – $5.8 billion versus $1.1 billion – but remember that Fortnite generates most of the money. Unity’s recent merger/acquisition of ironSource will only tighten its grip on the mobile gaming and content market, while Epic is paying to grow its market share through its online video store. 

In some ways, the two companies are more complementary than competitive. In addition, a recent study noted that both gaming engines have applications in other areas, from AI to television productions to being the foundation of the metaverse. The researchers went as far as to suggest that gaming engines from companies like Epic Games or Unity are “set to become influential actors in all social and economic arenas that start to rely on game engines for the provision of software or services. This makes them an important subject to the study of platforms as they provide increasingly crucial building blocks in the digitization of economic, political, and social life.” That sounds like there is a large total addressable market for both companies in the future.

Conclusion

ARK apparently is neutral on the debate, as Unity is also part of the new venture fund portfolio, which currently includes a dozen public tech companies. Another metaverse player, Roblox (RBLX), is on the list, along with a couple of companies we recently covered, including DraftKings (DKNG) and Roku (ROKU). The portfolio certainly seems to reinforce the idea that the digitization of life will increasingly dominate our lives. We’re still convinced that Unity is the right play for us. Epic Games would certainly be worth a second look if it ever goes public, but at just 8% of the ARKVX portfolio – a number that will surely decline as the fund adds more companies – the exposure is minimal. The fact that Tencent is reportedly on the hunt to add to its gaming empire, while China’s real-life emperor makes life difficult for domestic businesses, might make a takeover of Epic Games particularly attractive.

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