Unity Technologies Stock: A Pure Play on the Metaverse

Some people binge-watch TV series. We binge-watch movie trailers, because we generally don’t have the time to devote to a season’s worth of episodes or Oscar-contending films, but we don’t want to exist entirely in a pop culture vacuum. As you might expect from geeky MBAs who cover emerging technologies, our sweet spot is science fiction. The latest binge found that just about every other sci-fi movie coming out is set in some sort of multiverse in which the central character slingshots through parallel realities, usually in a heroic effort to keep Reality with a capital “R” from collapsing. It’s hard not to suspect that Hollywood is using the multiverse to hype the metaverse.

Unless you do exist in an alternative reality, it’s been impossible to ignore the chatter around how we will soon start living our best digital lives through avatars in virtual worlds created out of Mark Zuckerberg’s masturbatory fantasies. Lots of questions remain. Are we already avatars in someone else’s metaverse (aka, the Elon Musk living-in-a-simulation theory)? Do we really want to head down what is undoubtedly a dystopian hellscape (aka, the Ready Player One future)? Will people spend real money on non-real stuff (aka, online porn)? Well, we know the answer to the last one, as Robinhood-types spend millions on buying “prime” virtual real estate and other digital assets with no intrinsic value.

We’ve written a few articles recently on how we might invest in the metaverse sans the hype, and we’re pretty locked on sticking to enterprise-based solutions rather than the drivel that passes for social interaction. One pick-and-shovel play is to analyze in real time the vast rivers of big data that will flow as companies operate, optimize, and monetize these three-dimensional virtual worlds. A more direct way to invest is in the underlying technology used to build the metaverse. 

About Unity Technologies Stock

That brings us to Unity Technologies (U), a company that we first covered as one of the best ways to invest in virtual reality. But here’s the thing: there’s virtual reality, augmented reality, mixed reality, and extended reality. In reality, the metaverse is co-opting all of these concepts. Whatever else it may or may not be, the metaverse is now the default term for how humans will interact with digital content – increasingly across 3D platforms in real time. A number of technologies are integral to this more dynamic form of the Internet. Computer-brain interfaces? A direct portal to the metaverse, no mouse required. 5G networks and beyond? A superhighway for the metaverse, with minimal latency. The Internet of Things? A bridge between our universe and the metaverse, giving it senses. 

And San Francisco-based Unity Technologies? The 18-year-old company is a world builder. Or, more accurately, Unity provides all the tools for game designers, artists, architects, engineers, and others to develop real-time 3D content on more than 20 different platforms, from Apple and Microsoft operating systems to mobile to VR/AR devices. Prior to its September 2020 IPO, Unity had raised $1.3 billion as a startup. Today, it has a market cap of about $33 billion and has outperformed the Nasdaq over that timeframe – about +55% vs +30%. Annual revenue breached the $1 billion mark to $1.1 billion in 2021, an increase of 44% from the prior year.

In fact, since becoming a public company, Unity has averaged 43% revenue growth and holds a significant market share in mobile games. So, we know that we’re invested in a high-growth company with upside. What we want to learn today is how Unity is more than just a gaming engine and how that might help make it a master of the metaverse.

How Does Unity Make Money?

First, let’s look at how Unity makes money. The company splits its spoils roughly into two categories: 

• Create Solutions: Customers who use the platform to create content pay a subscription fee for products and services, which are available at various price points.
• Operate Solutions: This revenue is a combination of revenue-share and usage-based business models. This segment provides “customers the ability to grow and engage their end-user base, as well as run and monetize their content with the goal of optimizing end-user acquisition and operational costs, while increasing the lifetime value of their end users.”

Let’s talk a bit more about the latter, since it accounts for roughly two-thirds of all revenues (based on the first three months of 2021, as Unity’s 10-K for 2021 has not yet been released, just some of the year-end results). A “substantial majority” is monetization revenue when an end-user (ie, some pimply faced kid sitting in his mom’s basement blasting zombies) installs an application after seeing an advertisement (contracted on a cost-per-install basis) and when an advertisement starts (contracted on a cost-per-impression basis). Unity takes a cut from these marketing activities. 

Following the Money

One drawback is that Unity and its customers rely on data collected and shared on end-user devices, such as an iPhone or PC, for targeted advertising. So the recent efforts by Apple to strengthen privacy measures by requiring applications to obtain an end-user’s permission to be tracked means that Unity and its customers will probably lose some of this monetization revenue. To this point: Facebook recently announced the new Apple rules will cost it at least $10 billion in ad revenue this year – and then saw a quarter of its market value evaporate overnight. In general, governments are regulating tech companies into being more transparent, so expect other platforms that Unity and its clients rely upon to follow suit. It will probably take at least the next 12 months to assess impacts to the bottom line. 

Unity is aware of this risk and is looking to expand other Operate Solutions to compensate. In 2018, for example, it introduced its own cloud hosting platform, Multiplay, to support ongoing game and application operations for clients who don’t want to maintain their own hardware infrastructure. The company expects revenues from this and related turnkey services to grow as a percentage of total revenue. Despite the possible headwinds, guidance for 2022 looks very good:

There are some valid reasons for that optimism. 

One metric for how Unity tracks performance involves focusing on customers that generated more than $100,000 of revenue in the trailing 12 months, which represents the majority of the company’s revenue and revenue growth. At the end of 2021, this category grew to 1,052 customers, compared to 793 at the end of 2020. Significantly, no customer accounts for more than 10% of revenues. Another metric the company touts is its dollar-based net expansion rate, which compares its revenue from the same set of customers across comparable 12-month periods. The calculation divides current period revenue by prior period revenue. The 2021 dollar-based net expansion rate was 140%, meaning current customers are spending and generating 40% more money than they did the year before.  

Weta Lot of Acquisitions

Of course, there’s a reason why Unity is growing its revenue and customer base so quickly. It provides one of the leading platforms in existence today to help customers create the future worlds of the metaverse in gaming and beyond. The company recently strengthened its portfolio with the $1.62 billion acquisition of Weta Digital’s tools, pipeline, technology, and engineering talent. Weta Digital is the New Zealand company behind the digital effects in movies like Avatar, Game of Thrones, Lord of the Rings, and Suicide Squad.

Unity is buying the technical side of the business, while the creative types who employ those tools will be spun into a separate company called WetaFX, with Sir Peter Jackson maintaining majority ownership. In turn, WetaFX will likely become one of Unity’s biggest customers. Unity estimates the Weta Digital acquisition will add as much as $10 billion to its current addressable market of about $35 billion.

The November 2021 acquisition is one of more than two dozen by Unity since 2011, as the company has not been shy about adding technology and talent to improve its product over time. In 2021 alone, Unity acquired seven companies, spending at least $2 billion, including the Weta Digital acquisition. The metaverse will not come cheaply. 

The Metaverse as a Digital Twin

Now let’s look at metaverse applications beyond gaming and film – what we’re calling the enterprise metaverse. Unity is run by some big brains who are naturally positioning the company to be a so-called thought leader in the industry. From Dave Rhodes, a senior vice president at Unity: “At Unity, we believe there will eventually be a digital twin of every real-life object, environment, and even people. Our goal is to enable every creator to have the tools to do so.” 

This is exactly what we’ve been talking about in our last few pieces on the topic, and it’s very encouraging to hear that Unity sees this application as a key part of its solutions portfolio. A digital twin is a virtual representation of a real-world object or system. It can be anything from a factory to a smart city. In fact, Rhodes recently provided some real-life examples of these digital twins that his company is developing with its customers. Topping the list is Hyundai, which is partnering with Unity to build what the duo refer to as a meta-factory:

This digital twin of an actual factory being built in Singapore will enable Hyundai to “test-run a factory virtually in order to calculate the optimized plant operation, and enable plant managers to solve problems without having to physically visit the plant.” In addition, consumers will be able to “trial, test and engage various auto-related solutions digitally, long before choosing which to transfer to physical vehicles.” The whole press release from the South Korean automaker reads like one of our recent metaverse articles on the value proposition of the technology: “Hyundai and Unity’s partnership will further accelerate innovation in the field of intelligent manufacturing, integrating AI, 5G and other advanced technologies into a next-generation smart factory platform.”

Conclusion

What the metaverse will and will not be – or whether it will ever be fully realized – is certainly up for debate. But there’s no arguing that our real and digital lives are merging – evolving – in ways we may not yet anticipate (or yet know how to monetize). Unity is well positioned to be one of the technology platforms upon which both the social and enterprise metaverses are built. It’s estimated that more than 2.5 billion people play games based on the Unity engine, putting it on par with the 2.9 billion people who scroll Facebook, which lost about $10 billion on the metaverse last year. 

While the social media giant’s deep pockets are a concern over the long term, a more immediate challenge to Unity Technologies is the Unreal Engine from Epic Games, a private company currently valued at $42 billion. In a future article, we’ll look at the startup behind Fortnite and whether the metaverse is epic enough for both companies.