Quick Take

Unity Software (U) has filed to raise $950 million from the sale of its common stock in an IPO, according to an amended registration statement.

The company provides a platform for creating 3D content for a variety of industries.

Unity has produced an enviable revenue growth trajectory while turning in the direction of lowered operating losses and operating cash burn, so the IPO is worth investor consideration.

Company & Technology

San Francisco, California-based Unity was founded to develop a platform to enable users to create 3D games, media & entertainment content, architecture, engineering & construction visualizations, and automotive, transportation and manufacturing content.

Management is headed by president and Chief Executive Officer Mr. John Riccitiello, who has been with the firm since November 2013 and was previously CEO at Electronic Arts (EA) and Managing Director at private equity firm Elevation Partners.

Below is a sample short film created by Unity’s Demo Team:

Source: Unity

The company’s primary offerings include:

The Create Solutions system is primarily provided through a monthly subscription revenue model, while the Operate Solutions offering is provided via revenue-share and usage-based revenue models.

Unity has received at least $1.2 billion from investors including Sequoia Capital, Silver Lake Partners and JA Technologies ApS.

Customer/User Acquisition

The firm targets a wide variety of publishing studios and individual creators and accepts clients through either its Create or Operate solutions.

Frequently, customers onboard through one solution and later begin to use the other solution.

Sales and Marketing expenses as a percentage of total revenue have been trending lower as revenues have increased, as the figures below indicate:

Sales and Marketing

Expenses vs. Revenue

Period

Percentage

Six Mos. Ended June 30, 2020

24.8%

2019

32.1%

2018

35.3%

Source: Company registration statement

The Sales and Marketing efficiency rate, defined as how many dollars of additional new revenue are generated by each dollar of Sales and Marketing spend, was 1.1x in the most recent reporting period, as shown in the table below:

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Sales and Marketing

Efficiency Rate

Period

Multiple

Six Mos. Ended June 30, 2020

1.1

2019

0.9

Source: Company registration statement

The Rule of 40 is a software industry rule of thumb that says that as long as the combined revenue growth rate and EBITDA percentage rate equal or exceed 40%, the firm is on an acceptable growth trajectory. U’s most recent calculation was 24% as of June 30, 2020, so the firm needs some improvement with regard to this metric.

The company’s dollar-based net expansion rate was 142% as of June 30, 2020. A figure above 100% indicates strong product market fit and an efficiency sales and marketing process. Essentially, it is negative net churn and 142% is quite impressive.

Market & Competition

According to a 2020 market research report by ResearchAndMarkets, the global gaming industry is expected to grow at a CAG of 12% from 2020 to 2025.

The immersive gaming segment is expected to generate $4.5 billion by the end of 2020.

E-sports and fantasy sites have continued to attract gaming investment as they represent ‘immense potential.’

Also, the report forecasts that the console segment is expected to see ‘significant growth’ during the forecast period.

Major competitive or other industry participants include:

For its Create Solutions system:

  • Epic Games

  • Chukong Technologies

For its Operate Solutions system:

Financial Performance

Unity’s recent financial results can be summarized as follows:

  • Growing topline revenue

  • Increasing gross profit and gross margin

  • Significant operating losses but lowered negative operating margin

  • Sharply reduced cash used in operations

Below are relevant financial results derived from the firm’s registration statement:

Total Revenue

Period

Total Revenue

% Variance vs. Prior

Six Mos. Ended June 30, 2020

$ 351,325,000

39.0%

2019

$ 541,779,000

42.3%

2018

$ 380,755,000

Gross Profit (Loss)

Period

Gross Profit (Loss)

% Variance vs. Prior

Six Mos. Ended June 30, 2020

$ 279,025,000

46.4%

2019

$ 423,182,000

41.3%

2018

$ 299,488,000

Gross Margin

Period

Gross Margin

Six Mos. Ended June 30, 2020

79.42%

2019

78.11%

2018

78.66%

Operating Profit (Loss)

Period

Operating Profit (Loss)

Operating Margin

Six Mos. Ended June 30, 2020

$ (52,282,000)

-14.9%

2019

$ (150,669,000)

-27.8%

2018

$ (130,301,000)

-34.2%

Net Income (Loss)

Period

Net Income (Loss)

Six Mos. Ended June 30, 2020

$ (54,087,000)

2019

$ (163,190,000)

2018

$ (131,602,000)

Cash Flow From Operations

Period

Cash Flow From Operations

Six Mos. Ended June 30, 2020

$ (15,419,000)

2019

$ (67,936,000)

2018

$ (81,059,000)

(Glossary Of Terms)

Source: Company registration statement

As of June 30, 2020, Unity had $453.3 million in cash and $641.7 million in total liabilities.

Free cash flow during the twelve months ended June 30, 2020, was negative ($100.1 million).

IPO Details

U intends to sell 25 million shares of common stock at a midpoint price of $38.00 per share for gross proceeds of approximately $950 million, not including the sale of customary underwriter options.

Assuming a successful IPO at the midpoint of the proposed price range, the company’s enterprise value at IPO would approximate $10.5 billion.

Excluding effects of underwriter options and private placement shares or restricted stock, if any, the float to outstanding shares ratio will be approximately 9.49%.

Per the firm’s most recent regulatory filing, the firm plans to use the net proceeds as follows:

We currently intend to use the net proceeds we receive from this offering for general corporate purposes, including working capital, operating expenses, and capital expenditures. We also intend to use a portion of the net proceeds we receive from this offering to repay the outstanding $125 million of indebtedness under our credit facility, which we borrowed in order to provide liquidity in case of any material impact on the financial markets related to COVID-19 but which we have not used to date.

Management’s presentation of the company roadshow is available here.

Listed underwriters of the IPO are Goldman Sachs, Credit Suisse, BofA Securities, Barclays, William Blair, Oppenheimer & Co., Piper Sandler, Stifel, Wedbush Securities, Academy Securities and Siebert Williams Shank.

Commentary

Unity is seeking U.S. capital markets financing to pay down recently-incurred debt and generate a public market for the stock.

The firm’s financials show strong top-line revenue growth and gross profit growth, reduced operating losses and cash used in operations.

Sales and Marketing expenses have been dropping as revenues have increased; its Sales and Marketing efficiency rate has increased to 1.1x.

The market opportunity for creating 3D digital content is large and expected to grow at a substantial rate in the coming years. Video gaming is an enormous global industry with strong growth prospects.

According to a May 2020 compilation of public SaaS firm multiples, the stock market is valuing them at an all-time high:

Source: Meritech Capital Partners

Unity is seeking to go public at an EV / Revenue multiple of 16.4, a price below the next twelve months revenue equity value weighted multiple of 20.4x shown above.

While the IPO isn’t exactly cheap, I’m impressed by the firm’s revenue trajectory, reduced negative operating margin and lowered use of cash in operations.

Unity has a strong industry tailwind in its favor and has diversified its revenue stream into two streams, content and monetization, so the IPO is worth a close look.

Expected IPO Pricing Date: September 17, 2020.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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