While the major stock indexes have surged over the past few years, some stocks have been left far behind. Video game engine developer Unity (NYSE: U) has underperformed the market by a mile over the past few years.
Investors weren't wrong in punishing the stock. Unity spent big on acquisitions that didn't pay off, and a bone-headed attempt to nickel-and-dime developers was a disaster. These mistakes ultimately led to a company reset, major layoffs, and new leadership, and the company's stock is down about 88% from its all-time high.
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While a turnaround will take time, Unity is a comeback stock worth betting on for investors willing to stomach some risk.
A unique position in the video game industry
Unity is an example of a company with an incredible asset that has utterly failed to build a viable business around it. The Unity game engine is one of two commercial game engines, along with Unreal Engine from Epic Games, that have emerged as go-to options for video game developers. There are plenty of alternatives, including commercial and open-source projects, but the path of least resistance is choosing one of the big two.
Despite this position in the industry, Unity has been struggling. The expensive acquisition of ironSource, meant to bolster the mobile advertising business, hasn't produced results. Worse, the bungled rollout of additional fees for developers, based on the number of installs, infuriated Unity's developer base and severely tarnished the brand.
That second error ultimately led the company to replace its CEO and embark on a vast cost-cutting effort that involved major layoffs. New CEO Matthew Bromberg took the step of killing off the hated additional fees entirely, instead raising subscription pricing for Unity's largest customers. The company is also rebuilding the tech stack behind its advertising business in an effort to deliver better results for advertisers and ultimately put the business on the right track.
Long-term potential
Revenue is still in decline, even after excluding the lines of business Unity has exited as part of its reset, and the bottom line is deep in the red. The company is valued at roughly $9 billion, which is tough to justify based on the current results. Unity should generate around $1.8 billion in revenue this year, putting the price-to-sales ratio at around 5.
That rich valuation makes the stock risky, and it could sink much further if the situation at the company doesn't improve. However, with the Unity engine as popular as it is, it's not hard to imagine a future where Unity is worth far more than its current market capitalization.
The company needs to get its core business growing again. Higher subscription fees will help, as will new AI-powered products that cost extra. Unity Muse, which enables developers to generate content and behaviors using AI, is priced at $30 per seat per month. Instead of punishing developers with new fees, the company can add value with new products.
Beyond the core game engine, Unity needs to fix its advertising business. The company is reworking the machine learning stack and data infrastructure that powers its advertising business in the hopes of delivering higher returns on investment to its advertisers. Given the ubiquity of the Unity engine in the mobile games industry, getting advertising right is a huge opportunity.
If Unity can successfully leverage its leading game engine while fixing its relationships with developers, the stock could be a big winner in the long run.
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Timothy Green has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Unity Software. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
