Unity Software Inc. S-1 August 2020

Infrastructure for the “Metaverse”

[disclaimer: Although 10Ks and S1s are snapshots of the company in question, I am interested in the nature of the business and economics of the industry / sector. These articles will not go into financial analysis of companies but highlight interesting business models, macro and microeconomic insights of the industry and companies, interesting accounting issues, risks and any interesting tidbits I can discern. These are not recommendations to buy or sell any securities of the company in question.]

Unity Software is the creator of the Unity Gaming Engine and Platform. Unity and Epic Games (Unreal Engine) are two of the bigger players in the gaming engine and platform space as detailed in this Financial Times article. As the internet and cloud gaming, sSports and entertainment evolves towards what is generally called the “Metaverse” it is likely that these firms will help build the underlying software infrastructure.

Learnings about the Industry / Sector

• Unity believes that the total market opportunity is approximately $29 billion across both gaming and other industries. Unity made $541M in revenue in 2019 so the TAM projected is about 58x the current revenues.

Gaming & AR/VR : In gaming, the company estimates the market opportunity for Create Solutions and Operate Solutions to be approximately $12 billion in 2019 across over 15 million potential creators.

Industries Beyond Gaming like Architects, Builders, Industrial Applications, Automation : In industries beyond gaming, Unity estimates the market opportunity to be approximately $17 billion today, based on the number of software developers, architects and designers they could potentially serve.

• The industry on the creative solutions side is comprised of proprietary game engines built in-house by large game studios, Unity, Unreal Engine (Epic Games) and Cocos2d (Chukong Technologies), which offer game development tools primarily serving the PC games and mobile games sectors, and, in the case of Unreal Engine (Epic Games), industries beyond gaming.

Learnings about the Company

• It is estimated that 53% of the top 1,000 mobile games on the Apple App Store and Google Play and over 50% of such mobile games, PC games and console games combined were made with Unity.
• Has approximately 1.5 million monthly active creators that developed over 8,000 games and applications per month in the six months ended June 30, 2020.
• Revenue grew from $380.8 million in 2018 to $541.8 million in 2019 respectively, representing year-over-year growth of 42%.
• The Unity platform consists of two distinct, but connected and synergistic sets of solutions.
• The Create Solutions are used by content creators — developers, artists, designers, engineers and architects — to create interactive, real-time 2D and 3D content.
• While the Operate Solutions offer 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.
• Unity has a total of 3,379 full-time employees, across 44 offices in 16 countries. Of these 1,879 employees are involved in research and development (software engineering).
• Unity uses Google as their public cloud provider and has a cloud service agreement with Google, pursuant to which they are committed to spend an aggregate of $189.0 million between December 2018 and December 2024.
• Sequoia Ventures 24.1%, Silver Lake Partners 18.2% and JA Technologies (founder’s holding company) 8.2%, David Helgason (founder) 4.4% and DFJ Ventures 1.8% are the top owners of the Unity Software, with CEO John Riccitiello owning 3.4%.
• Revenue grew from $380.8 million in 2018 to $541.8 million in 2019 respectively, representing year-over-year growth of 42%.
• Unity being a software company has phenomenal gross margins of 78%. It is not profitable but with revenues growing at over 40% it is likely to become profitable in the future.
• Balance sheet is strong, they ended June 2020 with 453M in cash.
• In terms of key metrics for enterprise software the number of customers with contract values greater than $100,000 is 74% of Revenue and they are 600 customers in 2019, this grew from 68% and 484 customers in 2018.
• The dollar based expansion rate (land and expand strategy pursued by all enterprise software) is 133% for 2019.

Customers > $100,000 Revenue Over Time

% of Revenue Represented by Customers > $100,000 Revenue Over Time

• Unity is actively working with industries beyond gaming who are increasingly embracing interactive real-time 3D content. They are looking to invest in new products that will expand the platform into several new industries, including architecture, engineering, construction, automotive, transportation, manufacturing, film, television and retail, and across use cases, including automobile and building design, online and augmented reality product configurators, autonomous driving simulation and augmented reality workplace safety training, among others. As of the end of 2019 about 8% of their customers contributing more than $100,000 were in industries beyond gaming.
• Of the $542M Revenue in 2019 about 30% came from the “Create Solutions” vertical and about 54% from “Operate Solutions” and rest from Strategic Partnerships.

• The Revenues have good geographic diversity with 27% of revenues coming from the US, 31% from EMEA, 12% from China and remaining 30% from rest of APAC

Conclusion

Unity along with Epic Games (Unreal engine) are leading infrastructure players in the gaming / 3D entertainment space. Over the next few years / decades this space will rapidly evolve with AR / VR, Online gaming, eSports and movies melding into the “metaverse” — we should expect Unity to be a key player.