Should you buy Unity software after the 30% stock market crash?

Shares of Unit Software (U -5.55%) were down more than 30% last week after the company said revenue growth would slow to between 6% and 8% year-over-year in the second quarter. This is a massive deceleration from the 36% increase in first quarter revenue. Management had previously said it expects revenue growth of around 30% per year over the long term.

However, the fast-growing games software provider entered the quarter with a high price-to-sales ratio above 15, which is costly for a company that expects to post single-digit growth in the near term. When a company doesn’t offer the growth implied by a high stock valuation, the stock typically drops.

But now that it has hit new lows, should investors buy it expecting a rebound? Let’s first review what management had to say on the earnings call.

Image source: Getty Images.

What went wrong

Unity has hit a snag within its Operate Solutions business, which accounted for most of its revenue in 2021. For a quick introduction, the company generates revenue from Create Solutions, including revenue from tool subscriptions real-time 3D software development. Operate Solutions includes revenue for additional services, such as monetization tools for video game developers, in addition to hosting and in-game voice chat services.

Segment revenue 2021 Annual growth
Create Solutions $327 million 41%
Operating Solutions $709 million 51%
Other $75 million 7%
Total revenue $1.1 billion 44%

Data source: Unity Software. YOY = year after year.

Unity has revenue sharing agreements with mobile app advertisers, which are included in Operate Solutions. This segment had experienced a deceleration in revenue growth, resulting from AppleiOS mobile privacy changes make it harder for advertisers to track users.

However, a failure in Unity’s Audience Pinpointer tool made a difficult situation worse. This tool uses machine learning to make user acquisition easier for app makers, but one issue is causing reduced accuracy for customers, which hurts sales.

Another issue that affected the revenue forecast is that some erroneous data was ingested by a large customer. It will take time to reconstruct the data and model the training that Unity uses to serve customers. Management estimates that the two issues will reduce its revenue for the year 2022 by approximately $110 million, or 8%.

Unity’s Competitive Advantage

The good news is that these issues affecting the Operate Solutions business are speed bumps that aren’t expected to continue into 2023. Buying growing businesses after a strong sell-off based on fixable issues can be a coping strategy. winning investment. CEO John Riccitiello is confident that Unity will overcome short-term hurdles.

On the earnings call, Riccitiello said: “We have the right strategy to meet today’s challenges, and we have the right talent that has overcome many challenges in the past and come out on top. . Here we are.”

Riccitiello reminded investors of the long-term advantages Unity has in serving a growing addressable market for real-time 3D content. Its main advantage is that more than half of all video games are built with its software and analytics. This provides Unity-exclusive data of over 3 billion monthly active users on all games created with its software.

CFO Luis Visoso’s comment highlighted the most important reason to consider buying the stock: “We believe we are in the early stages of one of the biggest transformations in technology: the shift to real-time 3D. We will continue to invest to capture the opportunity while quickly leading to sustainable and growing profitability.”

Indeed, Unity increased its long-term revenue opportunity from $29 billion to $45 billion with the acquisitions of Weta Digital and Parsec last year. These agreements strengthen Unity’s ability to reach more customers by broadening the accessibility of its products across multiple devices and broadening the diversification of its product offering in 3D design.

Unity will continue to grow

The stock hit a 52-week high of $210 at the end of 2021 and has fallen to $39.74 at the time of this writing. The recent drop has reduced Unity’s market capitalization (total shares outstanding multiplied by share price) from $45 billion to $11.8 billion. That’s a price-to-sales ratio of 9.4, based on Unity’s last 12-month revenue of $1.2 billion.

Table of U PS ratios

UP/S ratio. Data by YCharts. TTM = last 12 months.

I thought Unity was a good stock to own at $100, and I think it could be real value at under $40. The only issue that could keep the stock low for a while is bottom line losses, which have weighed on many growth stocks in 2022.

Since Unity is a software services company whose recurring revenue comes from subscriptions, it should become a very profitable business as it expands its customer base over time.