$U | Unity Deep Dive (Part 1)
$U | Unity Deep Dive (Part 1)
Re-defining reality
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This is the first of two articles that I will publish on Unity. This time, I decided to break the deep dive into two parts because of its extensive length. Topics will be divided between both articles as follows:
Part 1 (the article you are reading right now)
1. Brief History
2. What Unity does and how it makes money
3. The Gaming Industry
4. Use cases for other industries
5. The metaverse
6. Key performance indicators (KPIs)
7. Unity vs Unreal
8. Management Quality and Culture
Part 2
9. Financial Statement Analysis
10. Common Stock
11. Ownership
12. Unity’s opportunity
13. Guidance
14. Why Unity?
15. Risks
16. Performance and valuation
17. Key Highlights
18. Final word
As you can see, there is a lot to cover.
Before getting started I would like to state the objective of the deep dive and a brief disclaimer. The objective of this article is to provide a deep dive on Unity ($U) but it should never substitute your own due diligence. I would never recommend investing or trading solely on third party information.
The following analysis was conducted in the weeks before the 6th of July 2021 so it does not take into account any information released about the company after that date.
Let’s get started!
1. HISTORY
Unity Technologies was founded in 2004 under the name Over the Edge Entertainment in Denmark by David Helgason (right), Nicholas Francis (left) and Joachim Ante (middle).
The company failed in its first video game commercial launch in 2005 but saw potential value in the game development tools they had used to build it. The objective of the company was to “democratize” game development by making the development of 2D and 3D interactive content more accessible to a wide variety of creators, not just professional developers. Oh, if you were wondering how their first game (GooBall) looked like…
The company’s success grew with the launch of the iPhone in 2007 as it was positioned to support creators who developed mobile games. That same year, the company changed its name to Unity Technologies. In 2010, the company launched the Unity Asset Store as an online marketplace where users could sell project assets to each other. The idea of the asset store was to democratize game development even further by making it a collaborative activity. Several years later, the company started expanding outside of the gaming industry to industries such as film and television and automotive.
In 2014, Unity acquired Applifier, which had a mobile video ad network that would later become Unity Ads. This same year the company acquired two additional companies: Playnomics, which would become Unity Analytics and Tsugi, which would become Unity Cloud Build. In October of this same year, Helgason stepped down as CEO (he remained in the company as executive VP) and John Riccitiello, former CEO of Electronic Arts, took over.
In 2016, Niantic released Pokemon Go, which was built using the Unity engine.
Facebook had also used the Unity engine several times as part of its VR ventures. Taking advantage of this success, the company held several rounds of funding that valued the company around $3 billion (2016).
From 2017, the company started working with Alphabet in ventures related to augmented and virtual reality. The company completed its IPO in September 2020 and traded at an initial valuation of $13.7 billion.
I don’t consider this section to be of the highest value add so I’ll let you investigate further if you are curious about the history of the company. Some of the things described or mentioned here may sound confusing to those who don’t know what Unity really does so let’s find out in the next section!
2. WHAT UNITY DOES AND HOW IT MAKES MONEY
2.1. What the company does
Before going into what the company does I am going to explain what a “Game Engine” is because you will read this term a couple of times throughout this article.
A game engine is basically the core software where developers create content and then use to run this content. Imagine having a place where you can place objects, personalize them and then give them the motion you desire, well that would be a game engine. I avoided the word “game” in the definition and I used “content” instead because there are many use cases for game engines outside the gaming industry. Don’t worry, we will go through some of these use cases later on!
Now that we know what a Game Engine is, let’s take a look at what the company does (spoiler alert: is something related to a game engine).
Unity allows creators to create and operate interactive, real-time 2D and 3D content (from now onwards you will probably see the following acronym “RT3D” which stands for Real Time 3D). As this sentence may seem a bit vague, I want to go over some of the words included in it:
Creators are the direct users of Unity and use its software to develop their content. They range from game developers to artists, architects, automotive designers, filmmakers and others. Creators also have differing levels of expertise which shows that someone without a developer background can also learn to use Unity. This is coherent with the company’s vision since the beginning: the democratization of game development
Interactive because it allows end-users to connect with the content and with one another. For example, in a multiplayer game, what one end-user does instantly influences the experience of another end-user. End-users are the people who play the game, watch the film etc.
Real-time because it instantly adapts to end-user behavior and feedback. Images are rendered very fast (up to 120 photorealistic images per second) to create a lifelike experience
3D because graphics are expressed with shape and depth. This allows the company to add value in the Augmented and Virtual reality (ARVR) segment which, as we will see later on, has widespread applications across many industries
Unity’s software offers several advantages for creators as it allows them to visualize and iterate on their creations real-time and collaborate with each other to edit the content simultaneously. These editions are rendered and displayed very fast to create a more seamless and efficient development experience. This is very important because it reduces considerably the time required for any specific workflow.
Another important advantage is that it allows creators to deploy these developments in many platforms without needing to incur in additional development. We will also go over this in a bit.
As you might have already noticed, gaming is at the core of Unity’s offering but Unity’s products and technology enjoy widespread application in several industries beyond gaming, some of which are listed below:
Automotive, transportation and manufacturing
Film, animation and cinematics
Government and aerospace
Architecture, engineering and construction
Brands and creative agencies
Gambling
EdTech
Being able to apply its technology to so many different industries gives the company a huge amount of optionality. Optionality is also a word that you will read several times through the articles.
To summarize, the company offers software that allows creators to create and operate interactive content across many different industries and through many different platforms without needing extra developments. The words create and operate are of vital importance to understand the company so I will go over them in the following section.
2.2. How does Unity make money?
Unity offers many products across two distinct but complementary solutions: Create Solutions and Operate Solutions. Unity also makes money through strategic partnerships with several technological providers and other revenue from sales mainly coming from their asset store. Revenue was distributed in the following way in the year 2020:
As Create and Operate Solutions drive the majority of revenue I will be focusing on explaining these two revenue streams and I will briefly explain the “Strategic Partnership and Others” component of revenue.
Create solutions
First I will explain what “Create Solutions” are and then I will explain how Unity makes money with them.
Create Solutions enable creators to create, edit, run and deploy real-time 2D and 3D content through a robust software development engine that can be augmented both with Unity features and/or third party functionality. Content only needs to be created once to be later deployed across more than 20 platforms which include Windows, Mac, iOS, Android, PlayStation…
There are many products embedded under this solution but Unity offers a modular platform in which creators can leverage the products and use what they need. This way, solutions can be “personalized” for creator needs.
The full stack of technologies are configurable through the Unity editor user interface that is available on Windows, Mac and Linux operating systems. This editor allows creators to drop content (images, textures, sounds…) into a virtual workspace from which they can configure and compose scenes of objects. Once all of the objects have been included, creators have a wide variety of components that they can add to these objects to make content dynamic and interactive (i.e. Unity physics is an example of a component that makes objects subject to the forces of friction and gravity). If you want to take a quick glance at how the editor works I found this video on YouTube. If you don’t want to check out the video, this is how the Unity Editor looks like:
Once the creator has finished creating his/her content and he/she is ready to deploy, Unity runtime interactively renders the content in real time on end-user devices.
Okay so we could say that Create Solutions is a pretty appropriate name as it enables creators to create content but, how does Unity monetize these products?
The company has a subscription based revenue model for its Create Solutions. An overview of the core plans can be found in the table below:
What you can see in the table above is basically that Unity is free for everyone making less than $100,000 in revenue with the content created using the engine. This has important implications because it seems as if Unity is only targeting monetization of the big guys while empowering smaller creators to keep improving.
Taking a look at the payment methods available, only annual subscriptions are allowed and there is no option to cancel subscriptions in advance (well, you can cancel it if you like, but you are not getting the money back). Unity Enterprise only offers monthly payments while the other paid plans can be paid either monthly or in a one-time upfront annual payment. The fact that cancelations are not allowed and that payments are upfront allows the company to have a more predictable cash flow. If you want to see a detailed comparison between these plans you can do that here.
Another important thing to note is that only Unity’s Enterprise product allows customers to modify the source code, making the platform totally adaptable to their needs. We will see later on in the “Unity vs Unreal” section why this is an important difference between both game engines.
I like that the company is specifically targeting students because this will increase the stickiness of the product going forward. Customers will be hiring graduates that are already familiar with the engine which will increase switching costs and will create a similar effect than the one created with AutoDesk’s ($ADSK) software.
Unity also offers a wide range of other products that specifically target certain creators and/or industries which can be bought as an addition to the core offerings discussed above or independently as add-ons. For example, Unity Reflect targets the construction industry and can be bought independently.
Operate solutions
Once the content has been created and deployed, Unity offers its customers the ability to:
Grow and engage their end-user base
Run and monetize their content
Cloud operations
Unity offers several products that allow their customers to achieve these goals such as Unity Ads, Unity In-App purchases (IAP), delta DNA and Vivox. A brief explanation of these products can be found below:
Unity Ads: helps creators by connecting their games to ad networks. They can be used to either monetize the existing player base or to acquire new players (via ads on other games).
Unity IAP: allows creators to sell a variety of items such as premium content, virtual goods and subscriptions directly within the game. For example, imagine you are out of lives while playing Candy Crush (I know that this game belongs to King which belongs to Activision (ATVI) but it’s just an example) and you decide to buy some more, that type of purchase could be powered by Unity IAP.
DeltaDNA: gives creators analytics on player behavior so they can act on it to increase user engagement. If a creator knows what keeps his end users engaged he has a great advantage to increase this engagement further.
Vivox: enables text or voice chat in games so that other players can yell at you when you are demonstrating certain skills in the game.
Some of these operate solutions are not available for free plans although monetization products can be bought for any of the plans, regardless if free or paid:
Unity does not disclose how Operate Solutions revenue is distributed across its different products. One could imagine that Unity Ads make up the majority of these revenues because, Ingrid Lestiyo, the manager in charge of Op. Solutions, is a digital ads specialist.
Operate Solutions allow the company to generate revenue from the ongoing management and success of the content, regardless if this content was created on Unity or using third-party software. This has the effect of expanding the LTV of their customers and sharing their successes which is important for the company because it allows it to profit from a growing gaming industry.
Okay so how are these solutions monetized? Operate Solutions are monetized through a combination of revenue-share and usage-based business models depending on the product:
Monetization products make up the majority of Operate Solutions and are primarily based on a revenue-share model. They are billed on a cost-per-install basis or, to a lesser extent, on a cost-per-impression basis.
Engagement, cloud hosting services and voice chat services are sold on usage and billed monthly with some of them including a fixed-fee usage amount. This group includes products such as Multiplay, Vivox and deltaDNA that are fairly new. The company expects that these products’ contribution will grow as a percentage of Operate Solutions revenue over the long term as they gain traction.
I built the following slide to give a brief summary of what I talked about in this section:
For an overview of how Unity’s products are distributed across these solutions you can check out the following image:
With this, I have already guided you through 90.9% of Unity’s revenue. It’s time to take a look at the remaining 9.1%.
Strategic Partnerships & Other revenue
The name “Strategic Partnerships” might be confusing because they are in fact considered customers by Unity. They refer to partnerships with certain hardware, operating system and console providers that pay Unity so that the company makes the games developed using Unity’s software compatible with their platforms. For example, Microsoft might pay Unity so that content created on Unity’s engine is also available instantly on XBOX.
This way, creators can deploy their creations in many platforms without the need to write native code. Unity also includes ongoing support and updates in these contracts with their strategic partners.
Strategic Partnerships are normally multi-year arrangements where customers pay as milestones are achieved or pay in advance on a quarterly basis.
Other revenue is primarily generated through the Unity Asset Store. The Unity Asset Store is a marketplace where creators upload and sell different assets or tools that can be used for the creation of content on Unity.
This works in a very simple way. For example, using the image above, you could purchase for 67€ the Mountain Environment and forget about having to create something similar.
Unity keeps a commission of 30% for each sale made on the asset store. Even though the asset store is not an important contributor to revenue, it’s an important component of Unity because it simplifies development for many inexperienced creators which is what Unity is all about, remember? The democratization of game development.
Now that we know what the company does, it’s a good time to give a brief overview of the core industry where it operates: gaming.
3. THE GAMING INDUSTRY
The pandemic affected many industries, some in a positive way and others in a negative way. Gaming was no exception as it enjoyed significant tailwinds as the pandemic unfolded. With governments imposing lockdown restrictions, gaming engagement spiked throughout the globe, driving increased spending with it.
The pandemic helped players see that games are not a place where you simply play, they are also a place where you can socialize. 2020 was also the year when many people started to see the potential application of games to other industries (what you can sometimes see referred to as gamification).
I would probably need a full 100 pages to go through the whole gaming industry so the objective of this sections is to provide an overview and allow readers to see why Unity is uniquely positioned to take advantage of its growth going forward. Let’s start with the basics.
The gaming industry is involved in the development, marketing and monetization of video games. I know this is a very abstract definition but giving a more precise definition for an industry of this size is almost impossible, especially because many players of different nature are involved in it. For a little bit of size context here, the gaming industry is the biggest subset of the entertainment industry, doubling revenue generated by the music and movie industry (combined!). According to Grand View Research, revenues for the gaming industry were estimated at $167.5 billion in 2020.
The following graph may help you in some way understand how the gaming industry works:
If you are having a hard time searching for Unity, you can find it in the top-right corner of the graph. After seeing this graph and understanding more or less how the gaming industry works, it’s also important to see how it has been evolving lately. Players play games from three main devices: console, PC and mobile. Revenues across these devices have enjoyed differing growth rates:
Although the chart ends in 2019, the pandemic has brought forward significant growth, driven especially by increased engagement by players and new business models such as Free-to-play.
The chart also shows that mobile gaming is on the rise. 9 years ago, mobile gaming was not as popular as PC or console but the trend has clearly shifted and now mobile represents a greater part of global revenue. While PC and console revenues have grown at about 5% per year, mobile game revenue has grown at about 27% per year driven primarily by increased market penetration of smartphones and increased capabilities of these devices. In fact, it is estimated that 52% of global market revenue (which is estimated around $176 billion for 2021) will come from mobile:
The rise of mobile gaming was also aided by an imbalance of demand and supply (caused by the pandemic) for consoles such as the PS5, which left many players with no option but to go to their mobile phones to play games. Although this imbalance should eventually subside, it is not expected to do so in the very short term.
As you can already imagine, this trend has given massive tailwinds to Unity because its engine basically dominates the mobile game industry. According to a survey conducted by Unity, 61% of mobile games are made using Unity:
Although this is great, there is also one drawback because it’s precisely the mobile segment the one which is going to suffer more from IDFA updates by Apple (more on this on the second article).
Trends in monetization have also changed considerably during the last years. The Free-to-play (F2P) model has been made popular since the release of Fortnite where most of the revenue is generated via in-app purchases after giving players the game for free. This trend seems to be continuing, with in-app purchases making a greater part of total revenues as years go by:
In fact, according to Grand View Research, some trends like F2P, Massive Multiplayer Online (MMO) and multiplayer games are expected to continue their growth into at least the next 8 years. Nothing surprising here because when F2P is established, it’s very difficult to go back to how traditional games were monetized and the social component of games calls for increased multiplayer usage going forward.
The gaming industry has been growing fast lately and it has been clearly aided by pandemic tailwinds but, is this growth expected to persist? The answer is “Yes”. The gaming industry is estimated to compound at an 8.2% CAGR until 2027, sizing the industry in $291 billion that year. This growth will be primarily driven by mobile gaming as smartphone penetration continues to increase throughout the globe and viewing and gaming capabilities improve for this device.
Unity is perfectly positioned to take advantage of increased growth in the mobile gaming industry (through Create Solutions) and the new trends in monetization (through Operate Solutions). Now it’s time to see why Unity is much more than “just” a gaming play.
4. USES CASES FOR OTHER INDUSTRIES
Although we have just seen an overview of the gaming industry, the truth is that Unity has great optionality as its game engine and its ARVR capabilities have widespread applications in other industries. This is exactly why I said earlier that the name for the engine might not be appropriate, it’s much more than just a “game” engine.
In this section I will go over some of the use cases outside the gaming industry for Unity’s technology.
Automotive Industry - Volvo
Unity has helped Volvo achieve an E2E toolchain by using virtual reality at every stage, from design and R&D to consumer-facing applications. According to Volvo’s innovation leader Timmy Ghiurau:
We use Unity as a glue between our projects and modules. It’s not designed to replace existing tools, but enhance them by delivering a complete virtual car experience.
Using Unity, Volvo has achieved a more collaborative, accessible and productive workflow. One of the main advantages is that it reduces the necessity of generating expensive prototypes which are now only necessary at certain milestones, everything else is virtualized. The following is an image of a Volvo Car made with Unity:
For more information about the Volvo case study you can click here.
Architecture, Engineering and Construction - Skanska
Skanska is a Sweden-based construction company that uses Unity in their standard worker-safety training programs. In this case, Skanska is not a direct customer of Unity as it is the company OutHere who provides these services for Skanska using Unity.
The objective of the project is to reduce accidents and create safer construction sites by reaching the emotions of their workers via VR. VR allowed the company to simulate life-like risk situations where workers could work on their decision making under such situations.
For more information about the Skanska case study you can click here.
Film, animation and cinematics - Oats Studio
Unity helped Oats Studio produce “Adam” in 5 months, a production that would’ve taken up to a year under normal conditions. Unity’s engine allowed the team to work in a collaborative way, being able to watch their progress with everyone’s updates included in real time as opposed to a traditional waterfall structure where some segments must be finished before others start.
The Oats Studio team also highlighted the ease of use of the platform, stating that including external data and modifying the scene in Unity’s timeline made them feel as if they were not even working.
For more information about the “Adam” case study you can watch the following behind the scenes video.
I feel as if I could be talking about use cases for Unity’s technology for hours but this is not the objective of this section. The objective of this section was to show several examples of how the company’s products and technology can be applied outside the gaming industry.
As you can see, Unity can be used in almost any industry across different types of uses such as training, design, development...I also think that Unity could be very beneficial if applied to education as it would create a whole different experience for children. Imagine studying the Romans and being able to go to Ancient Rome to live the experience. I feel that this would be a great breakthrough for the educational system.
If you want to go through all of the possible use cases for Unity you can do that in their webpage.
You may be asking yourself the following question: How does Unity grow into these new verticals if their core industry has always been gaming? Well okay, let’s face it, you probably weren’t asking yourself that question, but I am going to tell you anyway.
On many occasions, Unity acquires smaller but already established companies in verticals beyond gaming with the objective of entering into these new verticals or expanding on existing ones. The company also pursues acquisitions with the objective of increasing its product offering (like deltaDNA). These are some of the company’s most recent acquisitions:
VisualLive is an AR company that operates in the architecture, engineering, and construction (AEC) industry to reduce costs and increase efficiency. Unity acquired VisualLive to complement their product Unity Reflect.
Finger Food Advanced Technology Group is a company that uses advanced technologies such as AI, VR, AR and robotics to help global companies solve complex problems. This company is cross to every industry beyond gaming and will be directly integrated into the company’s division Unity Industrial which is in charge of the development and deployment of scalable RT3D solutions and services to any industry or enterprise.
Artomatix is a software company that uses AI and neural networks to streamline 3D artistic workflows in top studios worldwide. This company helps creators to accelerate their creative workflows so it can also be seen as a cross investment for many industries.
Clearly the company has many options available outside the gaming industry. Now it’s time to talk about one of the “coolest” things that the company can participate in going forward: The Metaverse.
5. THE METAVERSE
I can’t do a full report on Unity without talking about the Metaverse because it would make me feel as if I was leaving the very-long-term opportunity for the company behind. This is why I decided to dedicate a full section of the article to it. Some of you might be familiar with the term “Metaverse” while others might be thinking that this term is some kind of science-fiction terminology.
The objective of this section is to make an introduction to some aspects of the Metaverse and to get your imagination going. The objective is not to try to paint a clear picture of the Metaverse because I think that it is a very abstract idea and everyone will probably imagine it differently.
Some history first
The term “Metaverse” comes from the words “Meta” which means “Beyond” and “Verse” which stands for “Universe”. It was first introduced by Neal Stephenson in his novel Snow Crash back in 1992 (yes, your calculations are correct, 29 years ago) where he narrates the story of Hiroaki Hiro, a pizza delivery guy in the real world who follows a parallel life as a samurai in the Metaverse which is a massive multiplayer VR world. What the author basically imagined was a virtual world where everyone could create avatars (this word was also introduced by Neal) and interact just like in real life but on a parallel reality.
For this novel, Neal Stephenson gained his “tech Nostradamus” fame even though he has admitted the following in several interviews (and I quote):
I was just making shit up.
He now works for a startup called Magic Leap as Chief Futurist (is this real life?) where he helps develop an augmented reality platform. What I find kind of magical about his story is that he created a universe that he thought could never be achieved and now he is actually working towards building it. This shows that the only tech barrier in this world is nature. The term was later popularized by Matthew Ball who even has a webpage where there is a section entirely dedicated to the Metaverse.
What is the Metaverse?
The metaverse is seen as the natural successor of the World Wide Web (internet). In its full aspiration, the metaverse is expected to be the gateway for most digital experiences and a key component of the physical world. Due to its expected presence in both worlds, it’s also expected to be the next great labor platform. Almost every business model can be potentially disrupted by it and it will also alter the way we live. If you are having a hard time imagining it, think about someone who lives in Texas while working virtually for a company located in New York or someone who visits a shop to buy something (virtual or physical) from the comfort of their home.
Even if the Metaverse does not achieve its full potential it is expected to be worth trillions of dollars in the - still very distant - future. We all know what happened to companies that tried to benefit early from the internet trend such as Amazon, Apple, Microsoft, Facebook, Google...In fact, many of these companies are already thinking ahead of the rest and are investing (and have been investing already for years) large amounts of money into this space. This is what Mark Zuckerberg shared in an early 2020 post on his Facebook page. He talks about his vision on the Metaverse (it’s long, but it’s worth it):
Augmented and virtual reality are about delivering a sense of presence -- the feeling that you're right there with another person or in another place. Instead of having devices that take us away from the people around us, the next platform will help us be more present with each other and will help the technology get out of the way. Even though some of the early devices seem clunky, I think these will be the most human and social technology platforms anyone has built yet.
The ability to be "present" anywhere will also help us address some of the biggest social issues of our day -- like ballooning housing costs and inequality of opportunity by geography. Today, many people feel like they have to move to cities because that's where the jobs are. But there isn't enough housing in many cities, so housing costs are skyrocketing while quality of living is decreasing. Imagine if you could live anywhere you chose and access any job anywhere else. If we deliver on what we're building, this should be much closer to reality by 2030.
The Metaverse is obviously not easy to build and it will probably come as a natural development of the technologies that high-end tech companies are investing in. There is no clear roadmap towards building the metaverse and it will probably be built by the community as a whole rather than any specific company. These are some of the characteristics that the metaverse should have to achieve full potential:
As you can probably imagine after looking at these core components, the metaverse brings with it a high computational challenge as it has to allow live interactions between millions of users which clearly differs from how the internet is built today.
Even though the metaverse is expected to become a reality several decades from now, we are starting to see how some of its pieces are starting to come together. In fact, if you think about it, the pandemic has forced everyone to move their relationships, work and every other aspect of life to the virtual world through the internet which can be understood as some type of metaverse prototype.
How does Unity fit into the metaverse?
Before talking about Unity’s role in the Metaverse, I think that it’s important that you know the company’s vision on it. Timoni West, VP of Tools at Unity, said the following in an interview:
I think at its fundamental core is..it’s a connected group of different worlds or creations that people have made that are accessible across worlds. We assume these worlds to be digital but with the rise of cross-reality devices that we are seeing we could argue that the metaverse could extend to the physical world.
In fact, the company views mixed reality (physical and virtual) as highly beneficial for society because it is more sustainable and it will allow people to create experiences without moving or to create virtual objects that replace physical objects.
With Unity’s focus on AR/VR and it’s obsession with virtualizing the real world the company is expected to be at the core of the metaverse. In fact, the company is already helping create an example of a metaverse, obviously it’s a subset of a full potential metaverse, but the abstract idea of the metaverse is already there: let’s talk briefly about ZEPETO.
ZEPETO is a 3D avatar platform where users can create, buy and sell virtual items using the platform’s currency. It has allowed celebrities such as Selena Gomez to host fan meetings and brands like Gucci and Nike to launch their latest fashion items on it. The same way that social media revolutionized online marketing, the Metaverse is expected to disrupt this industry to levels never seen before although ads will need to find a way to merge with the immersion experience rather than interrupting it.
Although this app is far from what the metaverse is expected to become, you can see that many companies are working towards it and many of them are using Unity. If you want examples of other companies that are creating Metaverses I can think of Fortnite, Minecraft, Animal Crossing and Roblox. Beyond the gaming industry I can think of Facebook with Horizon, its virtual social media platform that currently runs on an invite only beta.
Final thoughts on the Metaverse
Before starting to investigate the Metaverse I was not familiar at all with it but I now see it clearer. Maybe in a decade (maybe more) the line between the virtual and the physical worlds will blur and the Metaverse will help take down the remaining barriers that exist between people. This will bring new business models, new ways to live and will enormously benefit companies that are at the core of it such as Unity. Something that was created as sci-fi in 1992 might become a reality in 2030. Technology never disappoints.
If you are having trouble imagining something like this, you can watch this concept video from Adobe (ADBE). The demo starts in minute 2 and is 2 minutes long:
If you are still having a hard time imagining it, you can watch the film “Ready Player One” which is more focused on how gaming can build the metaverse. I saw it recently as I researched for this part and I enjoyed it quite a bit.
We have already gone over some topics that give us some context about Unity and of the industries where it operates. Now it’s time to dig into some numbers!
6. KEY PERFORMANCE INDICATORS
In this section I will go over some of the KPIs but, before going into detail, I would like to go over some interesting numbers/facts for the company (all of these numbers are updated as of Q42020):
Games made with Unity served 2.7 billion monthly active end-users
71% of the top 1,000 mobile games were made with Unity
Of the top 100 game development companies, 94 used Unity some way or another
Apps made on Unity averaged 5 billion downloads per month
Beyond gaming, 10 of the Top 10 auto manufacturers were using Unity
I think that these numbers speak wonders about the company’s market reach.
Now turning to the KPIs, I am going to go over Dollar-Based Net Expansion Rate (DBNER) and Number of Customers that contributed more than $100K to Unity’s revenue.
Dollar-Based Net Expansion Rate (DBNER)
DBNER measures the ability of the company to maintain and expand its relationships with customers. This metric compares Create and Operate Solutions TTM revenue for a set of customers across comparable periods by dividing TTM revenue at the end of the period for this set of customers by TTM revenue of this same customer group at period start. Well this explanation seems a bit confusing! But don’t worry, you will end up understanding it if you don’t already.
DBNER does not include revenue by customers that were added during the period although it does include existing customer renewals, expansions, contractions and churn. If DBNER is higher than 100%, it means that customers are expanding their relationship (i.e. they are contributing more to revenue) with the company and it may be seen as a proxy of product quality and stickiness. A number under 100% would indicate that customers are spending less money on the company’s products. Obviously, the higher the DBNER, the better.
Unity’s DBNER is currently high and has been evolving positively:
Several things stand out from this graph:
DBNER is currently 140% which is pretty high. This means that customers included in the calculation of this metric are contributing 40% more to revenue than in the comparable period (one year ago)
DBNER enjoyed a substantial increase from 2020Q1 to 2020Q2 which was caused primarily by pandemic tailwinds. Lockdowns increased gaming engagement substantially which translated into increased Operate Solutions revenue which drove higher DBNER.
This is the great thing about Operate Solutions, as they are monetized on a revenue-share or usage model, when Unity’s customers manage to increase engagement and monetization, Unity benefits too.
With the rollout of the vaccine and as lockdowns ease, DBNER seems to have corrected to more normal levels although it still remains substantially higher than pre-pandemic levels which indicates that COVID may have brought a permanent change with it.
If we take all these things into account and we exclude the effect of COVID we can conclude that the company is being successful in growing their relationship with existing customers. For the most recent quarter, DBNER increased +200 b/p sequentially and +700 b/p on a YoY basis.
Customers contributing more than $100K to revenue
Looking at DBNER we were able to analyze the ability of the company in growing relationships with existing customers. That metric, as I mentioned before, does not include revenue generated from new customers so we can’t draw a clear picture of the effectiveness of the company adding new customers if we just take a look at DBNER.
We don’t have a clear picture of how many new customers the company is adding because the company does not disclose this number but it does disclose how their big customers are getting, at least until reaching a certain threshold ($100K in TTM revenue):
It’s important to note several things before jumping to analyze this metric. This metric may (or may not) include customers from two different origins:
Existing customers that expanded their relationship with Unity until reaching $100K in TTM revenue in the period under review
New customers added during the last twelve months that started generating $100K in TTM revenue during their first year
The truth is that the company does not separate between both of these groups.
Looking at these numbers by themselves we can see that Unity is indeed increasing its big customer count but at what rate is the company increasing them? On a YoY basis, customers > $100K are growing as follows:
In this graph we can see a similar pattern as in DBNER, with customer > $100K growth accelerating in 2020Q2 due to pandemic tailwinds driven by Operate Solution revenue. With engagement decreasing to lower, more usual, levels, Operate solutions revenue decreases which creates a slowdown in customers that generate more than $100K in revenue. These are however, very impressive growth rates that yield a 29% CAGR over the three year period. According to the company in their S1, only 55% of these customers are using both Create and Operate Solutions, so there is still a significant opportunity to cross sell.
DBNER and Customers > $100K in revenue are related KPIs. DBNER includes customers that aren’t necessarily above the $100K threshold so the two KPIs also have some differences of course. Apart from these differences, both KPIs have the same underlying growth driver: the ability of the company to expand its relationships with customers. In fact, customers who contribute more than $100K of revenue are the ones that are driving higher DBNER by continuing to expand their relationships with the company, which has the effect of increasing how much these customers represent of total revenue:
74% of total revenue is generated by customers that contribute over $100K in revenue. This might seem high but revenue is actually very diversified if you take into account the following:
74% of revenue is being generated by more than 837 customers which I would say is very diversified for a company like Unity
This shows that Unity has a lot of creators that are under-monetized who could start contributing meaningfully to revenue in case the company decides to monetize them. In fact, as of June 30 2020 there were approximately 1.5 million monthly active creators on Unity
These KPIs are very impressive overall especially when you take into account that pandemic tailwinds seem to be staying. Brief recap:
High DBNER shows product quality and stickiness
29% CAGR in Customers over $100K
7. UNITY VS UNREAL
If you have made it until this point, kudos to you. Don’t think many people will. You can reply to the tweet where I have posted the deep dive saying: “I made it!” so then I’ll know :)
To wrap up this first of two articles, I think it’s important to understand how Unity’s engine differs from its most important competitor in the space: Epic Games’ engine Unreal.
As Unity’s business is divided between Create Solutions and Operate Solutions it has different competitors for each of these segments. In the Operate Solutions segment the company faces a large number of competitors that include big companies such as Amazon, Facebook, Google, Microsoft and Tencent, some of which are Unity’s strategic partners. In the Create Solutions segment the company faces competition primarily from Epic Games’ game engine Unreal and from proprietary solutions:
For a complete vision of games made with Unity and Unreal you can take a look here and here, respectively. Just to point one out, Call of Duty Mobile was made in Unity.
You should never talk about Unity vs Epic Games because Epic offers many products/services that Unity does not offer. Epic makes money by developing their own games, through the Epic Games Store and through the Unreal Engine but it generates the majority of its revenues through game development, especially since the launch of Fortnite.
However, Unreal and Unity can be compared and are in many cases treated as perfect substitutes. If they are substitutes, why would someone choose one over the other? Well, they are not exactly alike, let’s find out.
First, you should take into account that both started with a different vision. While Unity was focused on making itself more accessible for small teams and small projects, Unreal started focusing on AAA titles and big professional teams. Lately both companies have started moving to the other’s territory by adding additional features outside their area of expertise: Unreal is introducing features that make its platform more accessible while Unity is trying to introduce features to capture more AAA title development.
With respect to versatility, both engines are quite similar. They both have 3D, 2D and AR/VR capabilities although Unity excels in AR/VR over Unreal, especially because it has been in that segment longer. Unity is also the preferred platform to develop mobile games. We can say that both offer a comprehensive set of solutions across many industries although Unity has an edge in some of these capabilities.
If we look at programming language, Unreal uses C++ while Unity uses C#. This means that Unity requires less coding than Unreal at the expense of graphical performance and customization (later in this section we will see how DOTS aims to reduce this performance discrepancy). This said, Unreal integrates “Blueprints”, a visual scripter which is a great alternative to coding as it allows you to do the same things without needing to code. Unity had no integrated visual scripter until recently when it rolled its own solution called Bolt:
As I have already mentioned previously, Unity’s is a bit easier than Unreal because it does not require so much technical and coding abilities. Ease of use has always been Unity’s objective since the vision of the company was the democratization of game development. This is why Unity is so prolific in educational environments and among smaller teams.
With respect to source code, Unreal is open source which allows full customization while Unity is open source only if the customer purchases the enterprise solution. Unity does not allow you to modify the source code if you don’t purchase the enterprise option but it does allow you to see it. This obviously impacts personalization but it helps inexperienced creators avoid making fatal mistakes.
Both engines are very different in how they monetize. Unity uses a monetization model where it charges monthly subscriptions to those customers who make more than $100K in annual revenue. On the other hand, Unreal makes money through a revenue-share model where they take 5% of the content’s revenue. Recall that even though Unity does not have a revenue-share model for its Create Solutions, it is able to monetize customers on a revenue-share model through its Operate Solutions.
Up to now we have seen that Unity and Unreal are quite similar although Unreal seems to have an edge for AAA titles due to availability of high performance. What is Unity doing to solve this discrepancy? The answer is DOTS.
Data Oriented Technology Stack (DOTS)
DOTS is a combination of technologies that work together to deliver a data-oriented approach to coding. It is based on three pillars: Entity Component System (ECS), the C# Job System and Burst:
ECS allows the developer to define how data is organized in memory and how it is accessed by the CPU which sets the foundations for a data-oriented approach rather than an object-oriented approach. This data-oriented approach avoids cache misses which make the use of the CPU more efficient.
The C# Job System allows creators to write fast, parallelized code. It basically allows having many parallelized tasks run at the same time which increases the performance with respect to single thread code.
The Burst compiler gets the C# code and produces highly optimized machine code.
Up to now you might be a bit confused, especially with the terms object-oriented and data-oriented approach, so let me explain a bit further.
In an object-oriented approach, everything is centered around the construction of things, their make-up and the definition of what they do and how they interact so basically everything is centered around objects.
On the other hand, on a data-oriented approach everything is centered around data, not objects. Data is separated from logic and is packed together according to its usage. Just to give a simple example. Imagine you have objects with height and weight, in an object-oriented approach every object will have the data attached to it while in a data-oriented approach, the heights and the weights will be bundled together in two different data structures (heights and weights) and the functions will be separated from the data:
One of the great benefits of object-oriented programming is that it mirrors how the real world is constructed so the logic is easily understandable by humans. Data-oriented design is much better overall because it allows a more efficient use of memory and allows the parallelization of tasks.
These advantages of DoD are very important not only to achieve increased performance, it’s also important because applications are evolving very fast and CPU and memory performance can’t keep up with them, so DOTS allows to continue delivering higher quality content taking into account these constraints.
To show what DOTS is capable of. Unity released this video which features 4.5 million mesh renderers, 200k unique building objects, 100k unique audio sources and 5,000 dynamic vehicles:
Final thoughts on Unity vs Unreal
Both Unity and Unreal engines serve the same purpose but are currently specialized in different segments of the gaming industry. Unity dominates mobile games and AR/VR, two of the fastest growing segments of the industry, while Unreal still dominates the more professional landscape of AAA titles.
Both platforms are very sticky as they require different skill sets by the creators using them so if a creator is highly specialized in one of them it is highly unlikely that he/she will start using the other one. This is exactly why both Unity and Unreal are targeting students and have educational resources at their core, they know that “luring” a student to use their platform can increase their market reach going forward.
Even though both are different I think that they are both working towards the same end goal and are developing features that take them closer to the competition. I think that the gap between both platforms will close eventually (for example with the development of DOTS) and I remain extremely bullish for both. This is a huge market and they basically have an oligopoly so I think that they can both win big. I conducted a poll about this several weeks ago:
8. MANAGEMENT QUALITY & CULTURE
If you are a growth stock investor, you have to be well aware that probably your future returns will mainly come from management’s ability to provide value from sources that are not even present today. This is why it’s of utmost importance to carefully study management, especially its track record and fit within the company. This is precisely the objective of this section, to go over management, the vision of the company and corporate culture.
8.1. Management Quality
As I mentioned in the “History” section, Unity was founded by David Helgason, Nicholas Francis and Joachim Ante. Of the three co-founders, two (Helgason and Ante) still remain in the company:
David Helgason stepped down as Unity’s CEO in October 2014 although he still remains in the Board of Directors.
Joachim Ante still works for the company as Chief Technology Officer (CTO).
Nicholas Francis left in 2013 to pursue other ventures.
David Helgason’s successor as CEO in 2014 was, former Electronic Arts’ CEO, John Riccitiello.
8.1.1. John Riccitiello
Riccitiello is the former CEO of Electronic Arts where he worked 11 years occupying several positions before transitioning to the CEO role. Before becoming EA’s CEO he co-founded Elevation Partners (a private equity investment firm) and he also invested and worked as an advisor in several startups like Oculus VR. Riccitiello was a member of the board for approximately one year at Unity before transitioning to the CEO role.
In the press release where Unity announced Riccitiello would become CEO, Helgason said the following about his successor:
We've had the chance to work together over the last year-and-a-bit and come to recognize how similar our views are on the importance of the democratization of development to a thriving developer ecosystem and healthy games industry. We're in great hands.
Since being appointed CEO, Riccitiello has played a very important role in achieving what Unity is today. He is responsible for the company’s transition towards industries beyond gaming seeing that the technologies used in gaming could be easily applied to other industries such as automotive, construction, architecture...I think that this is really important because a big part of Unity’s opportunity going forward is centered around cross-industry use cases (i.e. foundations of the Metaverse) so it’s great to be in the hands of the person that envisioned this strategy since the beginning.
This said, John Riccitiello is also known for things that transcend his professional role at Unity and they are not particularly positive. In 2019 he was accused of sexual harassment by Anne Evans, former vice president of Talent Acquisition at Unity. According to Evans, John Riccitiello directly propositioned Evans to have sex and she refused so Riccitiello supposedly threatened her to stay silent if she cared about her professional career. Anne Evans later got fired and claimed that her layoff was caused by this incident although the company denied the claims and argued that she was fired for serious misconduct and gross lapses in judgement. This lawsuit is still ongoing, as it can be read in the 10K:
In addition, in June 2019, a former senior-level employee brought a lawsuit against us in the San Francisco County Superior Court alleging claims arising under California law for retaliation, termination in violation of the California Fair Employment and Housing Act, failure to prevent discrimination and retaliation, wrongful termination, defamation and slander. This lawsuit included allegations related to alleged actions by our CEO, John Riccitiello. These allegations were reported in the media. We filed an answer denying every allegation of unlawful conduct made in the complaint and a motion to compel arbitration. The court granted our motion to compel arbitration.
I don’t know whether Riccitiello will end up being held liable (I am not a judge) for these charges but the company faces reputational risk with this lawsuit. I expect reputational risks, if any, to be temporary for the company itself because if the CEO is finally held liable, he will probably resign and the company will appoint another CEO and will continue to execute on its vision.
One would expect to see some sort of consequence of this situation like a decline in share price or bad reviews in GlassDoor. The first did not happen because, when Riccitiello was accused of these charges, Unity was not publicly traded so the company IPOd with this information publicly available to investors. Riccitiello did not receive bad reviews in GlassDoor either as 93% of reviewers approve of him as the CEO.
Even though I think that John Riccitiello is a very good CEO for Unity due to his vision, his ability to execute this vision and his experience in the gaming industry, I think that the company does not face too much key man risk because it has a very talented management team overall.
As it is obvious, I would prefer the company to be founder-led but I am okay if 2/3 founders still remain in the company in one way or another. As I will show you in the “Common stock” section, founders still have significant stake in the company.
8.1.2. Management team
As Unity is involved in many industries and is constantly expanding its use cases, it needs a diverse management team with some sort of expertise in all of Unity’s core areas. Well, the good news is that Unity has a very diverse (understood in a knowledge context) management team. Let’s go over some of its managers and areas of expertise:
The company recently appointed Luis Felipe Visoso as CFO after the departure of former CFO, Kim Jabal. He previously worked as a CFO in Palo Alto Networks and AWS so he brings cloud and cybersecurity expertise to the company
General Counsel, CLO and Senior Vice President Ruth Ann Keene served as vice president for 11 years at Autodesk before joining Unity which gives her ample experience in 3D development
Clive Downie is Unity’s CMO. He has a great background in the gaming industry, having served in companies such as EA and Zynga in the past
Joachim Ante is co-founder and has been CTO at Unity for over 19 years. It’s great to see a co-founder still in the management team
Ingrid Lestiyo is responsible for Unity’s Operate Solutions. She founded Mobsmith, a mobile ad-serving platform that was acquired by Rubicon, where Ingrid served as CEO.
I could go over every manager’s background and area of expertise but this would make this report extremely boring and the objective is to enjoy the report (hopefully). You can clearly see that all of the core business areas of the company (3D, ads, development, cloud…) are more than covered by Unity’s management team.
8.2. Vision
I have gone over this topic throughout the article although I want to briefly go over it again so you can have it concentrated in one section. In the “History” section I went over the vision that the company had since the start and this vision of democratizing game development and empowering creators has not changed up to this day although the company has indeed widened this vision beyond gaming.
Another thing I have talked about is Unity’s vision of the Metaverse in the words of Timoni West which will also be important going forward. If you think about it, both of these visions (about the company as a whole and the Metaverse) are very related because the Metaverse will not be achievable without empowering creators to create real-time 3D interactive content.
8.3. Company Culture
Company culture can have both positive and negative effects on companies. The truth is that measuring positive effects from company culture is very difficult but there are many examples out there where bad company culture has ruined strong business models.
Unity shares on their webpage their core values:
These values are consistent with the company’s vision as being customer (creators) centric and learning from failures are going to be key in the success of the company going forward.
8.3.1. Glassdoor
Now let’s take a look at the GlassDoor ratings of the company. Unity has over 600 reviews on GlassDoor:
Overall rating: 4.4/5
Values and culture: 4.5/5
Diversity and inclusion: 4.4/5
Personal/Work balance: 4.4/5
Management: 4.3/5
Compensation: 4.3/5
Career opportunities: 4.⅖
89% would recommend to a friend and 93% approve of John Riccitiello as CEO (with 370 reviews) as noted previously. This is overall a very strong GlassDoor rating although I am a bit skeptical on the evolution of these ratings because it matches almost perfectly the moment when the company went public:
This big increase might come from two main sources which seem to be very related to the IPO:
Stock options to employees
Management encouraging employees to positively rate the company
The same behavior although less abrupt can also be seen is John Riccitiello’s rating:
I decided that starting from this deep dive I will provide a “GlassDoor ranking” for all the companies I have done deep dives on. Unity currently ranks 2nd after Draftkings (note: ratings are as of the moment I did these deep dives, not current ratings):
Draftkings: 4.5 / 5
Unity: 4.4 / 5
Palantir: 4.2 / 5
Airbnb: 4.2 / 5
Pinterest: N/A (did not include this metric at the time which clearly shows that deep dives are improving)
8.4. Final thoughts on this section
Overall, I like Unity’s management team and I think that it is perfectly capable of executing on the company’s vision going forward. The team has expertise in every core business area and ample experience in the industries where Unity operates. I will, however, closely monitor in future reports the evolution of the sexual harassment lawsuit against Riccitiello just in case it poses significant reputational risks for the company.
Unity has high GlassDoor ratings although their evolution seems a bit suspicious which may be indicative of the company encouraging employees to leave good results or big stock options, either way, this is a good sign of great corporate culture and employee wellbeing.
We can conclude that the company has a good management team overall and a great vision.
And with this, we get to the end of the first of two articles on Unity. The next one will come out tomorrow (07/07) so you have some time to digest this one.
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Stay well!
IQ