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Podcast: Fluctuating Tides S1:E3 (permalink)
calendar icon 2021-09-01 00:00:00 +0000 UTC


Analyzing Unity Software (U), insiders and IPOs, mindshare as a qualitative factor, and how being like flash is good.

Show Notes

Tickers mentioned in this show: U

Tidal River Investments positions the after the first show airing:


Collected U data spreadsheet

Photography from Tidal River Investments can be purchased at https://tidalriverinvestments.com/


Welcome to Fluctuating Tides, the Podcast, Episode 3. I’m your host, SomeCodingGuy, and let’s get right to it!

This week I’m going to be analyzing Unity Software, ticker U, as in, just the letter “U”, a game engine heavyweight with a $38billion market cap that grew up with casual games to a full-service software powerhouse handling everything from simulation to gamer analytics. Unity spiked a lot in popularity during the pandemic when they IPOed last year, and while the stock isn’t cheap, they look like an emerging leader in gaming for at least the next decade.

For this week’s knowledge segment, I want to talk about IPOs and insiders, from an investor’s perspective, since I’m not a lawyer.

What’s an IPO? Just in case you’re unfamiliar with it, an Initial Public Offering or IPO is a way that a company can raise money by selling some of their stock to the public for cash, usually so they can expand faster. There’s a lot of details to this, but that’s the short version.

“Insiders” get their name since they typically have “inside knowledge” of what’s going on at a company which may materially affect what happens to a stock - your executive management team and board of directors will usually be insiders during the normal course of business, since they tend to make decisions on major events that’ll later be told to the public. Where this occasionally gets people into trouble is when they trade on this information before the public has access to it. There’s some common techniques to avoiding this sort of thing, such as a 10B5-1 plan or a blind trust, so the insiders are no longer directly controlling their trades in the company. The 10B5-1 uses regular sales or buys on a predetermined schedule, while the blind trust involves getting a trusted third party to do the trading on the insider’s behalf.

In the case of Unity, there’s a lot of insider sales activity going on. Now normally when I see a lot of insiders dumping a stock, I stay away from it, so I focused in on it right away before looking at anything else. In this case, Unity had just done an IPO late last year after being in business for nearly 20 years, and there were a lot of rounds of funding before the IPO to get there. Pre-IPO financing can get complicated, but fortunately at the IPO, most of the various classes of shares were converted to common stock, making things easier. A few of the early players had decided to cash out at or around the IPO, and a several of the insiders appear to be doing regular sales, probably through a plan, and none of this is that surprising given the company’s age, the IPO, and the stock run up, so I made some notes about it and decided to keep going.

In the game development community, you can’t really go anywhere without hearing about Unity. Game devs absolutely love that Unity is free and easy to get started with, and there’s a wealth of online tutorials on using it to build build games. Unity has managed to stay very creator friendly, with the community focused on getting a high-quality game engine with physics and console and mobile support, which Unity leaves free until passing $100k a year in revenue. This has led to a large vocal community of game makers that champion the product and are familiar with the toolset.

While most Unity customers are not paying for the products, in the last quarter there were about 900 of them that each generate more than $100,000 a year in revenue who do, none of which contribute more than 10% of all revenue on their own. Unity splits this up into it calls the “Create” segment, for products related to getting a game built, and the “Operate” segment, for products related to having the game available and possibly revenue generating. These segments, and the smaller “services” segment, are collectively on track to generating a billion dollars in revenue this year, and they’re diversified globally into roughly equal parts between the Americas, EMEA, and Asia Pacific. While they’ve been growing at a whopping 40% a year, management has guided that they believe they can continue to grow by at least 30% a year for the next 10 years.

After their IPO some large expenses, they still have over a billion dollars on their balance sheet, leaving them with enough money for operations. Of concern is that they also have just over a billion dollars in stock compensation outstanding with lots of insider activity as discussed earlier, but it seems like most of the players that really wanted to get out at the IPO already have.

Their CEO, John Riccitiello, is a veteran of the gaming industry, originally coming from Electronic Arts. He’s been focused on maintaining investment in R&D and future adjacent growth industries and art tools, having referred to art tooling as “the ammunition in this war is art”. Expect to see continued investment in tooling and platforms, as they continue to reap the benefits of supporting all major gaming platforms today with just a single code base, and converting their funnel of community game developers to those in the more than a $100k of revenue club.

Now there is a lot of competition in the game development space, including free tools such as Cocos and Godot, and the semi-free Unreal Engine, if you list your games in the Epic Games online store, but none of these platforms comes close to the Unity tooling in terms of approachability and developer mindshare. While each engine has carved out a niche, such as FPS game and Unreal or 2d games and Cocos, Unity already has a pipeline from education on centered around their products, and their much simpler C# based development environment.

In its simplest case, I view Unity as having the same growth trajectory that Flash did, which was nearly 20 to 30 years in the market, given developer hesitance around retooling when something is working just fine for their business. With around 5 billion monthly active users based on downloads of games built on their product, there’s already a lot of momentum, and I like their play as selling “picks and shovels” in the gaming industry.

The stock has pulled back quite a lot this year, probably due to tough year over year comparisons against the COVID lockdowns, when games and app downloads were at their all-time highs. Looking at QoQ growth, detailed in the show notes, with a well-tested CEO that’s committed to the space, and the adjacent simulation industries that Unity has been developing, including the AR and VR platforms they support, I think Unity has a good chance of keeping to the 30% annual growth that management has been guiding. The stock isn’t cheap at about 35 times sales, but between their full-service suite, and their developer mindshare, I think there’s more here than the market has priced in.

Given all of this, Tidal River is going to take a position in Unity this week.

I included a more detailed version of this in a spreadsheet lined from the show notes. While this is fairly risky stock, Unity seems to be the market leader that’s well placed to take advantage of growth in the gaming world, and I’m putting my money where my mouth is.

If you like the podcast and want to see more content like this get created, feel free to subscribe on your favorite podcast app, or buy a photo from tidalriverinvestments.com - money earned on the photos gets deposited in the investment account. As always, Tidal River Investments and I are not financial advisors, market analysts, or otherwise in any way offering advice for or against any of the securities discussed - meet with a financial advisor for that information. Stocks and funds may not be good investments for you, depending on your financial situation.

We’re here for learning, not advice, and I wish you the best on your financial journey, and remember, tides fluctuate!