Is Unity Software Stock a Buy?

Unity Technologies (You 1.16%) went public in 2020, sparking sky-high expectations, and for good reason. According to the company, more than 70% of mobile video games are created using its gaming software, giving it a prominent place in the industry.

The company also makes money from its advertising services. And having so many apps in its ecosystem theoretically gives it an advantage over its competitors.

It’s also worth considering that Unity appears to have a lot of room to expand beyond its core video game application. Its software creates 3D images in real time, which can be used in film, virtual reality (VR), manufacturing, and more. Since it’s a tool that can be used in so many ways, the company appears to have incredible growth potential.

Unity’s potential has also been strongly validated by third parties. Meta-platforms lost over $8 billion on its VR ambitions in the first half of 2024 alone, so it’s clear it wants to win in VR at all costs. And in 2015, CEO Mark Zuckerberg reportedly wanted to acquire Unity for billions of dollars. That was well above its valuation at the time, and suggests that Unity’s products are special enough to be the envy of the tech world.

Unity clearly has promise. And yet, the stock has fallen about 75% since its initial public offering (IPO). Investors surely want to know what’s going on.

The failures of past management are numerous and have contributed to its poor results. It starts with a history of overvalued acquisitions that ultimately failed to drive revenue growth. And related to this problem, Unity continues to dilute shareholders with stock compensation, while it regularly posts large net losses.

To better visualize the earnings problem, consider this: As of the end of 2023, management says it has accumulated $3.1 billion in losses since the company’s inception. Moreover, it expects to continue losing money for some time, as it invests in research and development, among other things.

However, Unity is now under new management. Has anything changed for the better?

Why it’s a good idea to wait to buy Unity stock

On May 15, Matthew Bromberg took over as CEO of Unity and said he was there to “implement change.” He also said the focus was now partly on profitable growth, which sounds encouraging. But details are scarce, so it’s hard to be objectively optimistic.

Whatever the details, nothing exciting appears to be happening in 2024. Unity is winding down some non-core businesses, so some numbers need some clarification. But management expects annual revenue of nearly $1.7 billion for its strategic portfolio, which is down 2% to 3% from 2023.

It looks like the growth part of Bromberg’s plan needs some time. As for stock compensation, it has declined on a relative basis. But as the chart below shows, it remains elevated, at over $100 million in the second quarter.

Share-based compensation (quarterly); data by YCharts.

The reduction in stock-based compensation expenses will take time, but in the meantime, it will likely hamper bottom-line profits. That said, free cash flow factors that in, and Unity is free cash flow positive at $80 million in the second quarter.

This is a positive for the company right now, and free cash flow could increase in the coming quarters. However, investors should keep in mind that the company will likely use this money to pay down its debt.

The company owes more than $2.2 billion in convertible bonds (the debt is unlikely to be converted because the deals were done at much higher stock prices). In 2026, $1.2 billion of that will mature, with another $1 billion maturing in 2027.

Unity repaid more than $400 million in the second quarter alone, more than its cash flow. The company has more than $1.2 billion in cash, which is a good thing. But over the next two years, management will likely pay close attention to its convertible debt.

Here’s why I bring this up: When it comes to creating shareholder value, companies typically need to grow, generate profits, and reward shareholders by reducing their share count. But in Unity’s case, revenue is falling, cash flow is going to debt, and the share count continues to rise.

Unity is a promising company that has been revamped and could see some positive changes. But since there isn’t much to say about it right now, I wouldn’t buy the stock today. At the very least, I’d wait for a more concrete plan from management. And it might also be a good idea to wait a little longer after that to make sure the new management is up to the challenge.

Randi Zuckerberg, former head of market development and spokesperson for Facebook and sister of Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Jon Quast has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Meta Platforms and Unity Software. The Motley Fool has a disclosure policy.