Unity – Russian roulette

Unity gambles with its market position and brand.

• Unity’s financial requirements have led it to alienate its customers which if left unresolved could cause its dominant position to erode and with it the substantial long-term potential it has as the platform for The Metaverse.
• Unity has updated its terms of business which will now require developers who meet either revenue or install thresholds to pay a per-install fee on top of the other fees they already pay.
• Needless to say, developers are hopping mad and a group of 12 have written an open letter stating that they have turned off all monetisation on Unity and IronSource (acquired in 2022) until the new fees are cancelled.
• The 12 are also encouraging other developers to do the same and one (Mega Crit (see here)) has gone so far as to say that it is dumping Unity and going elsewhere for its next game.
• This is a big deal because turning off the monetisation of games via advertising will hurt the individual developers far more than it will hurt Unity in the short term.
• Around 97% of all revenues from games on smartphones comes from advertising meaning that each of the 12 will lose almost all their revenue while Unity will still earn revenues from those studios who continue to monetise with Unity.
• Consequently, in this game of chicken, the studios are likely to blink first but one also has to consider the damage that this may do to Unity’s long-term position.
• I have long thought (see here) that the real opportunity for Unity is not as a game engine but as the unifying platform for the creation of The Metaverse.
• In order to succeed there can be only one Metaverse and at the moment all of the digital ecosystems are busily creating their own proprietary version of the Metaverse none of which will interoperate with each other.
• However, many of them are using Unity to render their 3D environment which provides Unity the opportunity to become the unifying element that allows The Metaverse to function as one rather than many.
• Assuming The Metaverse takes off, this is a far larger opportunity than the one that Unity currently addresses and offers the possibility to move away from advertising towards a subscription or revenue fee model.
• However, if developers now rebel and start seeking alternatives to Unity, then the market will fragment and others will have a greatly improved chance to be the platform of The Metaverse rather than Unity.
• Hence, Unity is running a big risk, but I understand why the company has been forced down this road.
• In this market, unless you are an AI company, growth, profits and cash flow are now required to support a high valuation and Unity’s ability to deliver these has diminished in the last 12 months.
• This is why the shares are down around 80% from their all-time high and have bounced around between $25 and $48 for the last 12 months.
• To break out of this, Unity needs to earn more money from a market that is not growing nearly as quickly as it was during the pandemic and the opportunity of The Metaverse remains many years away.
• By clipping the ticket on installs, Unity will make more money from every game but it will do so at the cost of its customers, many of whom are small developers who are struggling as it is.
• Unity’s thresholds are high enough such that only the biggest developers are likely to end up paying this fee, but these studios are making a lot of noise which will impact small studios who dream of becoming big studios (as they all do).
• Hence, I suspect that Unity will affect some sort of a climb down by increasing the thresholds or getting rid of the new fees completely because competitors are already jumping at the chance to lure Unity customers to their own engines.
• This will not help the financial performance, but Unity is now free cash flow positive and has $1.6bn in the bank, so it has the means to play chicken with the developers.
• The real winner here is the competition which has a window of opportunity to erode Unity’s market share which could break the market for mobile game engines wide open.
• In this scenario, I can’t see Unity lasting very long as an independent company, but it would not be a digital ecosystem or game developer that would acquire it due to the loss of independence that would result.
• Instead, a company like Nvidia, Qualcomm or Arm would make much more sense as an acquirer.
• I still struggle with the value of Unity but if the shares weaken materially should the boycott spread, then a speculative position on the basis of an acquisition might be worth looking at.