Could Unity become the next Adobe?

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Unit software (U) initially looks like a game company. Its game engine, which simplifies the development of cross-platform titles, is used to create more than half of the world’s mobile, console and PC games. It also helps developers analyze their games and monetize them with in-app purchases, ads, multiplayer tools, and other services.

However, Unity’s cloud-based tools can also be used to develop non-gaming digital experiences for education, enterprise, e-commerce and mixed reality markets. Its recent acquisition of Weta Digital, which created special effects for films like The Lord of the Rings and TV series like game of thronesalso gives it a solid footing in the cinema market.

Image source: Getty Images.

Unity locks all of those customers in with three tiers of paid subscription plans. This prisoner-taking business model makes Unity look younger Adobe ( ADBE )which also locks customers into cloud-based subscriptions for its digital media and enterprise software.

So could Unity, which today trades at around a seventh of Adobe’s market capitalization, become as big as this cloud software giant? Let’s review their similarities, differences, and growth trajectories to find out.

The similarities and the differences

Unity’s business strategy is similar to Adobe’s, but it’s much less diverse. All of Unity’s business revolves around its namesake game development engine, which serves as the foundation for value-added services (such as ads and in-app purchases) and strategic partnerships. Adobe’s portfolio includes dozens of applications, including Photoshop, Illustrator, and Acrobat, which serve a wide range of creative and enterprise customers.

Unity operates three main businesses: Create Solutions (29% of its revenue in 2021), which houses its main development engine; Operate Solutions (64% of its revenue), which provides its value-added services and revenue-sharing plans to developers; and Strategic and Other Partnerships (7% of its revenue), which signs partnerships with other companies.

Unity primarily competes with other game engines, such as Epic Games’ Unreal Engine. However, deeper expansion of the 3D graphics design market could make Unity a contender for Autodeskwhich owns 3ds Max and Maya, as well as Adobe’s Dimension.

Adobe operates two main businesses: Digital Media (73% of its revenue in 2021), which includes its Creative Cloud and Document Cloud services; and Digital Experience (25% of its revenue), which hosts its enterprise analytics, marketing, e-commerce and e-signature services.

Adobe’s Creative Cloud services compete with a wide range of smaller competitors, while its digital experience services compete with similar services from Selling power, Microsoft, Shopify, and other tech giants. Adobe is firmly profitable by generally accepted accounting principles (GAAP) and non-GAAP measures, but Unity is not yet profitable by either measure.

How Unity could become the next Adobe

Unity’s revenue grew 43% in 2020, 44% in 2021, and expects 34% to 36% growth in 2022. The company estimates it can generate annual revenue growth of more than 30%” over the long term” and break even on a GAAP basis in 2023. By comparison, analysts expect Adobe’s annual revenue to grow at a compound annual growth rate (CAGR) of just 13.3 % between 2021 and 2024.

Unity’s long-term growth could be driven by the secular expansion of several markets. Mordor Intelligence estimates that the global video game market will continue to grow at a CAGR of 9.6% between 2022 and 2027. The virtual and augmented reality markets could also grow at a whopping CAGR of 40.7% between 2022 and 2030 , according to Report Ocean, as more companies develop immersive metaverse experiences.

The development of more in-app advertising, which should be immune to ongoing platform-related changes on iOS, Android, and other operating systems, could also generate tailwinds for Unity’s Operate Solutions business. Unity will also likely acquire other companies to expand its Operate Solutions portfolio to sell additional services.

If Unity maintains a CAGR of 30% from 2021 to 2030, its annual revenue would grow from $1.1 billion to nearly $12 billion by the final year. That would put it in the same league as the current Adobe, which generated $15.8 billion in revenue in 2021.

Why Unity could become the next Adobe

If Unity can maintain its target growth rates, it could generate massive multibagger gains over the next decade. Diversifying its cloud services beyond video games could also bring it closer to Adobe.

I own both of these stocks and think Unity looks like a younger, hungrier Adobe. It’s leveraging its gaming market dominance to expand into other markets, its margins are gradually improving, and it’s shrewdly locking in customers with a sticky cloud-based ecosystem. Unity stock isn’t cheap at 19 times this year’s sales, but Adobe was also trading at similar valuations – but offering less than half the growth – just a few months ago.

Therefore, investors who can handle short-term volatility should consider accumulating shares of Unity at these levels. This is a promising company that could be mentioned in the same breath as Adobe, Autodesk and other cloud-based design giants in the near future.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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