What is surprising is the company’s guidance for the second quarter, which saw a cliff-like slowdown in revenue growth, which was also significantly lower than market expectations.
After the U.S. stock market closed on May 11, Beijing time, the game engine leader Unity released its results for the first quarter of 2022. As a high-quality shovel stock in the Metaverse, the overall performance this quarter was basically within the guidance, and the main thing that was slightly lower than market expectations was the Operate business, which was affected by the advertising industry. But what is surprising is the company’s guidance for the second quarter, which saw a cliff-like slowdown in revenue growth, which was also significantly lower than market expectations.
The detailed reasons were not disclosed in the performance briefing. Dolphin believes that the main factor is still the drag of advertising headwinds on Operate’s revenue. According to the rough calculation of the guidance data, Operate’s revenue is likely to experience negative growth. In addition, there may be the impact of exchange rate changes.
1. In the first quarter, Unity achieved a total revenue of US$320 million, a year-on-year increase of 36%. Unfortunately, it did not exceed market expectations as before.
2. Among Unity’s three businesses, the Create solution accelerated its growth again, with a growth rate of 65% yoy, exceeding market expectations by 50% yoy. After acquiring Weta at the end of last year to continue to develop non-game fields, management has indicated that Create will have a higher focus than Operate in the future.
3. Due to the decrease in the contribution of Operate’s advertising revenue, the overall gross profit margin dropped significantly by 6 percentage points to 70%.
4. R&D rates and sales rates continued to rise, but were mainly caused by the increase in employee equity incentives. After excluding this impact, only the R&D rates actually increased slightly. Considering the consolidation of Weta, the increase in R&D personnel costs is not unexpected .
5. For the guidance for the second quarter, the overall revenue is expected to be in the range of 290-295 million US dollars, which is significantly lower than the market expectation of 360 million. In addition, the overall profitability has also deteriorated rapidly due to the decline in the proportion of high-margin advertising revenue, and the operating loss rate under Non-GAAP is also as high as 21%-22%. In addition, considering the impact of advertising resistance encountered this year, Unity has also lowered its performance guidance for the whole year compared with the figures given in the previous quarter.
6. The short-term headwind of the advertising business, which mainly contributes to profits, has also escalated the market’s concerns about Unity’s profit model and cash flow. As of the end of the first quarter, the company held cash of 1.163 billion and free cash flow of 86 million, which was significantly positive, but mainly due to the cash inflow contribution brought by the substantial increase in long-term contracts. If this factor is excluded, free cash flow is still negative, but in the short term There is little cash flow pressure.
Long Bridge Dolphin Core Viewpoint
Unity’s report card this time is undoubtedly disappointing. When both large and small advertising platforms were most affected by Apple’s ATT last year, Unity performed “unscathed”, which also made the market more believe that Unity can overcome this year’s advertising headwinds China alone is good at it, but it backfires.
Dolphin Jun believes that advertising follows the change of demand cycle. If Unity’s forecast for the second quarter and the whole year is lowered, it is only because of advertising headwinds. In fact, we are not very worried about Unity’s long-term logic, but more need to survive. Bottom of this period.
On the contrary, if management mentioned some other factors in the revenue guidance in the later conference call, especially the description of some impact on Create business, such as competition from peers, such as the expansion of customers in non-game fields. If it’s not that smooth, then it’s time to recalibrate Unity’s long-term space.
But Dolphin believes that this possibility is not high judging from the increase in short-term and long-term contracts in the first quarter and the company’s recent series of business progress.
Judging from the company’s annual growth outlook, it is expected that the impact of advertising in the second half of the year will be gradually digested, and the overall performance will return to a relatively high growth rate. It is worth mentioning that employee equity incentives account for a large proportion of Unity’s compensation system, and Unity’s share price has been cut in half in this round of collection, which may have some impact on the stability of employees’ work.
As of today’s after-hours, Unity has touched a minimum of $32/share, which is significantly lower than the IPO offering price of $52/share. According to the 2022 revenue guidance ($1.35-$1.45 billion), the PS valuation is about 10 times, already Gradually fall to the current relatively mature, low-growth SaaS company valuation level.
Under the assumption that the long-term logic will not be affected, and considering the recovery of growth in the second half of the year and next year, Dolphin believes that the current Unity has fallen into a reasonably undervalued valuation range.
However, Dolphin also needs to remind that during the macro contraction period, the market’s requirements for growth stocks will be more stringent. Once the growth stalls, it will be difficult to confirm the bottom of the stock price under short-term sentiment.
Basic introduction to Unity business
Unity is mainly composed of two businesses, the Create solution and the Operate solution. The revenue contribution distribution comes from the seat subscription revenue of the main game development engine and the revenue of the advertising platform responsible for matching the bidding.
1. From the perspective of Unity’s business structure in the past few years, although Unity’s reputation lies in its absolute monopoly in the mobile game development engine market, in fact, the contribution rate of the Create solution business to the overall revenue is not the highest. And with the accelerated growth of rewarded advertising games, Operate’s advertising revenue has also risen rapidly, which has a greater support for Unity’s revenue, especially profit.
2. Looking back on Unity’s performance in the past two years, Create’s revenue has basically maintained a growth rate of 30%-50%, which is in line with the performance of a relatively stable SaaS platform, that is, the user penetration rate has reached the stage ceiling, but the sticky renewal rate is high Guaranteed, the annual revenue growth depends on the user’s use of more tools and software or the effect of the platform’s price increase.
For SaaS platforms, after the steady-state period after the customer expansion period, the profit margin will continue to increase, and the platform value will also be realized. This is also Unity’s long-term logic.
3. Although Unity’s operating losses are still relatively large at present, the main reason is that the monetization rate of the main engine is lower than that of its peers, and the profit model of Create has not yet run up. In recent years, the company has continued to increase its investment in non-game fields. extension.
4. Before the main business field is profitable, it will not hesitate to invest in new markets. Unity is tapping its own new growth drivers in advance. This is also mentioned in several speeches by the management. The company’s current strategy The point is to grab more of the market. But it also brought concerns about the profitability model and the company’s cash flow.
Although the listing raised 1.3 billion yuan, Unity’s acquisition of Weta at the end of last year cost nearly 1.2 billion yuan in cash. Therefore, in order to maintain the cash required for basic operating activities, the company had to raise an additional $1.725 billion through the issuance of a convertible note last quarter, which made the cash flow situation significantly eased and there was little short-term pressure.
Detailed interpretation of this quarter’s financial report
1. There are no surprises in revenue, guiding thunderstorms
1. Overall situation
In the first quarter, Unity’s overall revenue was 320 million, a year-on-year growth rate of 36%, basically close to the upper limit of the guidance. However, compared to the consistent performance that has far exceeded the guidelines and expectations in the past, the report card this time is not satisfactory.
But what surprised the market even more was the guidance for the second quarter. The revenue growth rate and profit level fell off a cliff, and the annual revenue also fell naturally, but the reduction rate was not as high as that in the second quarter. Therefore, the second quarter may be Unity’s fastest growth rate this year. bad time. The company did not disclose the reason in the performance briefing. Dolphin Jun guessed that it was mainly affected by Operate’s advertising headwind. In fact, Operate’s performance this quarter was already lower than market expectations.
Regarding why advertising headwinds can have such a big impact, Dolphin Jun believes that we can focus on the management’s explanation at the next earnings call. We will release the minutes of the conference call in the investment research group and the Changqiao community as soon as possible.
2. Segmented business
In terms of revenue structure, the Operate business is still the main contributor, but Create is catching up quickly. In last quarter’s earnings call, management had already given expectations that with the addition of Weta and Ziva, Unity’s Create solution business will grow faster than Operate in the future. Prior to this, most of the market’s main growth focus for Unity was on Operate.
Dolphin Jun believes that the acceleration of Create’s growth in the first quarter and the substantial increase in deferred revenue all show the trend of Create’s increasing prosperity. Among them, the early locking of long-term contracts can also support Create’s income in the short and medium term in the future.
3. Customer distribution
In the first quarter, the number of customers who spent more than US$100,000 in 12 months increased to 1,083. The spending expansion rate of old customers for more than 1 year was 135%, and the contribution of old customers to total revenue declined slightly.
Combining these two indicators, new customers with low payment levels are constantly being developed. These new customers are expected to increase their demand for product functions with in-depth experience of the Unity platform, and the average payment amount will also increase.
2. Changes in income structure, increase in equity incentives while weakening profits
Unity provides an advertising bidding matching platform, which mainly plays an agent role, and cannot actively control advertising inventory and placement. Therefore, when revenue is recognized, after a certain percentage of revenue is collected, most of the revenue is calculated on a net basis. Therefore, the gross profit margin of the Operate business, which is dominated by advertising revenue (accounting for about 80%-90%), will be very high.
In the first quarter, the proportion of Operate business revenue fell from 62% in the previous quarter to 58%. At the same time, the Create business, whose gross profit margin is not yet high (Create charges lower than its peers), increased by 5pct. As a result, the change in revenue structure has led to a weakening of the overall gross profit margin.
On the expense side, employee equity incentives have always been an important part of Unity’s compensation structure, accounting for more than 20% of total costs and more than 30% of total revenue. Compared with the fourth quarter, the proportion of equity incentives further increased in the first quarter.
If the impact of equity incentives is excluded, it can be clearly seen that the quarter-on-quarter weakening of operating profit is mainly due to the increase in the overall cost rate brought about by the revenue structure. From a year-on-year perspective, although profitability improved in the first quarter, under the guidance of the second quarter (-21%), the improvement trend of profit margins in the past two years also collapsed in the short term.
3. The short-term cash flow pressure is temporarily small
Since the profitability model has not yet come out, for Unity, cash flow is also a very key operating performance tracking indicator. As of the end of the first quarter, the company’s cash on account (cash and cash equivalents, restricted cash) accumulated to US$1.16 billion, an increase from the previous quarter, but mainly from the increase in advance receipts from long-term contracts.
The increase in long-term contracts here also includes the consolidation of Weta, so such a high net increase in long-term contracts in the first quarter is not sustainable. However, from the perspective of the company’s competitiveness in the non-game field, Dolphin believes that the growth of future contracts is still expected to be higher than last year.
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