Unity Stock Could Soar as Turnaround Takes Hold

Video game engine developer Unity (NYSE: U) is a classic case of a company with incredible assets that nevertheless fumbled its way into a crisis. Unity is one of two major commercial game engines that dominate the market, along with Epic Games' Unreal Engine. There are plenty of other options, but the path of least resistance is Unity or Unreal.

Despite this dominant position, Unity has made some disastrous decisions over the past few years that have decimated the stock. First, the $4.4 billion acquisition of app monetization company ironSource failed to ignite growth in Unity's advertising business. Grow Solutions, which encompasses ads and other monetization tools for mobile games, has suffered from declining revenue in recent quarters.

Second, Unity's attempt at monetizing its customer base through fees tied to app installs was a poorly communicated mess. The company's reputation went up in flames in a matter of days, and the ordeal ultimately led to the ouster of former CEO John Riccitiello.

Unity stock is down more than 90% from its all-time high, revenue is in decline, and the bottom line remains deep in the red. While this may not sound like an enticing investment opportunity, the company is finally taking the right steps to turn itself around.

Bringing costs under control

Soon after the former CEO departed, Unity began a full-scale cost-cutting effort that included substantial layoffs and a scaling back of the company's ambitions. Unity laid off around 25% of its staff earlier this year and began exiting lines of business that were not deemed to be part of its "strategic portfolio."

GAAP operating expenses dropped by 11% year over year in the third quarter of 2024, a step in the right direction. While Unity isn't close to being profitable, the company is producing positive free cash flow. This gives it the flexibility to invest in its core products and go after growth opportunities, even as it works to boost efficiency.

Rebuilding trust

New CEO Matthew Bromberg took over in May. While the cost-cutting effort was already well underway, Bromberg took the critical step of entirely cancelling the fees that had enraged developers. Those fees had already been scaled back, but the fact that they existed at all was an albatross around Unity's neck.

Developer trust isn't going to be rebuilt overnight, but Bromberg appears to understand that trying to nickel and dime Unity's developer base isn't the right approach. In lieu of the fees, Unity boosted its subscription pricing for its large customers, while making its free tier more generous. Some of the developers using the free tier will succeed and move into one of the paid tiers, and Unity will benefit from those customers' successes.

Focusing on the core

In addition to winning back developers, Unity is putting a renewed focus on its core products. Unity 6, the latest version of the company's game engine, is now available and loaded with performance improvements and new features. Artificial-intelligence (AI)-powered features make an appearance, promising to make developer workflows more efficient.

In the advertising business, Unity is full steam ahead on a reboot. The company has brought in new executives, is rebuilding its infrastructure and machine learning capabilities, and has quickened the pace of product improvements. For Unity's advertising business to succeed, it must offer a platform that can deliver solid return-on-advertising-spend for its customers. These changes aim to do just that.

An attractive turnaround stock

Unity's turnaround is going to take time, and GAAP profitability may be years away. But Unity's dominant position in the video game industry, and particularly the mobile game industry, positions it to thrive in the long run if it can get its act together.

Unity is now valued at just over $7 billion, down from more than $50 billion at its peak. While the stock may not reach those heights anytime soon, the company's position in the video game engine market and its potential in the mobile advertising market give it ample long-term growth opportunities.

In-game advertising spending is expected to top $20 billion by 2032 as it grows at a double-digit pace. Unity has only begun to tap into this demand.

A version of Unity that's run efficiently, doesn't anger its developer base, and offers an effective mobile advertising platform that delivers for advertisers is likely worth a lot more than $7 billion. While the turnaround will take time, Unity and its new leadership are finally moving in the right direction.

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Timothy Green has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Unity Software. The Motley Fool has a disclosure policy.