Top News

#1: Unity Earnings Illustrate Continued Advertising Challenges

Source: Unity

Unity Software’s shares sank after its Q4 earnings announcement for the 2022 fiscal year missed the mark. Analysts polled by FactSet expected Unity would report a GAAP net loss of $0.42 per share and $438 million in revenue for the quarter. While the company delivered a top-line beat, with sales of $451 million (or 43% growth year over year and 40% sequentially), earnings per share came in at a loss of $0.82 as operating expenses surged, driven by sales and marketing expenditures. 

While Unity was able to beat revenue expectations, it had to spend considerably more on marketing to do so. Note that Unity merged with Israeli ad-tech company ironSource during the past quarter, too, inorganically boosting top-line results. Management did not provide commentary on the size of the impact, and the company said “analysts should make their own calculations and adjustments as they deem appropriate.”

Guidance for the 2023 fiscal year also missed expectations as well. Analysts were anticipating about $520 million in revenue for the full year, and Unity guided in the range of $470 to $480 million. This is about 9% shy of midpoint expectations, which have been trending upwards since Unity’s Q3 earnings, when guidance was more in line with consensus.

The stock slid by 15.9% on February 23rd, the most since Q1 2022 earnings last May. Stock based compensation (SBC) for both the quarter and the year grew significantly. SBC in Q4 2022 was $173.9 million, 78% higher than Q4 2021’s total of $97.9 million. For the entire fiscal year, SBC was $537.8 million, up 55% from the prior year; this represents roughly 40% of revenue, a fairly absurd number. These measures are reconciled to arrive at adjusted EBITDA, which is why analysts place more scrutiny on GAAP totals, which in Unity’s case continue to underperform expectations. Management’s EBITDA target of $1 billion in 2024 is on an adjusted basis, but if high SBC trends continue, much of hitting this target may be attributable to adding back SBC and making that “profit” metric extremely misleading.

Profit metric
Source: Koyfin

Other issues contributing to the stock’s slide include the loss of paying customers for the Create segment, which includes the company’s subscription offerings for its development engine. Customers with revenue above $100,000 fell by about 1% in Q3 2022 (last quarter), marking the first decline for the segment since Unity’s IPO. While customers increased in Q4 2022, this is likely entirely due to the ironSource acquisition, and management has not provided reconciliation for what standardized figures would look like. Given this lack of disclosure, it is likely that customers organically declined in Q4 as well.

Unity Q4 2022 Earnings
Source: Unity Q4 2022 Earnings

The quarterly report also came with a substantial change to Unity’s reporting structure, primarily due to integrating Unity’s ironSource acquisition into the business. These changes saw Create Solutions merge with Strategic Partnerships, and Operate Solutions renamed to Grow Solutions. Previously, Unity reported through three segments — Create Solutions, Operate Solutions, and Strategic Partnerships & Other. Create Solutions is the company’s content development business, in which developers subscribe to a plan which includes the Unity engine, various development tools, and a wide range of third-party plugins and services. This ranges from free, for users who received less than $100,000 in revenue or funding in the most recent 12-month period, to upwards of $2,040 per year per seat for enterprise customers. 

Operate Solutions is based on revenue sharing rather than subscriptions. This segment included Unity’s advertising efforts, mainly based off its Unified Auction platform, which is the company’s real-time bidding exchange for ads in Unity products. Operate also included deltaDNA, a game analytics and marketing company acquired in 2019, and various other subsidiaries with cloud-based offerings. Lastly, Strategic Partnerships & Other included its bespoke arrangements with its largest partners, which include both fixed-fee and revenue sharing agreements. The “other” portion primarily includes the Asset Store, a marketplace run by Unity where game development teams of all sizes can buy and sell 2D and 3D models, SDKs, audio resources, and other assets.

Going forward, Create Solutions will include all previously reportable items plus Strategic Partnerships, which will cease to exist as a segment, and Unity Gaming Services, which includes services for game monetization and multiplayer networking. This will serve to increase FY2022 revenue from $508 million under the old reporting structure to $716 million. Operate Solutions will be renamed Grow Solutions, and will continue to include advertising products, publishing (Unity’s Supersonic subsidiary), device-management (its Aura subsidiary), and marketing (its Luna subsidiary). The effects of the change in reporting structure for both segments can be seen in the charts below. Note Q4 2022 earnings include the impact from the merger with ironSource, which closed last November. 

Create Solutions grew every quarter under the old reporting structure, while Operate (now Grow) fared less well, only growing in Q4 due to the ironSource merger. This is a reflection of weakness impacting the mobile games market with regard to a significantly weaker digital advertising environment. While guidance was not provided for individual segments, management commentary calls for a 10% contraction in the game ads market in 2023. Unity of course is also not immune to Apple’s IDFA changes, and the macro impact of a post-lockdown environment where gaming revenues have shrunk as consumers resume in-person activities is reducing spending on digital goods.

Create should fare better driven by the proliferation of assets utilizing Unity’s development platform. The company’s applications have grown tremendously since its days as just a gaming engine. Immersive experiences in VR, AR, and XR are being built for various platforms, including Meta Quest, Microsoft HoloLens, and HTC Vive. Like its rival Epic Games, Unity has seen wide use in the film and animation industry, too, growth which may accelerate after the assets from the Weta Digital acquisition in 2021 are made available to customers. The architecture industry has also benefited from the Unity toolset, using it to create interactive visualizations of urban environments. Last but not least, the healthcare sector has created virtual simulations for medical training, wherein practitioners can train on virtual models rather than actual humans. 

Still, Create will not be enough to free Unity from its post-IPO doldrums, as Grow comprises about half of the company’s revenue in the current reporting structure. The company only forecasted a return to trend growth in Grow “when the economy improves,” an opaque declaration given solid consumer spending numbers and the lowest unemployment rate in 54 years. The market has continuously discounted Unity’s valuation since its September 2020 IPO. At the end of the 2020 fiscal year, the company had an EV/Sales ratio of 51.7x. In 2021, this ratio fell to 36.6x, and as of the last report, stands at just 8.4x. Annual revenue growth fell from 43.8% in 2021 to 25.3% in 2022, despite the inclusion of ironSource revenues in Q4. 

Annual revenue growth
Source: Koyfin

This forecast is likely too optimistic, given digital ad spending forecasts continue to decline. As of October 2022, Insider Intelligence forecasts a $5.5 billion hit to digital ad spending in the U.S. versus its prior forecast in March, due to the same factors mentioned above. In an inflationary environment with a Fed Funds rate nearing 5%, investors’ appetite for “hyper-growth” SaaS has been tempered. If the macroeconomy were to improve, Unity will need to prove that ad spending on its platform is improving in lockstep, to justify even its current valuation.

While the ironSource acquisition was undoubtedly pricy given Unity paid a 74% premium to its share price, there are long-term synergies between the two operations that should prove fruitful. In particular, ironSource’s ad mediation offering — which helps app developers work with multiple ad networks (including Unity’s) in one spot — are a major complement to Unity’s other advertising services. IronSource’s app revenue solutions also help developers optimize their app monetization in a post-IDFA world, in which targeting has become much more difficult. 

Overall, Unity’s report highlighted the company’s challenges with sustained profitability sans SBC, and a deteriorating digital advertising market affecting half of its business via the Grow segment. The market has discounted Unity relentlessly since its lofty IPO in September 2020, during the peak of easy-money euphoria. Of course, it is not all negative for the company, as Create continues to grow despite uncertainty over organic customer growth post the ironSource acquisition in Q4. Unity’s main goal, at least in the near term, should be to integrate ironSource with the new Grow segment as rapidly as possible, and cost costs — especially SBC — where possible.  

#2: Gaming IPO Activity Plunged in 2022. What Comes Next?


It’s no secret that 2022 was a landmark year for deal-making activity in gaming. In January alone, the year kicked off with Take-Two’s acquisition of Zynga for $12.7 billion, followed a week later by the announcement of Microsoft’s all-cash takeover of Activision Blizzard for $68.7 billion. These rank as No. 2 and No. 1 of the top video game acquisitions of all time. 

Then, as January was about to come to a close, Sony announced a deal to acquire Bungie for $3.6 billion, in an attempt to secure additional first-party resources amidst the growing battle for exclusive content (though Bungie would remain a multiplatform development studio) and live service talent and expertise. While megadeals were scant for the rest of the year, given rapid deterioration in markets, there were still $41 billion in closed deals and an additional $70 billion of announced deals, according to InvestGame’s Global Gaming Deals Activity Report

The robust M&A environment only explains one side of the year’s gaming financing story, however. Public offerings activity plummeted in 2022, from $24.5 billion the previous year to just $4.6 billion, a decline of 81%. More than half of the year’s total was comprised of Take-Two’s bond offering in April, when it raised $2.7 billion across three tranches to partially fund the purchase of Zynga. 

This raised Take-Two’s debt level considerably, as the company had just $200 million in long-term debt in the previous quarter. When looking at just IPO, SPAC, and Direct Listings, activity was down a whopping 95%. InvestGame notes that among gaming companies brave enough to IPO or SPAC during the year, their share prices “have significantly decreased compared to the closing price of the first day of trading.” This created a feedback loop dissuading other companies from going public in 2022, a phenomenon endemic to the entire tech sector. 

Further gains in the share prices of publicly traded gaming companies will be the gating factor for IPO activity in 2023. Companies have shown a willingness to stay private for longer and longer periods, but they may use a material improvement in economic conditions to raise money via equity financing. Since its trough in October 2022, the VanEck Video Gaming and Esports ETF (ESPO), the largest gaming fund globally, is up 26%. This is still sharply lower than at any point in 2021 though, and the fund is down 38% from its February 2021 peak. 

Fund Metrics
Source: Koyfin

Even for more creditworthy gaming companies like Take-Two, corporate bond yields are north of 5%. The company’s credit curve has jumped from yielding 3% to 4% during its issuance last April to 5% to 6% this February. For other companies, while debt financing at these levels may still be preferable to IPOing and subsequently taking a big valuation hit (like Roblox in 2021), if the current uptrend can be sustained through the second quarter, we may see direct listings and IPOs reemerge. As for SPACs, it’s unlikely the structure will ever make a strong comeback, especially given increased scrutiny around investor disclosures. 

Gaming investors have been eagerly awaiting the IPO of Fortnite developer Epic Games for more than two years, since the company hired an investor relations specialist in February 2021. The company has been waiting on the sidelines, thanks to the ease at which it has been able to raise private funding. Epic has also been waiting for the resolution of its lawsuits against Apple and Google over app store policies, which Epic alleges are anticompetitive. Epic’s lawsuit against Google is set for a jury trial on November 6th of this year, which may delay an IPO until 2024. 

Still, if a settlement is reached earlier, or Epic decides to go public amid ongoing litigation, it would likely be the second largest gaming IPO of all time, behind Roblox. Epic’s most recent venture round saw it raise $2 billion from Sony and Kirkbi at a $31.5 billion post-money valuation last April. This is only slightly higher than its $28.7 billion valuation it garnered in April 2021, but it’s still a positive development given most other gaming companies saw their valuations decline over the same period. Fortnite has also been unavailable on Apple and Google’s app stores since August 2020, and its (potential) return may represent a catalyst for the company, whose revenues are still primarily driven by Fortnite microtransactions.

While not a gaming company per se, there is a slight chance instant messaging social platform Discord may see a public markets debut in 2023 as well. The company has raised just under $1 billion over 16 venture and secondary market financing rounds. Discord’s most recent venture round was its Series H in September 2021, where it raised $500 million in new funding, at an approximate valuation of $15 billion. Note however that last November, the Fidelity Contrafund, which owns private shares of Discord, slashed its internal valuation for the platform from $550.6 a share in May 2022 to $373.7 a share in June 2022, a 32% reduction. Coupled with the fact that Discord’s monetization is currently limited to Discord Nitro and server boosts, an IPO for the platform may come in 2024 or later. 

Aside from these larger players, a handful of other private gaming companies may look to go public in the future. Korean Crossfire developer Smilegate last mulled an IPO in 2019 to fund development of a mobile version for its Lost Ark RPG, but such a port has not yet been developed. Hong Kong blockchain game developer Animoca Brands raised $110 million at a $5.9 billion valuation last September, utilizing its investors to become “pre-IPO ready.” Last but not least, miHoYo, the developer and publisher of Genshin Impact, could look to IPO in 2023, now that Chinese scrutiny on the video game industry has started to abate.

While IPO activity in 2023 will probably not come close to 2021’s milestone, it is difficult to imagine a market environment for gaming worse than last year’s. We expect equity financing in 2023 to exceed last year’s totals, while debt deals should be limited given rising interest rates. In particular, we may see more activity outside of China (including Hong Kong) given the end of COVID-zero policies and regulators’ declaration that the tech crackdown is “basically over.” 

Top Movers

Weekly Top gainers
  • For the week ending February 24th, 2023: the median return for gaming companies tracked by Naavik with a market capitalization exceeding $500 million was -1.63%.
  • GREE Inc. was the top gainer for the week, gaining 10.2%. While there was no specific news related to the company, GREE reported earnings two weeks prior on February 8th, when the company’s operating profit exceeded its forecast due to strong performance from Heaven Burns Red, a free-to-play mobile game. The title made Google Play’s list of “Best Games of 2022” last November. (Link)
  • Unity plunged -25.4% on the week after its FY 2022 Q4 earnings report disappointed the Street, particularly as guidance for 2023 missed expectations by a large margin. The company’s Grow segment (which was renamed from Operate), which contains its advertising capabilities, only grew due to the acquisition of ironSource as the digital ad market continues to suffer. Unity’s earnings are explained in more detail in the Top News section above. (Link)

Most Notable Strategic Investments

SockMonkey Studios
Source: SockMonkey Studios
  • Canadian video game developer Behaviour Interactive acquired U.K.-based SockMonkey Studios for an undisclosed sum. Behaviour is the largest game developer in Canada, with over 1,200 employees across its three business units — Studios, Digital, and Business Solutions. The developer is behind titles such as Dead by Daylight, Middle Earth, and Fallout Shelter, and currently makes games for all platforms. SockMonkey is mainly a contract studio, and has co-developed or ported about two dozen titles since its inception in 2013. The studio will be rebranded as Behaviour UK, and will provide external development services business through its parent firm to existing clients such as EA, Take-Two, and Netflix. (Link
  • India-based Kratos Studios acquired IndiGG using some of the proceeds from its recent seed round, where it raised $20 million at a $150 million valuation. IndiGG is a subDAO of Yield Guild Games (YGG), and the transaction was executed as a token-transfer wherein Kratos purchased $INDI tokens from existing holders. Kratos co-founder Manish Agarwal said in an interview with The Block that “token holders will be swapped for the dollar value they initially invested so that they don’t have to mark down their investment.” Kratos also plans on reissuing new tokens within a year’s time for further fundraising. (Link)

Most Notable Venture Financings

  • Azra Games raised $10 million in extended seed funding in a round led by a16z Crypto. Azra is currently working on a sci-fi action RPG called Legions & Legends, which will incorporate NFTs as in-game collectibles. Prelaunch passes were also launched on OpenSea with a floor price of about 0.30 ETH, which will unlock benefits “in all future games in the Azra universe.” The team is led by Mark Otero, who was formerly General Manager at EA Capital Games, where he oversaw the launch of Star Wars: Galaxy of Heroes. (Link)
  • Strider raised $5.5 million in a seed round co-led by Makers Fund and Fabric Ventures. The company was founded by executives from EA, Rockstar, and Jam City, who collectively worked on story-driven IP like Harry Potter, Grand Theft Auto, Red Dead Redemption, and Westworld. Strider is still pre-product, but the team aims to create a platform enabling communities to create stories together via “communal storytelling.”  Furthermore, while the company is currently incorporated in the U.S., it is exploring becoming a DAO to emphasize the community-driven project. (Link)
  • London-based Quell raised $10 million in Series A funding led by Tencent. Quell is the “first dedicated fitness gaming platform,” offering hardware wearables which enable activity in the company’s upcoming titles. The system’s first title will be Shardfall, an action RPG which will debut alongside Quell’s first fitness wearables called Impact. The company plans on launching multiple titles over the coming years, with plans for online and local multiplayer modes. (Link)
  • Kratos Studios, a web3 gaming studio based out of India, raised $20 million in seed funding at a $150 million valuation. The round was led by Accel, and had participation from other VCs like Prosus Ventures, Courtside Ventures, and Nexus Venture Partners. Co-founders Manish Agarwal and Ishank Gupta plan on using the funding to expand further into Southeast Asia, building distribution capabilities in these emerging markets for their web3 games. The proceeds were also used to fund the acquisition of IndiGG, which is covered in more detail in the Strategic Investments section above. (Link)


  • Microsoft signed a 10-year deal with Nintendo to ensure that future Call of Duty games will continue to make their way to Nintendo players. That same day, the company also signed a 10-year deal with Nvidia, to bring Xbox PC games to GeForce Now. Microsoft President Brad Smith tweeted on February 21st that the company was “committed to providing long term equal access to Call of Duty to other gaming platforms.” This remains a key issue surrounding Microsoft’s planned acquisition of Activision Blizzard. Both the FTC and the U.K.’s Competition and Markets Authority (CMA) specifically named Call of Duty as a concern for gaming competition, with the CMA going as far to say the franchise may need to be divested for it to approve the deal. Smith rebuffed this prospect, stating that the deal would not go through without Call of Duty remaining under Microsoft. Sony was offered a similar 10-year contract last November, though the two sides are reportedly “not close” to a deal. (Link 1) (Link 2)
  • Sony’s State of Play 2023 took place on February 23rd, where the company showcased new games for the PlayStation 5 and PSVR2. Highlights from the presentation regarding PS5 content included a new trailer for Destiny 2: Lightfall, the latest major expansion for the Bungie MMORPG, a trailer and August release date for Baldur’s Gate 3, and extended gameplay for Suicide Squad: Kill the Justice League, which launches on May 26th. In terms of PSVR2 releases, five new games were announced. These include a new action title from nDreams called Synapse and a new game based on sci-fi author Isaac Asimov’s Foundation books called Journey to Foundation. (Link)

A big thanks to Mario Stefanidis, CFA for writing this update! If Naavik can be of help as you build or fund games, please reach out.

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