Unity has been struggling to find its footing for a while now. Prior to the runtime fee fiasco, the company was dealing with slowing growth, the aftermath of bad M&A decisions, and persistent unprofitability.

Since then, Unity has continued to make headlines for all the wrong reasons. Press coverage has been dominated by reports of layoffs, executive departures, and product divestitures. As a result of all the bad press and its poor financial performance, the market has punished Unity with another 60% share price decline over the past year.

On paper, the company seems to still be stumbling from mistake to mistake. However, many of its recent moves have been calculated and should ultimately set the company on better footing. In today’s digest, we’ll discuss the key business developments since the runtime fee debacle and offer our predictions on how these changes will affect Unity’s two key business lines: its development engine Create (about 30% of its revenue) and adtech arm Grow (approximately 70% of its revenue).

The Interim CEO's Reign

After John Riccitiello’s ignominious departure from Unity, James Whitehurst stepped into the interim CEO role while the board searched for a permanent replacement. Whitehurst has a long and distinguished resume, his crowning achievement being his 12-year tenure as the CEO of Red Hat, which culminated in a $34B sale to IBM in 2019. He was seen as a steady hand who could help manage the customer backlash and steer the business on a course toward profitability.

Managing the Customer Backlash

Some of the loudest complaints were addressed before Whitehurst joined the company, when Unity revised its runtime fee proposal in late September, noted in the image below.

When Whitehurst stepped into the interim CEO role in October, he stood by the revised runtime fees, but promised no more surprise changes that would have a “material impact” on developers. Although Unity’s customers perceived the fees as a simple cash grab, Create’s traditional seat-based licensing model had to change because it clearly wasn’t a sustainable business. Introducing runtime fees was a critical step toward making the engine business profitable. It also offered an avenue for future growth as the seat-based licensing model slowed with increasing penetration.

As much as Whitehurst’s public statements and private discussions with developers have helped assuage fears of other sudden changes, the situation has left developers painfully aware of their dependence on Unity. This is especially true for mobile developers, where Unity has a 69% market share in the top 1,000 games.

Unity's path to rebuilding trust with developers will be a long-term project, and the company will have little margin for error. Given that the Create business still isn’t profitable, and the additional revenues from runtime fees don’t kick in until Unity 6 is rolled out in late 2024, Whitehurst also reined in costs to set the business on the right course.

Steering the Company Toward Profitability

The company’s restructuring plan was guided by a shift in mentality from “Let’s spend a lot and hope revenue ultimately scales” to “Where do we have competitively differentiated businesses that can generate meaningful profits?”

Portfolio Rightsizing

This started with pruning the product portfolio, which has branched out in many different directions through internal growth initiatives and M&A, with $5.3B spent since 2019.

Specifically on M&A, many of these deals were struck at incredibly high multiples. The acquisitions pushed Unity into a scattershot mix of services in which it had no right to win. For context, the $5.3B spent on M&A amounts to more than 90% of Unity’s current market capitalization.

One of the most publicized moves was the unwinding of Weta Digital, a suite of software solutions for high-quality art animation that Unity had carved out from Weta FX (the best-in-class visual effects and animation studio behind "Lord of Rings", "Avatar," and more) for $1.5B in 2021, at more than 20 times its revenue.

When Unity bought the business, Weta Digital’s only customer was Weta FX (about $70M of annual revenue), and Unity’s goal was to turn these tools into a full-suite solution that artists could use to create and animate. This was part of a misguided attempt to drive additional seat-based licensing fees from artists, but the move put Unity into competition with incumbents like Autodesk, Adobe, and SideFX. Sensing that Unity had no right to win against these well-resourced competitors, Whitehurst pulled Unity out of the business and refocused Create on serving developers.

Another major portfolio change was shrinking down the professional services organization, which provided custom software development and deployment services for Unity’s development engine. The recently announced divestiture of the Digital Twins professional services arm to Capgemini was part of this broader shift. The rationale behind this was to reduce exposure to a more competitive line of business with lower margins, and remove distractions from Unity’s core software development business.

Other portfolio divestitures include exiting renting out physical server capacity for Unity’s multiplayer services and closing Luna, an ad creative consultancy that came with the ironSource acquisition. (We recently hosted the founder of Multiplay, which was acquired by Unity and became its multiplayer services business, on our podcast here.)

In total, this portfolio rightsizing reduced revenue by $283M (13% of 2023 reported revenue), but was accretive to the bottom line, as these businesses operated at significant losses.

Integrating ironSource

The other key strategic move Whitehurst oversaw was the integration of ironSource into Unity. Despite the merger closing in November 2022, Unity’s internal advertising technology team and ironSource continued to operate semi-independently, maintaining separate data engineering and data science teams.

Taking so long to integrate was a huge mistake. Unity wasn’t capturing synergies from combining the dataset across both ad networks, and the business floundered with no clear leadership across the Grow business. The integration was finally completed in Q4 2023, and the business is now operating under a unified leadership structure and go-to-market motion. (This came with the exit of the ironSource founders.) These moves should ultimately help Unity’s Grow business compete better against its primary competitor in the mobile gaming advertising ecosystem, AppLovin.

Layoffs

In addition to all the reshuffling discussed above, Unity also announced an additional 25% workforce reduction in January 2024, along with other cost-cutting measures (cloud hosting savings, office footprint consolidation, and software license optimization). These moves are expected to lead to an additional $250M in savings before accounting for stock-based compensation.

Given all the portfolio shifts, restructuring expenses, and the time it takes for these changes to be reflected in the financials, it’s hard to quantify the impact of Whitehurst’s tenure as interim CEO. The opaque nature of the financials resulting from all the reshuffling caused the stock price to slide an additional 17% under his leadership.

Irrespective of the numbers, Unity is undoubtedly in a better position than it was a year ago. The company is leaner and more agile, focused on areas where it can win, and under more cohesive leadership.

Matt Bromberg, who was selected in May as Whitehurst's permanent replacement, still has a lot of wood left to chop, but his predecessor set him up for success.

Predictions on the Bromberg Sovereignty

Bromberg’s near-term objectives as CEO will be rebuilding employee morale at Unity after so many layoffs and making the business “economically” profitable. While Unity is now cash flow positive thanks to its merger with ironSource, the business still relies heavily on stock-based compensation to pay its employees. To put this into context, stock-based compensation amounted to 31%, 40%, and 30% of revenue in 2021, 2022, and 2023, respectively.

Making the business sustainable will start with the successful launch of Unity 6, the latest version of the real-time engine, later this year. Unity 6 will need to show sufficient improvement versus the prior version to drive developer adoption, which in turn will lead to the pickup of runtime fees. These fees won’t flow through earnings until 2025-26, as developers will need time to build and launch games.

Using some napkin math, if Unity can capture an additional 0.25% (10% of the fee cap) in developer revenue, this could result in an additional $170M in revenue (an approximately 35% uplift on the “strategic” Create business), all of which will flow to the bottom line. This will be a critical part of plugging the $470M “economic” cash flow shortfall in 2023.

At the same time, the company should also see revenue growth from its move to sunset its “Plus” subscription tier and force users onto a much more expensive “Pro” tier which affects less than 10% of users.

The other key step toward economic profitability is turning around Unity’s Grow business. Given that Unity and ironSource didn’t share a common data platform until late last year, the company had encumbered itself by providing two separate, inferior solutions to customers. In addition to the synergies of integrating the businesses, Unity is also reinvesting heavily into its machine-learning capabilities in hopes of following in the footsteps of AppLovin’s success with AXON. (We recently did a deep dive on AppLovin’s turnaround here.)

While these changes don’t guarantee success, they are tangible steps toward improving the adtech product, which has fallen behind the competition over the past few years. Hopefully, this can help Unity regain some of the market share it ceded to its competitors.

Conclusion

Unity is in better shape than the headlines indicate. In his short tenure as interim CEO, Whitehurst quelled the strongest developer backlash from the runtime fee fiasco, streamlined the company, and oversaw the integration of Unity’s largest acquisition to date. He’ll also continue to be involved with the company as the Executive Chairman of the board and act as a valuable advisor to the current CEO.

The launch launch of Unity 6 will be the key event to watch. Given that the current seat-based licensing model is clearly unsustainable, if the runtime fees don’t come through, Unity will be forced to find other ways to raise prices and make even deeper cuts across its business. This will come at a real cost to both the company and its customers.

Equally important to the company’s turnaround will be reinvigorating growth in the Grow business, which accounts for more than 70% of revenue. Its solution will need to catch up with that of its peers and give clients a reason to come back. The company will also need to watch out for impending changes related to app-tracking transparency (like Android Privacy Sandbox), which could have an adverse effect on targeting models. A key indicator to watch will be the relative performance of Grow versus AppLovin’s adtech business.

Both of the drivers behind a successful turnaround are well within Unity’s control. We’re hopeful the new leadership team can execute these goals and chart a course for Unity that creates value for all stakeholders: customers, employees, and shareholders alike.

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Content Worth Consuming

Global Gaming Deals Report Q2’24 (investgame.net): “The InvestGame team is pleased to present the Q2’24 Global Gaming Deals Report, providing a comprehensive analysis of the current market dynamics within the gaming industry.”

The Secret to the Metaverse: Matthew Ball (Secret Stash Podcast): “Matt Ball literally wrote the book on the metaverse – with a new update out in late July. So who better to chat all things metaverse and distribution with? In the last several years, Matt has become known as one of the most astute writers and thinkers about the nature of business, innovation, IP, and the deep structural factors that shape the entertainment and gaming industry.”

Gen AI: Too Much Spend, Too Little Benefit (goldmansachs.com): “Tech giants and beyond are set to spend over $1tn on AI capex in coming years, with so far little to show for it. So, will this large spend ever pay off? MIT’s Daron Acemoglu and GS’ Jim Covello are skeptical, with Acemoglu seeing only limited US economic upside from AI over the next decade and Covello arguing that the technology isn’t designed to solve the complex problems that would justify the costs, which may not decline as many expect.”

Building Immersive Ad Tech During Game-ageddon with AdInMo COO Joanne Lacey (Rise and Play Podcast): “In this episode of Rise and Play, new cohost Tiffany Keller joins the podcast. Tiffany has spent the past decade in product management across several billion dollars plus earning franchises at three of Gaming’s top five acquisitions and the most downloaded games of the decade. She sits down with Joanne Lacey, COO and Board Director at Adinmo, a privacy-first in-game monetization platform working with free-to-play mobile game publishers and developers.”

The Streaming Advertising Showdown (with Adam Epstein) (Mobile Dev Memo Podcast): “In this episode of the Mobile Dev Memo podcast, I speak with Adam Epstein, the CEO and founder of Gigi, a CTV advertising buying platform specializing in Prime Video. We discuss the current CTV advertising landscape, including: What is motivating the dramatic growth of CTV advertising spend?; The distinct pricing strategies implemented by Netflix, Disney+, and Amazon for their ad-supported tiers; The different targeting and measurement solutions offered by the major streaming services; Why CTV measurement is challenging when inventory is purchased through third-party DSPs; The availability of targeting data across various streaming services and programmatic channels.”

In Other News

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• Igloo, Inc. raises $11M for new consumer blockchain, Abstract
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📊 Business & Products:

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• LightSpeed’s new performance capture studio prioritizes safety and creativity
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• Atari partners with Coinbase to bring Asteroids and Breakout to blockchain
• How to watch Evo 2024, the biggest fighting game tournament of the year
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