AppLovin Should Buy Unity

AppLovin Should Buy Unity‍

AppLovin and Unity are big players in gaming, each offering unique support for developers. AppLovin focuses on app monetization and user acquisition, helping games reach larger audiences and earn revenue. Unity, widely used by indie and mobile developers, provides a flexible platform for building games and interactive 3D experiences across devices.

In August 2022, there was talk of a merger, which could have created a powerhouse in gaming tools and monetization (AppLovin). Though they remain separate, both companies continue to shape the industry, giving developers the tools to grow and succeed.

As a reminder, in July 2022, Unity announced plans to merge with ironSource, a platform that enables mobile developers to monetize and scale their apps and games. The all-stock deal valued ironSource at approximately $4.4bn and the goal was to combine Unity’s game development platform with ironSource’s monetization and distribution tools. The merger was finalized on November 7, 2022.

Shortly after the announcement of the merger, AppLovin extended an unsolicited offer to acquire Unity with the following terms: (AppLovin):

• All-stock deal valued at $17.54bn
• Unity shareholders would receive 1.152 shares of AppLovin Class A voting stock and 0.314 shares of AppLovin Class C non-voting stock for each Unity share
• Unity shareholders would own about 55% of the combined company
• Unity's CEO John Riccitiello would become CEO of the merged entity, with AppLovin's CEO Adam Foroughi as COO

Unity’s board of directors unanimously rejected the offer, stating the offer was “not in the best interests of Unity Shareholders.”

Since rejecting AppLovin’s offer in August 2022, Unity’s stock dropped ~40% over the next year and is currently trading at $20.50/share today (the initial offer from AppLovin valued Unity at $58.85/share). Conversely, when AppLovin made the initial offer, AppLovin was trading at around $38/share, and as of today, it is trading at over $290/share (+663%).

While we cannot confidently say we know what would have happened post-merger with John Riccitiello at the helm (he resigned as CEO of Unity in October 2023), we can report that Unity is worth less than half ($8.6bn) of what AppLovin offered to pay. If Unity shareholders owned 55% of the merged entity as proposed, their shares would be worth ~$53bn today based solely on AppLovin’s current market cap.

Health Checkup: Unity vs AppLovin

Since their respective IPOs, Unity has faced challenges with its stock price, especially following the end of the Zero Interest Rate Policy (ZIRP) era. The market clearly sees more opportunities for AppLovin moving forward. Despite Unity’s better-than-expected performance last quarter (Q3 2024), an improved full-year outlook, and appointments of a new CFO and CTO, the continued losses and declining revenues are casting doubt on the company’s future, as reflected in today’s ~7.7% stock drop.

AppLovin continues to operate at a very healthy level. The company has been consistently profitable for several quarters, surpassed consensus earnings per share (EPS) estimates for four consecutives quarters, increased revenue 39% YoY, and improved adjusted EBITDA by 72% YoY.Unity on the other hand has consistently reported operating losses since 2018 and has limited growth opportunities until at least 2028. The company will need to focus on creating a sustainable business model if they expect the market to gain optimism for the future.

‍Why Does An Acquisition (Still) Make Sense

‍After introducing a new pricing structure for access to their engine (Runtime Fee), Unity was met with overwhelmingly negative feedback from the industry (Game World Observer). Unity’s proposed Runtime Fee would charge developers a fee on a per install basis after certain thresholds were hit (e.g., $200k in revenue AND 200k lifetime downloads). In the wake of this negative press, AppLovin took advantage and launched Project Unifree, a free tool that streamlined the migration of games from Unity to another engine.

John Riccitiello stepped down a month later and the entire plan was scrapped a year later.

‍Now is the time for AppLovin to consider an acquisition as they have been accelerating while Unity is struggling to regain its footing and reputation.

‍Despite the divergence in performance, the two businesses continue to show synergistic potential. As a reminder, Unity generates revenue through two main products:

1. Create Solutions: game development engine and tools
   • Generated ~$793m, accounting for about 38% of the total revenue over the last year (Stock Analysis)
   • Offers different tiers: Unity Personal (free), Unity Plus, Unity Pro, and Unity Enterprise
   • Free for companies with less than $100k in revenue, paid plans for those above.
2. Grow Solutions: monetization tools
   • Generated $1.27bn in revenue, representing about 62% of the total revenue over the last year (Stock Analysis)
   • Product offerings that assist developers in monetizing and scaling their applications, such as advertising and analytics services

AppLovin generates revenue through two main segments:

1. Software Platform: suite of multiple software solutions for mobile developers
   • AppDiscovery: in-app advertising network, facilitating over $4bn in advertising annually. Advertisers pay on a cost-per-install (CPI) basis, while publishers are paid on a cost per thousand impressions (CPM) basis. AppLovin keeps 20-30% of the proceeds
   • MAX: mediation platform that helps app developers maximize their ad revenue
   • Other software products for user acquisition and monetization.‍
2. Apps: portfolio of over 200 free-to-play mobile games across multiple genres
   • Revenue comes from in-app purchases (IAP, about 70%) and in-app advertising (IAA, about 30%)

AppLovin has become one of the most important companies in games, but running an ad network and mediation platform in the post-IDFA world is difficult with the lack of user-level data available. AppLovin has tried to supplement their ad network with first-party data through their partner studios and apps business; however, this side of the company is currently being restructured. According to AppLovin CEO, Adam Foroughi, the company has acquired enough first-party data from its apps business to focus exclusively on building out their software capabilities moving forward (AdExchanger).

Strategically, leveraging data from their in-house apps business was the only legitimate way AppLovin could acquire enough first-party data to supplement the loss of third party data due to IDFA deprecation. The underlying issue, even if not publicly acknowledged, is that this effectively positioned them as a competitor to their own customers. If AppLovin controls the ad network and has a games/apps business, there is an inherent incentive to prioritize their first-party portfolio.

If AppLovin acquires Unity, it can offer a complete package that incentivizes developers to integrate a variety of tools and products that provide AppLovin with first-party data. With the stronger revenue and profitability of AppLovin’s monetization solutions, they can lower prices for the Unity game engine and analytics to encourage developer adoption (and stickiness). With more first-party data enhancing the effectiveness of their monetization tools, the reduced costs for game development create a powerful flywheel effect, encouraging even more developers to engage with its ecosystem.

‍Antitrust

‍While we believe this acquisition makes sense, it is important to discuss antitrust and anti-competitive concerns. Given recent trends—which may shift under the new administration—this would be a difficult proposal to pass with regulators due to the following concerns:

1. Vertical Integration: Unity is one of the top game engines used by developers, and AppLovin is one of the top providers of advertising and user acquisition tools. Together, they could have control of a significant portion of the mobile gaming ecosystem. Vertical mergers can create and heighten barriers to entry in a market and regulators prefer to see horizontal integration (mergers/acquisitions at the same level of the value chain).
2. Data Advantage: With the merger, AppLovin would gain access to Unity's extensive data from game developers, giving the joint entity a potential leg up in ad targeting and monetization strategies.
3. Impact on Developers: There are concerns that this type of merger could limit options and reduce bargaining power for game developers who rely on these platforms.

Takeaway: AppLovin is in a fantastic position to expand their value proposition to developers and expand their market share of game developers. An acquisition of Unity is a perfect fit strategically for what AppLovin needs: data. On top of this, Unity is facing an uncertain future and their reputation has continued to fall across the game development space, making an acquisition financially more attractive to AppLovin. While there are regulatory and financial headwinds, AppLovin is in a strong position if they were to look at reconsidering joining forces with Unity.