What a time it’s been for Unity. In the past six months alone, the company’s stock price has increased by a massive 49.1%, reaching $21.25 per share. This performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Unity, or does it present a risk to your portfolio? Get the full breakdown from our expert analysts, it’s free.
We’re glad investors have benefited from the price increase, but we're sitting this one out for now. Here are three reasons why you should be careful with U and a stock we'd rather own.
Why Do We Think Unity Will Underperform?
Started as a game studio by three friends in a Copenhagen apartment, Unity (NYSE:U) is a software as a service platform that makes it easier to develop and monetize new games and other visual digital experiences.
1. Declining Billings Reflect Product and Sales Weakness
Billings is a non-GAAP metric that is often called “cash revenue” because it shows how much money the company has collected from customers in a certain period. This is different from revenue, which must be recognized in pieces over the length of a contract.
Unity’s billings came in at $467.3 million in Q3, and it averaged 4.1% year-on-year declines over the last four quarters. This performance was underwhelming and shows the company faced challenges in acquiring and retaining customers. It also suggests there may be increasing competition or market saturation. 
2. Customer Churn Hurts Long-Term Outlook
One of the best parts about the software-as-a-service business model (and a reason why they trade at high valuation multiples) is that customers typically spend more on a company’s products and services over time.
Unity’s net revenue retention rate, a key performance metric measuring how much money existing customers from a year ago are spending today, was 98.8% in Q3. This means Unity’s revenue would’ve decreased by 1.2% over the last 12 months if it didn’t win any new customers.
Unity’s already weak net retention rate has been dropping the last year, signaling that some customers aren’t satisfied with its products, leading to lost contracts and revenue streams.
3. Long Payback Periods Delay Returns
The customer acquisition cost (CAC) payback period represents the months required to recover the cost of acquiring a new customer. Essentially, it’s the break-even point for sales and marketing investments. A shorter CAC payback period is ideal, as it implies better returns on investment and business scalability.
Unity’s recent customer acquisition efforts haven’t yielded returns as its CAC payback period was negative this quarter, meaning its sales and marketing investments outpaced its revenue. The company’s inefficiency indicates it operates in a highly competitive environment where there is little differentiation between Unity’s products and its peers.
Final Judgment
We cheer for all companies solving complex business issues, but in the case of Unity, we’ll be cheering from the sidelines. Following the recent surge, the stock trades at 4.8× forward price-to-sales (or $21.25 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - we think there are better stocks to buy right now. We’d suggest looking at our favorite semiconductor picks and shovels play.
Stocks We Would Buy Instead of Unity
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