Unity's revenue is mostly ads

I recently looked at Unity Software’s market cap and found something weird: their LTM revenue multiples are north of 20x. What the?! I’ve known this company primarily as an ad network, not some kind of overvalued SaaS company. I had to dig into what’s going on here.

I pulled the 10Q and skimmed to the section to Revenue breakdowns and Cost of Goods. I pretty much assumed that Unity is losing money and cashflow so the fundamentals on the top line are pretty much the only thing the market can trade on right now.

Revenue breakdown:

The primary takeaway is just that the majority (60%) of the revenue comes form their “Operate Solutions” business – their Ad Network. This ad network is not like Google either, it’s a 3rd party ad network, NOT based on its own content. Simply explained, every dollar that Google charges on its first party search engine that uses its ad network goes into Google’s pocket. Why? Google owns the search engine and they own the ad network - there’s nothing to share.

In Unity’s case, most of this revenue is shared with the developer using Unity’s network. Where are these revenue shares reflected? Let’s look at COGS.

COGS explanation and breakdown:

Industry knowledge tells me this is not possible. If you look at the gross profit margins reported (80%), we can infer that the revenue share to the publisher is not represented here. Most of the revenue share agreements that I know of are in favor of the publisher. Usually 70% to the publisher and 30% to the network (Unity in this case). This, by default, makes the gross margin on this revenue 30%, a far cry from the 80% displayed here.

So what’s going on? Where is the revenue share reported? I would only assume that the “Operate Solutions” revenue would be post-cut revenue share. If this is the case, then investors may be overvaluing Unity by assuming this revenue is something that it’s not.

It would be interesting to listen to an analyst call and hear someone ask the question where this revenue share is represented and why this post cut revenue deserves a 20x multiple.

Ending thoughts:

I’ve always been confused why Unity decided to make its ad network the monetization centerpiece instead of the more valuable platform and engine. I would like to see Unity start building services on top of its engine for developers to buy and make things easier to manage when building games. Perhaps even use its ad network more as a carrot for distribution rather than maximizing bids through monetization. I would also imagine that Unity would start building its own set of content (or acquire it) so they can make a better play for 1st party datasets.