Breakfast News: Unity Software – Measure Twice!
1. Unity Software: Measure Twice!
Team Hidden Gems
Silver Lake and Saudi Arabia’s Public Investment Fund have reportedly held talks to acquire Unity Software (U -2.12%), and we understand why.
We first recommended Unity (“The U”) in Hidden Gems at $17.09 in September 2024. We’ve made 22 additional recommendations and investments since then and have not sold a share. Today, the stock is at $50.34.
Let’s remind ourselves what Unity Software does and then consider the buyout together.
Unity makes the software that developers use to build video games, especially on phones. It also runs an ad business that helps those games find players.
CEO Matt Bromberg (a throwback all the way to America Online in 1999 – Motley Fool memories!) joined in May 2024 and inherited a company at war with those developers. He fixed that first, scrapping the controversial runtime fee and winning them back. He then rebuilt the company’s ad business around Vector, an AI engine.
Last quarter, these efforts produced Unity’s first GAAP profit since going public in 2020, on top of 32% revenue growth. Its Vector ad engine grew 126% year over year.
Vector’s edge comes from data. Roughly three billion people play Unity-built games each month, and what happens inside those games now trains Vector’s AI. More than 90% of new Unity projects opt in to sharing in-game data. Few rivals see inside the game itself. That advantage is a multiplier.
And that’s what attracts this investor consortium. It already owns major gaming businesses like Electronic Arts and Scopely. Owning Unity could deepen that integration, improving game development, player acquisitions, and advertising profitability across the broader portfolio.
Silver Lake has an excellent reputation as a long-term partner. The firm made its first investment into Unity Software in 2017, and its CEO Egon Durban joined the company’s board then as well. (Of course, that board seat also complicates this negotiation.)
Early reports suggest a first valuation of $25 billion (around $55 per share). To our eye, that doesn’t adequately reflect the value emerging in Unity’s advertising business.
What buyout price would we support? $75.04 per share.
Vector is taking market share in a competitive environment, and its existing advertising customers are increasing their spend. Unity Software has a path to generating gross margins in the mid-80s percent alongside returns on invested capital in the mid-teens.
You could, therefore, in just a few years, find this company driving double-digit top line growth with rising margins and capital efficiency, generating over $2 billion in free cash flow. Our ballpark $33 billion price is more valid than the aforementioned $25 billion.
And as long-term business owners in Fooldom, we’re very happy to keep holding our shares in an independent U!
2. CoreWeave and Anthropic Reveal Two Sides of AI
The artificial intelligence (AI) trade just got two very different signals. CoreWeave’s (CRWV -0.51%) debt-fueled expansion, a brutal sell-off in its stock and bonds, and questions about whether AI demand can justify the spending rattled investors. The AI cloud provider’s latest earnings offered some reassurance, sending Nasdaq futures up 1.4% this morning. CoreWeave popped over 10% in pre-market trading.
But there’s a wrinkle: while demand for AI computing remains red-hot, investors appear less willing to pay absolutely anything for a piece of the boom.
- The cost of keeping up: CoreWeave’s revenue soared 168% to nearly $3.7 billion in the third quarter, while its backlog hit $132.5 billion. The company also raised its full-year outlook. Yet it lost $709 million, carries $46.9 billion in debt, and expects to spend up to $39 billion on infrastructure this year. Those numbers offer a rebuttal to claims that AI infrastructure demand is cooling, but also highlight the enormous cost of meeting that demand.
- Anthropic offers a different reality check: The Claude maker’s IPO range of $70 to $78 per share values the company at about $1.4 trillion on a fully diluted basis. That’s hardly a modest valuation, but it came in below the expectations surrounding the AI darling. The takeaway? Investors are looking beyond AI hype and asking real questions about spending, returns, and sustainable growth.
3. Today’s Question!
Have you ever rooted against a buyout of a company you owned? Which one, and why?
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Source: www.fool.com — article syndicated from the publisher’s feed; all rights remain with the original publisher.