Unity Software Inc. (U) operates a real-time 3D development platform that provides its customers with software solutions for creating and monetizing real-time 2D and 3D content for phones, tablets, PCs, consoles, and virtual reality devices.

The company operates in the gaming and entertainment field but has also invested heavily in the Metaverse. A major contributor to this is the company’s acquisition strategy, which helped it accumulate new technologies. The company has acquired over 20 startups. However, the market for interactive real-time 3D or 2D content in industries beyond gaming is still nascent.

Recently, mobile technology company Applovin Corp. (APP) withdrew its merger proposal after Unity Software rejected its unsolicited $20 billion offer. U now plans to go forward with its own planned $4.40 billion acquisition of ironSource Ltd. (IS). U shares plunged on the news.

U’s stock has declined 73.4% over the past year and 75.6% year-to-date. It is down 26.8% over the past month to close its last trading session at $34.90.

Here are the factors that could affect U’s performance in the near term:

Bleak Financials

For the fiscal second quarter that ended June 30, U’s non-GAAP loss from operations increased 6,351% year-over-year to $44.13 million. Non-GAAP net loss rose 3,862.5% from the prior-year quarter to $53.14 million. Non-GAAP net loss per share attributable to common stockholders came in at $0.18, up 1,700% from the same period the prior year.

Stretched Valuations

In terms of its forward EV/Sales, U is trading at 8.42x, 230.3% higher than the industry average of 2.55x. The stock’s forward Price/Sales multiple of 7.99 is 217.8% higher than the industry average of 2.51. In terms of its forward Price/Book, it is trading at 5.84x, 50.9% higher than the industry average of 3.87x.

Negative Profit Margins

U’s trailing-12-month EBITDA margin and net income margin of a negative 41.17% and 54.01% are significantly lower than their respective industry averages of 12.86% and 4.21%. Its trailing-12-month ROE, ROTC, and ROA of a negative 30.98%, 12.64%, and 13.61% compare to their respective industry averages of 6.97%, 3.96%, and 2.64%.

POWR Ratings Reflect Bleak Prospects

U’s POWR Ratings reflect this bleak outlook. The stock has an overall rating of D, equating to Sell in our proprietary rating system. The POWR Ratings are calculated by considering 118 different factors, with each factor weighted to an optimal degree.

The stock has a Value grade of D in sync with its stretched valuations. It also has a D grade for Momentum, consistent with the stock trading below its 50-Day Moving Average of $42.21 and its 200-Day Moving Average of $75.35.

U has a Stability grade of D in sync with its five-year monthly beta of 1.90.

In the 22-stock Entertainment – Toys & Video Games industry, it is ranked #21. The industry is rated D.

Click here to see the additional POWR Ratings for U (Growth, Sentiment, and Quality).

View all the top stocks in the Entertainment – Toys & Video Games industry here.

Bottom Line

Although the company is growing in the metaverse space, its near-term prospects look uncertain. Moreover, U’s sharp bottom-line decline in its last reported quarter is concerning. With analysts expecting its EPS to decline by 100% in the current year (fiscal 2022), the stock might be best avoided now.

How Does Unity Software Inc. (U) Stack Up Against its Peers?

While U has an overall POWR Rating of D, one might consider looking at its industry peers, Spin Master Corp. (SNMSF) and JAKKS Pacific, Inc. (JAKK), which have an overall B (Buy) rating.

U shares were trading at $33.22 per share on Thursday afternoon, down $1.68 (-4.81%). Year-to-date, U has declined -76.77%, versus a -20.31% rise in the benchmark S&P 500 index during the same period.

Anushka is an analyst whose interest in understanding the impact of broader economic changes on financial markets motivated her to pursue a career in investment research.

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