Why is the market wrong when merging Unity Software with ironSource
3D Creator Stock Quotes Unit programs (Yu -9.71%) It fell 25% last week, with most of the decline occurring after the company announced it would acquire iron source (he is -8.21%), a leading monetization platform for mobile app developers. IronSource is very complementary to Unity’s gaming services business.
However, the timing and terms of the deal are surprising. Unity said the deal was an all-share deal worth $4.4 billion, which could change depending on how the stock performs in the near term. But given that Unity’s stock is already down 84% from its highs this year, investors aren’t looking favorably on the company’s decision to dilute shareholders by issuing more shares to fund the deal.
Furthermore, in the same announcement, management lowered its full-year revenue guidance. It now expects full-year 2022 revenue to be in the range of $1.3 billion to $1.35 billion, compared to previous forecasts of $1.35 billion and $1.425 billion. The company cited economic headwinds and competitive dynamics regarding its application monetization business, which intensified the fire.
Regardless, when looking at the value ironSource brings to Unity in terms of profitability, this deal should add tremendous value to investors in the long run.
The true cost of getting an ironSource
At the close of the transaction, each ironSource share will be exchanged for 0.1089 shares of Unity, which is expected to complete during the fourth quarter of 2022. The current transaction value of $4.4 billion represents a premium of 74% over the 30-day average exchange ratio, so The value can change depending on the performance of the stock.
But there is more. To compensate for the dilution for shareholders, Unity announced that it will buy back up to $2.5 billion in stock when the deal closes. This adds to the transaction account because more shares will lower the percentage of unit ownership for existing shareholders. In fact, the unit’s current shareholders will own approximately 73.5% of the combined company after closing.
On the surface, the acquisition is expensive, but let’s consider what the unit will get in return.
IronSource will make Unity more profitable
Over the past year, IronSource generated $139 million in free cash flow on $623 million in revenue, more than four times the free cash flow that Unity generated for 12 months. IronSource offers tools to help app creators launch, monetize, and attract users. This includes a platform where advertisers can bid to place their ads in the developer’s app.
These are two big players in game creation and monetization. While Unity also offers monetization tools through the Unity Ads platform, its specialty is its software engine which is used to make about half of all video games across mobile, console, and PC platforms.
Similarly, ironSource is used by 88% of the world’s top 100 downloaded games apple App Store in the US The combination of Unity and ironSource will give mobile game designers a way to test monetization strategies before the game is released. This is very valuable in mobile games where it is difficult to predict which games will succeed, especially for small studios.
Value for investors will accumulate quickly. Management expects the merger to generate $1 billion in adjusted EBITDA by the end of 2024. By the end of 2025 or year three, the synergies between companies should bring an additional $300 million to adjusted EBITDA.
Market participants focus on short-term issues, such as poor routing caused by a temporary problem Unity is having with one of its advertising products, as well as the cost of acquiring ironSource. But this ignores the long-term impact on profit margin and growth that this acquisition will have on the unit’s business.
John Ballard holds positions at Unity Software Inc.. Motley Fool has positions at Apple and Unity Software Inc. The Motley Fool recommends the following options: long calls in March 2023 worth $120 on Apple and short calls in March 2023 worth $130 on Apple. Motley Fool has a disclosure policy.