Unity Software: Measure Twice!

Silver Lake and Saudi Arabia's Public Investment Fund have reportedly held talks to acquire Unity Software (NYSE: U) ("The U"), and we understand why.

We first recommended Unity 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.

What Unity does

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.

Why the buyers want it

Vector's edge comes from data. Roughly 3 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.)

What we think Unity is worth

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, about 16 times that cash flow, is more valid than the aforementioned $25 billion.

Why a deal may not happen

Reported talks are only talks, and no offer has been announced yet. Plenty of conversations like this never turn into a deal.

Even a signed agreement would face hurdles. A purchase backed by a Saudi government fund could draw a U.S. national security review, and with Silver Lake's CEO sitting on Unity's board, directors will need to show shareholders they bargained hard on their behalf.

What we'd do

If an offer lands near $55, we'd hope the board holds out for more. That price wouldn't pay shareholders for the growth still ahead in Vector.

If it comes in near $75, we'd support it, and if the talks go nowhere, that's fine with us.

And as long-term business owners in Fooldom, we're very happy to keep holding our shares in an independent U!

The Hidden Gems Team has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Unity Software. The Motley Fool has a disclosure policy.