Unity Software Inc. (U, Financial) is a leading platform for the creation and monetization of real-time and interactive 3D content offering various solutions in business such as gaming, gambling, live entertainment, automotive and transportation, architecture, engineering and construction.
The company's stock soared 15.38%, closing at $42.38 on June 27, on the back of an announcement regarding a new marketplace for artificial intelligence software. Year to date, shares have gained nearly 65%, which is very impressive.
However, looking at the company's financials, I think there are severe risks that impact its investment potential.
What fueled the surge in Unity shares?
The rally in Unity Software's shares was caused by the launch of its two new AI platforms, Unity Sentis and Unity Muse, which it said are “designed to make creators more productive and their RT3D experiences more engaging." Unity Sentis, which is a cross-platform runtime inference engine, helps deploy AI models, while Unity Muse consists of tools used to speed up the creation of RT3D content. Together, the platforms leverage AI to enhance the interactivity of gameplay and RT3D-powered experiences, while accelerating creative workflows.
The company also set up a dedicated marketplace on the Unity Asset Store with a collection of solutions that will accelerate AI-driven game development.
Unity Software believes AI will continue to benefit the gaming industry and that its new platforms will offer more creativity and enhanced speed to digital creators so as to monetize their applications and ideas. This is definitely very positive news from a business perspective for Unity Software as it will likely help its revenue growth.
Benefits of AI creating content and applications
AI creating content and applications offers numerous benefits for Unity Software in regard to revenue growth. The technology can generate content and develop applications at a significantly faster pace than humans. This enables businesses to streamline their operations, increase productivity and deliver content or applications to market more quickly. By automating content creation and application development, organizations can save on labor costs and reduce the need for extensive human resources. It can also handle repetitive and time-consuming tasks, freeing up human resources to focus on more complex and strategic activities.
The two new AI platforms can offer benefits such as scalability, quality, innovation and creativity, as well as continuous learning and improvement in the app industry.
AI-powered systems can easily scale to handle large volumes of content creation or application development. Whether it is generating thousands of articles or developing applications for multiple platforms, AI can adapt and deliver consistent quality output. Further, AI algorithms can be trained on vast datasets and guidelines to produce content or develop applications that meet specific standards consistently. This reduces human errors, ensures quality control and maintains a consistent brand voice or application experience.
In the gaming space, which is a key focus of Unity Software, AI can generate novel ideas and innovative solutions by analyzing patterns and making connections in vast datasets. This can inspire new content formats and application features, or even facilitate the creation of entirely new products or services. AI algorithms can be continuously trained and refined based on user feedback and evolving data. This allows for ongoing improvement in content quality, application performance and user experience over time. With proper training and oversight, AI can help mitigate bias in content creation and application development. By leveraging diverse datasets and ensuring ethical considerations, AI can contribute to more inclusive and unbiased outcomes.
Notably, these benefits are expected to support more revenue growth for Unity Software, which is one thing it is good at. The sales growth for 2019 was 42.29%, 42.58% for 2020, 43.77% for 2021 and 25.26% for 2022. In 2022, the technology company generated $1.39 billion in revenue and reported a net loss of $921.06 million. This is one of the reasons why investors should be cautious.
Poor fundamentals and consistent net losses make Unity Software a risky play
Unity Software has several severe warnings from GuruFocus currently.
First, the Piotroski F-Score of 3 out of 9 is low, which implies poor business operations. Second, the Altman Z-Score of 1.62 is in the distress zone. This suggests bankruptcy is possible within the next two years.
The company also has a GF Score of 30 out of 100, which indicates it has poor performance potential going forward. Since it only received rating for three of the five criteria, however, its prospects are not fully reflected.
Unity Software has lost money over the past five consecutive years. The net income has fallen from a loss of $131.6 million in 2018 to $921.06 million last year.
It is clear that not only has Unity Software lost money, but has also widened its net losses.
What is even worse than a company having net losses? The quick answer is not generating cash. Unity Software is burning cash, which is the fourth severe warning. There has been a negative free cash trend for the past five years. The company generated free cash flow of -$119.08 million in 2018, -$94.97 million in 2019, - $20.24 million in 2020, -$153.39 million in 2021 and -$116.57 million in 2022.
In simple terms, free cash flow is the actual amount of cash at a company's disposal. As Unity Software has consistent negative free cash flow, it may have to soon turn to fundraising to remain solvent.
Unity Software is a classic example of a company that is driven by the momentum in AI but, at the same time, has poor profitability and a cash burn problem that creates a very fragile financial strength. These warning signs do not make Unity Software an attractive opportunity now.
