Is Unity Software stock a buy?

Unity Technologies (U 1.16%) went public in 2020 to skyrocketing expectations, and for good reason. According to the company, more than 70% of mobile video games are made using its game engine software, giving it a prominent place in the industry.

The business also makes money with advertising services. And having so many apps in its ecosystem gives it, in theory, an edge over its competition.

Also consider that Unity apparently has plenty of room to expand beyond its core video game application. Its software develops real-time 3D images that can be used in movies, virtual reality (VR), production, and more. Because it’s something that can be used in so many ways, the business would seemingly have incredible growth potential.

There has also been strong third-party validation of Unity’s potential. Meta platforms lost more than $8 billion on its VR ambitions in the first half of 2024 alone, so it clearly wants to win in VR at all costs. And even in 2015, CEO Mark Zuckerberg reportedly wanted to acquire Unity for billions of dollars. That was well above what it was worth at the time, and suggests that Unity’s products are special enough to be the envy of the tech world.

The drive is clearly promising. And yet, the stock is down about 75% from its initial public offering (IPO). Investors want to know for sure what it gives.

There are plenty of past management failures that have contributed to its poor returns. It starts with a history of overpriced acquisitions that ultimately didn’t drive revenue growth. And related to that issue, Unity continues to dilute shareholders with stock-based compensation while routinely generating steep net losses.

To better visualize the problem with profits, consider this: At the end of 2023, management says it has lost a cumulative $3.1 billion since the company started. Moreover, it is expected to continue losing money for a while as it invests in research and development, among other things.

However, Unity is under new management now. Has anything changed for the better?

Why it’s a good idea to wait to buy Unity stock

On May 15, Matthew Bromberg took over as CEO of Unity and says he’s there to “implement change.” He also says that some of the focus is now on profitable growth, which sounds hopeful. But details are scarce, so it’s hard to be objectively optimistic.

Regardless of the details, it doesn’t look like anything exciting will happen in 2024. Unity is winding down some non-core businesses, so some numbers need slight declines. But management expects nearly $1.7 billion in full-year revenue for its strategic portfolio, down 2% to 3% from 2023.

It looks like the growth part of Bromberg’s plan needs a little time. In terms of stock-based compensation, it has declined relatively. But as the chart below shows, it’s still high, at more than $100 million in the second quarter.

U stock-based compensation (quarterly); data by YCharts.

Reducing stock-based compensation expense will take time, but in the meantime, it will likely prevent net profit. That said, free cash flow adjusts for this, and Unity has a positive free cash flow of $80 million in the second quarter.

This is a positive for the business at the moment and free cash flow could increase in the coming quarters. However, investors should keep in mind that the company will likely direct that cash to pay down its debt.

It owes more than $2.2 billion in debt on convertible notes (the debt is unlikely to convert because the deals were done at much higher stock prices). In 2026, $1.2 billion is reduced, and another $1 billion is reduced in 2027.

Unity paid back more than $400 million in the second quarter alone, which was more than its cash flow. The company has over $1.2 billion in cash on hand, which is good. But over the next few years, management will likely pay significant attention to its convertible debt.

Here’s why I bring this up: When it comes to creating shareholder value, businesses typically need to grow, earn profits, and reward shareholders by diluting their stock. But in Unity’s case, revenue is down, cash flow is going toward debt, and the stock count is still rising.

Unity is a promising business that is under new management, so positive changes could be coming. But with little to do now, I wouldn’t buy the stock today. At the very least, I would expect a more tangible plan from management. And it would also be a good idea to wait a little longer after that to make sure its new management is up to the challenge.