Unity Software: The World Engine

Owning the Middle, the Metaverse, and Epic Competition

Welcome to the 183 new and curious minds who have joined The Operator since September 1! If you are reading this but have not subscribed, join 543 authentic and convivial others by subscribing here:

Hey team 👋

I’m super excited to bring you this deep dive today, on one of the most disruptive technology companies I have ever written about, Unity Software.

I tend to do a lot of research for this newsletter. You may have heard me talk about ‘getting in the weeds,’ in prior articles, but for this piece on Unity, let’s just say I took the red pill.

The year was 2000…

It was the day of my eleventh birthday, and I had just unwrapped a gleaming, futuristic, PlayStation 2. Exhilarated, I plugged it in, thumbed the power button, and fired up Final Fantasy VII. It was my first video game.

I still hear the space-age startup sound, the gentle whir of the console fan. I can see the pixelated characters running across a dystopian landscape, fighting to save a dying planet…

It can be challenging to look back and identify the events that molded us with any fidelity. But if I’m honest with myself, this is where my passion for storytelling began. For ‘leveling up,’ science fiction, and my interest in technology. I see it as no coincidence that twenty years later, I’m writing about disruptive companies, seeking out world-builders.

It also doesn’t surprise me that today, games are bigger than ever.

In 2021, a staggering 50% of 9 - 12-year-olds in the United States play either Roblox or Minecraft. Axie Infinity, the play-to-earn NFT game, has grown revenues by 12,000% over the past three months. Epic Games’ Fortnite boasts over 400 million global players, a user base that would rank as the third most populous country. In the world.

Yet there are whispers of even larger opportunities ahead – augmented/virtual reality, in-game economies built on blockchain technology, virtual worlds, and of course, the metaverse.

And somehow, at the heart of each of these trends is Unity Software.

I first heard about Unity in September of 2020, at which point it was preparing to IPO. Founded in 2004, Unity has transformed from a failed game-maker to the category-leader in game engine usage, exploring new verticals in film, automotive, construction and commerce.

But back in September I passed on the investment – after all, Epic Games’ Unreal Engine was the dominant player in the space. I make it a point to search for best in breed, and in the game engine space, that company is Epic. If we compare Epic versus Unity (as I did), Unity loses outright:

Unreal can render more realistic graphics, has a longer track record of AAA titles using the Unreal engine, and has built notorious blockbusters such as Unreal Tournament, Gears of War and Fortnite. And Epic is led by Founder-CEO, Tim Sweeney, a gaming visionary I consider a cornered resource.

But the deeper I dig into Unity, the more bullish I get. I think Unity at today’s $35B valuation will be one of those prices people look back on with regret, saying, ‘Damn. I thought about buying but I never did.’

Cloaked in the guise of the underdog, Unity has patiently manifested itself into the critical infrastructure of the gaming space. As of Q4 2020, the majority of the world’s games are built on Unity, and Unity-powered applications were downloaded 5 billion times per month. While Unity makes no games itself, by democratizing developer tools and aligning with creators, its technology has become ubiquitous in one of the fastest growing industries of our time.

Unity might not make headlines for splashy game releases, and it may lurk in the shadow of the Epic colossus for years. But I believe comparisons to Unreal obscure the thesis with a false narrative. In this way, Unity carries a characteristic I consider fundamental to my investment principles – Unity is misunderstood.

Last month I wrote about the importance of being misunderstood, in Opendoor, The Mythology of Disruption:

“I believe having a misunderstood business is that critical piece most correlated with outsized returns. More than TAM, margins, or who is at the helm, it is the market’s Eureka! moment of finally valuing a misunderstood business that drives vertical upside and multiple expansion. 

Your misunderstood business is my opportunity.”

Better yet, it is our opportunity. And, as understanding the investment thesis is what we are all about at The Operator, here it is:

-       Unity is becoming the de facto infrastructure layer of gaming.

-       Unity is demonstrating near limitless use-cases for its technology across the industries of construction, film, automotive, aerospace, and education.

-       Unity is a proxy on a rapidly growing industry and gaining marketshare, benefiting from generational tailwinds like virtual worlds, blockchain technology, AR/VR, the creator economy, and the metaverse.

-       Competition from Epic is overblown, and Unity may in fact be superiorly positioned for the competitive landscape of the future.

The bottom line is, if you believe our lives will become more digital over the next decade, rather than less, Unity perhaps stands to benefit most.

But to truly see this opportunity, rendered in Real-Time 3D, there’s much to discuss. We will cover the gaming space and Unity’s place within it, what it means to be perfectly positioned, competition, and of course, the metaverse.

Before we get too ahead of ourselves, cheers. Thanks for taking the red pill with me today. Let’s see how deep this rabbit hole goes.

Unity: SaaS For The Creator Economy

Unity’s business can be divided into two segments: Create and Operate. Reminiscent of Shopify’s division of subscription and merchant solutions, Create provides the tools to make a game, and Operate the tools to make that game a business.

Unity’s S-1

Create Solutions

Create solutions allow creators access to Unity’s proprietary engine to facilitate the design of digital experiences. There are several tiers, from free (Unity Student, Personal) to Plus ($399/year) to Pro ($1.8k/year) to Enterprise ($2.4k/year).

Create is paired with the ‘Unity Learn’ platform as well, where over 750 hours of free, curated educational content is available. As an on-brand cherry on top, this learning is gamified, with learners gaining experience points and leveling up for completing modules. (I love this).

Unity’s willingness to offer tiers of its Create Solutions and educational courses free of charge paints a clear picture of the strategy in place. Young developers, incubated in the Unity ecosystem, acquire the skillset to create compelling games. These developers go on to become Unity evangelists, building future games on the same engine that got them started. Meanwhile, successful creators drive outsized revenues through Operate solutions.

Interestingly, the Unity team have repeatedly stated vectors outside gaming represent a larger total addressable market (TAM), even today (Gaming TAM $12 B, Non-Gaming TAM $17 B). Unity is increasingly exploring these verticals with partnerships, acquisitions and R&D, and offers non-gaming solutions such as Forma, MARS and Reflect.

Operate Solutions

Operate Solutions allow creators to grow, engage, and monetize content. Solutions such as Unity Ads and Unity IAP (In-App Purchases) maximize monetization and are the primary drivers of revenues, whereas analytics product deltaDNA optimizes end-user engagement and behavior.

Over the years, Unity has expanded the product suite with differentiators such as Multiplay and Vivox. The former enables, you guessed it, multiplayer hosting, while the latter offers in-game, player-to-player communication.

For those of you not baptized in the digital blood and defamatory donnybrook of a multiplayer game like Call of Duty, these are mission critical elements. Multiplayer and voice communication are the connective tissue of social gaming, the sustenance of virality.

In this same vein, the Unity engine also offers cross-platform interoperability, which means a game built on the Unity engine can be made available on over 20 consoles or gaming devices with a click of a button. This widely expands a creator’s addressable market.

According to Unity CEO John Riccitiello, there are 5 million projects started on the Unity platform each month. 60 million a year. While not every one of these projects will become a published game earning revenue, many will, and that number is growing. If you consider each of these projects a potential monetizable business, Unity has built itself a veritable Helm’s Deep smack dab in the center of the creator economy, impressively dwarfing entrepreneurial marketplaces like Shopify, eBay, Etsy, or Magento.

Strategic Partnerships

Unity has also formed strategic partnerships to enable interoperability of customer content. Revenue is primarily via fixed-fee royalty contracts, and represents the smallest segment of Unity’s revenue.

Growing Wider And Taller

Unity has supercharged its offerings over the past few years with more than a dozen acquisitions. Although some might question an unprofitable hypergrowth company spending raised cash and shares on M&A, I see a method to the madness. Below I highlight two recent takeovers, and the underlying pattern at play.

Case Study: Interactive Data Visualization (IDV)

In July 2021, Unity Acquired IDV, the creator of SpeedTree, which is a suite of vegetation modeling and environment creation products for architects, designers, and filmmakers. If you follow Unity, perhaps you heard about this acquisition and like me, thought, “cool…bush software.”

Well, we were wrong.

SpeedTree’s software is so performant, so pervasive, I can almost guarantee you’ve already seen it in action.

SpeedTree is the software used to render foliage and vegetation in blockbuster games such as Horizon: Zero Dawn, Call of Duty: War Zone, The Witcher 3, Assassin’s Creed: Valhalla, and Ghost of Tsushima. For those of you who don’t play, these are of some of the most vividly designed and immersive virtual worlds, ever. Period.

I’ve collected some in-game sample shots to validate:

These are gorgeous games, with incredible environments.

SpeedTree is also a leading solution in the film industry, featuring prominently in James Cameron’s Avatar, The Great Gatsby, The Wolf of Wall Street, The Avengers, and Iron Man 3. The resume includes a Scientific and Technical Academy Award and an Engineering Emmy Award.

SpeedTree is not just a good tool for building lush and dynamic worlds, it is perhaps the best.

With this acquisition, Unity is forging a clear path upmarket into AAA-title territory. Furthermore, IDV’s strategy of bringing tools that traditionally inhabited the realm of video games to new frontiers like filmmaking aligns with Unity’s vision of an expanded role for their engine.

Case Study: Parsec

"You haven’t heard of the Millennium Falcon?"
[Obi-Wan Kenobi shakes his head]
"It’s the ship that made the Kessel run in less than 12 parsecs."

―Han Solo, Star Wars Episode IV

Announced on the Q2 earnings call, Unity will acquire Parsec for $320 million in cash. The a16z-funded start-up delivers the software that allows creators to work remotely (and in teams) on any device with the same powerful design tools and performance as their on-prem workstations.

a16z’s Martin Casado (and current Parsec board member) wrote the following about the Parsec opportunity:

“It’s not very often you see a demo that you think about for years. And yet that was the case with Parsec…

When I tried it, Benjy Boxer, the cofounder and CEO, was hosting a game on his desktop in New York and I was playing it in our offices in Menlo Park. Despite the physical distance, it felt as if I was playing the game locally on a beefy, gaming PC rather than from 3,000 miles away on my old, underpowered laptop. The responsiveness was unreal! Already then it had that touch of magic that typifies truly special products.”

Parsec became a viral hit for Unity employees during the pandemic, which triggered the curiosity of Unity’s leadership. After completing due diligence, it was concluded that Parsec was indeed an absolute rocket ship, and it was time to climb aboard.

This past year Parsec grew revenues at a rate of 170%, which is expected to accelerate in 2022. Parsec also touts a net expansion rate north of 200%, a supersonic figure that makes the growth metrics of data analytics titan Snowflake look downright plodding.

Parsec counts game studio royalty such as EA, Ubisoft, Square Enix and Blizzard as customers, however, the team is also expanding into non-gaming verticals such as filmmaking, architecture and engineering. The acquisition is expected to close in Q3, and per guidance, will not have a meaningful impact on Unity’s 2021E revenues.

Again, Unity appears to be focused on building a wider product portfolio that serves both gaming and non-gaming industries alike. Having a work-from-home developer solution for creators seems like a potential home-run product with compelling cross-selling opportunities. Parsec offers the tools to spin up a performant creative workstation from anywhere, on any hardware — software perfectly positioned for the post-COVID world.

Q2 Download: Growing Revenues and Losses

On August 10, 2021, Unity announced Q2 2021 financial results, and they were stellar. The short of it: Unity delivered a clean beat-and-raise, albeit with widening losses. Revenues grew by 48% to $273 million, an upside surprise of > $30 million. Gross profit was $215.8 million, resulting in margins of 78.9%. Results and visibility were strong enough for management to raise full-year revenue guidance by $45 million.

Operate was the belle of the ball, growing 63% year over year, benefiting from a deeper bench of products, recent acquisitions, and extensive use by an ever-expanding cohort of enterprises. 888 customers generated over $100k in revenue for the trailing 12 months, up from 716 the year prior. Furthermore, Unity logged a truly exemplary dollar based net expansion rate (DBNER) of 142%, second only to Snowflake of the businesses I cover.

Losses from operations were $149 million, and free cash flow (FCF) was negative at ($33.5) million. However, Q2’s FCF margin of -12% improved substantially from Q1, at which point it was -43%. Unity also reduced fiscal 2021 income loss guidance from $90 – 100 million to $55 – 65 million. Rising headcount and considerable R&D spending had the greatest impact on Q2’s bottom line, with the latter representing > 56% of revenues. Clearly Unity is prioritizing product investments and growth today, with profitability expected by 2023.

For Q3, Unity guided for revenue of $260 - $265 million, or growth of 31% at the midpoint. If this guidance is accurate, it would represent Unity’s first and only quarterly revenue decline I am aware of. While summer months are traditionally slower for gaming companies (particularly ones with usage models like Operate), this stinks of sandbagging to me.

As evidence, with nearly two of Q2’s three months in the books, Unity guided for Q2 revenues of $240 – 245 million. The team ultimately posted $273 million. So either June was ~50% better than expected or management was pitching soft guidance.  

I like beat and raises as much as the next guy, but it’s always helpful to discern sandbagging from a dented growth story. Given the recent hire of (former CFO of AWS and Palo Alto Networks) Luis Felipe Visoso as Unity’s Senior VP and CFO, I imagine he is intentionally softening expectations through his first year at the helm. In the meantime, conservative outlook with home-run earnings calls is the flavor du-jour. I expect Q3 revenues in the range of $275 - 285 million.

What I was most impressed with while reviewing the Q2 numbers was 48% growth against stiff Q2 2020 competition. From March to May 2020 most Americans lived their lives from the couch — many in front of gaming consoles. That Unity could grow nearly 50% off such an aberration of a quarter is the most compelling statistic in the Unity growth story.

When I began writing this article, Unity traded at $125/share, for a valuation of $35.3 Billion. However, following a tech nosedive, I was able to purchase a full position in Unity on October 4 around $119/share, which so far has been an excellent trade.

Tyler Okland, MD @Tyler_Okland_MD

Ok now that tech is rebounding I feel secure enough to announce I bought the dip yesterday.

As of today, Unity trades at $146/share, for a valuation of $41.2 Billion, or a price to sales ratio of 38.4. While this might seem high, I believe Unity warrants a premium, and can continue to grow into and expand the current valuation multiple. I outline my reasoning for this premium below.

Riding The Gaming Wave

Now that we understand Unity’s business and what it’s recent numbers look like, it’s time for my favorite part of this piece — The Unity bull case.

Let’s get to it.

Would it surprise you to know the market for video games today is larger than film, television and music combined, and growing more quickly?

According to ARK Invest, the global gaming market is expected to grow at 16% CAGR from around $200B today to nearly $400B by 2025. A dominant component is AR/VR, projected to account for revenues of $130B by 2030.

Gaming growth is largely fueled by ever-advancing mobile technology, which can now sustain multiplayer workloads and advanced graphics. Indeed, mobile is the fastest growing segment of gaming revenue, already larger than console and PC at 57% market share. The advent of 5G will only accelerate this trend.

Interestingly, Unity is the category leader of mobile gaming, reporting north of 71% of the top mobile games were built on Unity as of Q4 2020. As mobile games increasingly become the place we socialize and engage with friends, time spent on Instagram, Facebook and Snapchat will be repurposed to games built on Unity. More captive eyeballs means more advertising revenues, more in-app purchases, and more demand for Operate solutions.

Platform convergence also benefits from advancements in mobile technology, and is a massive tailwind driving gaming forwards. In the words of Unity CEO John Riccitiello:

“At best there are only a couple hundred million people in the world that will touch a console in a given generation. But mobile is well north of 2 billion, and when you combine those audiences you get the people that pay the most to participate with the largest possible audience.”

Platform convergence is what allows you to play Fortnite on your phone against players using their Xbox, or PlayStation, or any combination. This technology has revolutionized the gaming space, and geometrically expands the market.

Technological innovations are obvious drivers of gaming’s growth, but perhaps an even more potent accelerant is how we as a society are perceiving ‘games.’

As more of our lives are spent in virtual worlds, a cocktail of leisure, escape and social, these will become ‘third spaces’. Much in the way we binge a familiar Netflix show today, in the future we might find ourselves spending ever more time exploring virtual worlds, games and experiences.

Tomorrow’s family night might look less like movie and popcorn and more like let’s put on our VR headsets and go explore the world of Pandora. As Unity increases penetration into traditional gaming and AR/VR gains mainstream adoption, the company stands to benefit from two powerful growth waves.

And we are in only the early innings:

Video Games, The Idea

Take a moment to think about video games, the idea, as a business.

Hypothetically, I may love a particular video game, but eventually I have to unplug, eat, spend time with my (as of October 16) wife and friends, and of course, work. Right or wrong, work is where I spend the majority of my time.

But what if you could earn an equivalent salary in an engaging, virtual world, just by playing or contributing content? I believe we are rapidly approaching an inflection point in which regular, everyday people respond to the classic “What do you do?” with “Oh, I play video games,” or, “I design content for virtual worlds.”

If I sense you arching a skeptical eyebrow, stay with me.

In the Philippines today, thousands of workers have abandoned regular jobs to play NFT platform game, Axie Infinity, where players can earn around $2k per month. In August, Axie Infinity’s protocol revenue was not only the highest of all dapps and blockchains, it was 2.2x higher than the next closest competitor, the Ethereum blockchain.

I myself am the proud owner of four adorable Axie NFT’s.

If video games, the idea, were a business, in-game economies with competitive earnings potential represent a switching cost moat. Why go work 9 to 5 for a flawed manager when you can earn just as much (if not more) playing video games?

The virtual worlds of tomorrow represent the ultimate blank canvasses. Developers and artists will fill these infinite spaces with bespoke content, some as side-hustles, but many as full-time engagements. And consumers pay baffling sums for skins, digital real-estate, experiences, or NFT’s. The great migration to gaming will only accelerate the trends of Esports and live streaming, and working in these ‘industries’ will become increasingly lucrative.

There are growing network effects at play as well. Each year virtual worlds become more immersive, more interactive, which will only compound with VR/AR and advancements in mobile computing/gaming. As this happens, billions of individuals will be added to the gaming ecosystem, strengthening the network effects of games much in the same way a social media platform might.

The next major social media platform will be in gaming.

This is less prophetic than it is declarative – it’s already happening. The blockbuster successes of Fortnite, Roblox, Minecraft and Axie Infinity has at least as much to do with the social elements of these platforms as it does with the gameplay itself. Games are the new watering hole, the digital playground of a generation that devotes more time to playing, watching, and talking about games than any before it.

Indeed, Facebook’s Mark Zuckerberg has made it perfectly clear he expects the dominant ‘social media’ of the future to be gaming. Facebook has nearly 10,000 employees just working on its AR/VR projects.

If you have not deleted Facebook, fire it up. At the bottom of your screen you will see the ‘Gaming’ tab occupies a full 20% of the clickable options. And there is a ‘Watch,’ tab as well, where people live-stream video games. Said another way, gaming occupies almost half of the clickable options for an app that has close to 3 billion users.

Facebook even made a well-publicized attempt at acquiring Unity before the IPO. Zuck saw the role Unity would play as the infrastructure layer of our future definition of ‘social,’ and it’s fundamental.

Owning The Middle

Let’s take a moment to unpack the importance of Unity becoming ‘the infrastructure layer’ of these myriad secular trends. Some have aptly referred to Unity as a ‘pick and shovel play.’

Myself, I like to call it “owning the middle.”

By becoming the middle layer of the gaming space, Unity is engineering the atmosphere of our digital existence, perfectly positioned between developers and consumers. We might not see Unity there, but it’s critical, and all around us, like oxygen.

One of my favorite movie lines on the concept of owning the middle is found within the British crime film, Layer Cake. While speaking to a young Daniel Craig from the window of a 2000 Bentley Arnage, Sir Michael Gambon (AKA Dumbledore) chirped the following quote.

“Always remember young man, the art of good business is being a good middleman.”

This lesson resonated with me, for its wisdom as much as its simplicity.

There is something compelling, something inevitable about becoming the gatekeeper of the path everyone must pass through. I have a track record of preferentially valuing operators whose singular focus is becoming the middleman of their respective industries.

FinTech King and Prince Square and SoFi, respectively, are building a one-stop financial super app to box out byzantine banking products. Palantir is the analytics layer between raw data and enterprise, with Foundry serving an extensive product suite that make single-solution analytics look proper pedestrian. Opendoor cuts out each of the ancillary racketeers who profit from the real estate transaction, a cluttered legacy product that has been unacceptably poor for decades.

These are my core holdings, my highest conviction picks. More value, less cost, business and customer wins. This is owning the middle.

For their part, Unity is disintermediating each middleman in creative design, becoming the full-stop solution. As a result, creators and operators don’t have to pay and subscribe to dozens of different licenses – it is both cheaper and easier to simply purchase a bundled Unity subscription. This builds the switching cost moat.

Similarly, because Unity owns the middle, they can increasingly charge less than single-solution competitors per product and see more fall to the bottom line: this is the scale economies moat.

Owning the middle generates two critical moats, and it makes for a resilient business. Unity is able to say, in earnest, “We offer more value at a lower price.” As a consequence of this model, cursory customers become Unity missionaries, driving organic customer acquisition and outsized Operate growth.

But the endgame of middle-owned ubiquity is pricing power.

As Unity continues to differentiate itself from single-solution players and expands product functionality, it will be able to increasingly monetize contracts and subscriptions. This piece is critical, because today Unity’s software is under-priced, with a bias towards customer acquisition/relationships rather than billings.

In fact, Riccitiello referenced this on the Q2 earnings call:

“We sometimes get the question that if more than 50% of all games are built using Unity, isn't our growth prospect limited? Well, no. We believe we can 5x our penetration in games. Growing our penetration with artists is key to this effort…

The war among developers and publishers to win with consumers is over the best content. And in this war, the ammunition is art.”

From SpeedTree to Parsec, Unity is internalizing the artistic weapons of war, to be the armory of the creator economy. This strategy is a unified attempt to own the middle, to be the toll-man on future’s highway. It’s not sexy, and it often doesn’t make the news. But behind the stylized graphics and the distractingly-beautiful rendering lurks Unity, the ghost in the shell.

On Becoming The World Engine

Perhaps the most bullish outcome for Unity is that it’s no longer considered a game product. That Unity simply becomes the creative engine of the digital world – a composite of Autodesk, Adobe, game engine and world builder.

"We are investing in the development of products, services and go-to-market strategies that serve industries beyond gaming, where we believe our long-term potential is many times greater than in gaming."

John Riccitiello, Unity CEO

Unity is making impressive inroads into non-gaming frontiers, counting each of the top 10 automobile OEM’s as customers, securing strategic partnerships with incumbent Autodesk, and recently announcing Unity Metacast, a real-time 3D platform that will provide virtual sports content to consumers.

While there are early signals of this evolution, non-gaming verticals remain under-penetrated and under-monetized. In the S-1, Unity reported only 8% of its enterprise customers were in non-gaming industries. To grow into the valuation of Adobe, Autodesk and beyond (combined $330 B market cap), Unity will need to execute impressive strategy.

Recent acquisitions imply a ‘land and expand’ tactic:

-       SpeedTree (July 2021) the leading vegetation modeling and environment creation tool, allowing filmmakers, architects, artists and game designers to build lush digital worlds.

-       PiXYZ (June 2021) provides 3D preparation and optimization software, allowing engineers to import 3D data such as cars and planes and optimize/develop these models with VR capabilities.

-       VisualLive (March 2021) a tool for architects/contractors to overlay CAD/BIM models onto a physical jobsite in AR within minutes, integrating directly with Autodesk.

-       RestAR (December 2020) empowers fashion brands, online retailers and marketers to scan physical objects with a mobile phone and render a digital twin.

Unity has pegged its current non-gaming TAM at $17 Billion. But after doing this deep dive, I find myself again convinced management is sandbagging. The figure is truthfully much higher.

Are there really any limitations to use-cases for Unity software?

Let’s take the automobile industry as an example. Electric vehicles and autonomous technology represent one of the sexiest investment sectors today. What if you could leverage satellite imaging to render a digital city like San Francisco in 3D, complete with dynamic traffic data? You could take San Francisco’s digital twin to any of the OEM’s as an exhaustive hybrid dataset (synthetic + real-world), and use this model to accelerate autonomous software training.

Mind blown.

How much of an improvement would this be over the current status quo – individual drivers chaperoning prototype cars for millions of miles? This isn’t just 10x better technology, it is 100x, perhaps 1,000x better.

If only Unity was working towards such a solution…

But it is – Unity is quietly developing an eerily similar product. Unity even has a blog devoted to using synthetic data to train computer vision (CV) systems. In August, 2021, Unity announced the release of Unity Computer Vision Datasets, designed to reduce the cost of developing CV applications and train AI more quickly. Several months prior, Unity reported a collaboration with HERE Technologies, which includes next-gen location technology for autonomous driving, simulations, city-planning and digital twins.

Not tomorrow, but perhaps someday soon, we will be able to tour Tesla’s digital storefront in Unity VR, inspect a virtual Cybertruck, test drive in virtual San Francisco (or Planet Arrakis, for that matter), drive it in the physical world using autonomous technology trained by Unity’s hybrid datasets, while playing a mobile game built on the Unity engine. And maybe in that mobile game we can get around in a digital rendering of our Cybertruck, a unique NFT to bring along on any of our digital explorations.

I consider myself an imaginative guy, but I can’t think of an important industry the Unity engine will not disrupt over the coming years. The use-cases for Unity’s technology are not just many, but infinite, bringing to the fore the ultimate secular theme for Unity: the metaverse.

Unity Is Rendering The Metaverse

At this point it’s hard to imagine you haven’t heard the term, “metaverse.” Much like the breathless hype of ‘artificial intelligence’ or ‘deep learning,’ metaverse is in vogue, oft uttered and seldom deserved.

Here, I will try my hand at defining the concept. Truthfully this is the section that required the most research, the most mental gymnastics.

Matthew Ball is the deepest thinking essayist on the metaverse. I read tens of thousands of his excellent words in preparation for this article, and I recommend anyone begin their study of the metaverse with him. That out of the way, I am going to try something ambitious: to condense my explanation of the metaverse into one, definitive paragraph:

The metaverse represents a persistent, shared, virtual space, the synthetic successor to the modern day internet. Where today we have webpages, tomorrow we will have virtual places. The metaverse will represent infinite digital experiences built by individual creators and enterprises alike, that carry on in parallel to our physical world. The amount of users will be limited only by the number who wish to participate, and each user will have a sense of agency, or presence. The ecosystem will be supported by blockchain technology to engender inventory accuracy and permanence, that is, you may bring your digital assets with you across any of your experiences. Finally, the metaverse will host a robust economy based on cryptocurrency.

Are you seeing the vision? A realized metaverse unlocks trillions in addressable market, an opportunity geometrically larger than the modern-day internet. Each of these digital experiences will be built and quilted together by creators, who will increasingly look to Unity for the tools to do so.

Proper positioning for the metaverse growth wave will require early integration of blockchain technology into game design. Accordingly, Unity has already secured several key partnerships with blockchain technology providers such as Venly (formerly Arkane Networks). With the release of the Arkane blockchain gaming SDK for Unity, developers can publish in-game items from within Unity straight to blockchain without requiring deep knowledge of blockchain, smart contracts or transaction handling. Simple but crucial applications like NFT stores can be seamlessly added to a Unity game via this integration.

Blockchain technology will allow creators to build applications with money baked into the code. Crucially, this money is not subject to transaction fees as might a credit card or your Affirm checkout — this means more value accrues to creator and consumer, rather than aggregator. This is the hallmark of web 3.0 and the ethos of the metaverse.

While not a near or medium-term catalyst, Unity’s path to becoming the de-facto rails of the metaverse’s construction will fuel a new epoch of growth over the decade to come.

The below graph was scaled intentionally, and meant to represent the value associated with building infrastructural software for the next iteration of the internet.

This is huge.

No one company will be able to build or control the metaverse. Rather than Arasaka, we must have have a decentralized, free-market metaverse. That said, as this futurism represents a market many times larger than today’s internet, each of the mega-cap tech titans jockey today for tomorrow’s profits. Facebook, Apple and Microsoft are venturing further into virtual and augmented reality, Amazon’s AWS will undoubtedly power virtual experiences, and Google’s dominant search technology will perhaps sort them for us.

Unity competitor, Epic CEO Tim Sweeney, has voiced his concerns regarding big-tech’s involvement several times, quite publicly:

“It's a big and growing problem, the amount of power possessed by Google and Facebook. President Eisenhower said it about the military-industrial complex. They pose a grave threat to our democracy.”

Woah. If I was Zuckerberg or Pichai hearing those words I might give second thought to my strategic relationships in the game engine space.

But throughout the metaverse arms race, Unity has remained neutral, Switzerland, quietly building the infrastructure layer for contributions from big tech and individual creators alike. This behavior, I believe, sets Unity apart from the 800-pound gorilla, the competition — Epic Games.

Unity’s Epic Competition

More than valuation or profitability, the argument I hear most frequently against Unity is that Epic is a superior company. Remember, I began this journey in such a camp. More and more I see that argument as inaccurate.

Epic admittedly has a more performant engine. It also makes blockbuster, money-minting games like Fortnite, and is led by a visionary founder.

But it bears these advantages at a cost.

Much like a Ferrari, Epic’s engine likely overserves the vast majority of the market. Unreal primarily targets AAA titles, and claims the most realistic graphics and performance. While the Epic team gets cool points for this, they may be sacrificing usability for power. As an example, the Unreal scripting language is C++, compared to Unity’s C#. The former is more performant, yes, but the latter is much easier to learn. In the words of Riccitiello:

“It’s easy to make powerful tools that no one can figure out how to use, but what’s hard is making insanely powerful tools that are easy to use.”

Unreal’s engine is likely more than most developers need, which is why developer-friendly Unity has been able to capture majority marketshare, despite Epic Games’ 13-year head start. And while Epic appears to be expanding downmarket (both with ease of coding and customer orientation), they may find it challenging to unseat Unity from its dominant foothold.

COVID is the greatest public health crisis of our time, but it unlocked the creator economy, the rise of the side-hustle. More businesses will be started in 2021 than in any year prior, and both Unity and Unreal allow creators to monetize their passion for gaming. By positioning itself as the most developer-friendly, with easy-to-use tools and scripting language, Unity stands to benefit asymmetrically from creators moving to gaming.

Roblox as a Tailwind

There is no company minting more game creators than Roblox. While that may sound like additional competition for Unity, I believe it is quite the opposite.

It’s not unfair to say Roblox (and Minecraft) have a complete monopoly on the child and adolescent gaming demographic. Today, more than 7 million developers make games and experiences on Roblox for over 200 million monthly active users. On the Roblox website there are numerous interactive lessons for young developers on coding, game design and educational tools.

But those children and adolescents will one day grow up. They will become interested in more adult-themed content — experiences they can neither create nor enjoy on the Roblox platform. Armed with a Master’s in game design from Roblox University, these fledgling developers will turn to Unity.

Developers incubated on the viral successes of Roblox will in short order become a generation of adept Unity Create and Operate users. In this way, “competition” from Roblox is actually a tailwind. Once again, Unity finds itself in perfect position, propelled by the warm wind of opportunity.

Apple vs Epic

You can’t write a (decent) article on Unity today without including the Apple vs. Epic Trial. The high-profile and protracted battle between the largest company in the world and perhaps the most important voice in gaming (Epic CEO, Tim Sweeney) has been ugly at best.

On Sept 10, 2021, U.S. District Judge Yvonne Gonzalez Rogers rejected Epic’s efforts to compel Apple to allow third-party programs to be downloaded on its mobile devices outside the App Store. Similarly, she ordered Apple to refrain from prohibiting developers from communicating with users about alternative payment methods.

Tim Sweeney @TimSweeneyEpic

Late last night, Apple informed Epic that Fortnite will be blacklisted from the Apple ecosystem until the exhaustion of all court appeals, which could be as long as a 5-year process.

This…is a devastating and not unexpected blow for Epic.

While Tim Sweeney has made Apple vs Epic a moral fight for gaming’s future, at the end of the day his company concealed code from Apple to divert in-app payments directly to Epic. And regardless of what side you’re on, being blacklisted from the App Store is not a good position for Epic to be in.

Try searching for Fortnite on your iOS App Store. Nothing. That’s a problem.

Tim Sweeney continues to use Twitter to mudsling anti-Apple invective, which I can’t imagine is making things better. If relations continue to sour, Apple could potentially suspend the entire Epic Games Developer Account from the Apple ecosystem, preventing designers who built on the Unreal engine from app updates and development. If I were a developer selecting an engine for my game today, choosing Unreal bears a very real risk.

In the words of Mario Gabriele at the Generalist, while Unity may not benefit from launching blockbuster titles like Fortnite, “It's also less likely to find itself embroiled in distracting, expensive, and potentially strategically damaging disputes with a critical partner.” As Epic’s CEO has repeatedly pushed away potential partners representing trillions such as Apple, Facebook and Google, Unity navigates the ever-changing gaming landscape with grace.

I am preferential to companies led by founder-CEO’s, which is another reason I began this journey in the Epic camp (Riccitiello joined Unity from EA Games in 2014). Founders break down walls, they’re patient, and tend to compromise less on long-term vision for near-term profits.

But today, Riccitiello appears to be managing his company more strategically. Unity’s role as agnostic, impartial scaffolding will ultimately result in easier partnerships with the many companies who will make an immersive digital future our reality.

Like Sweeney, I believe internet 3.0 and the metaverse must be open ecosystems where most value accrues to creator and consumer rather than aggregator monopolies. I agree the 30% Apple App Store tax is ridiculous. But navigating the ever-changing landscape of the gaming space will require nuance, compromise and cooperation. Unity again, appears best positioned for this.

The Place Where All Roads Converge

It seems like each of the companies I explore are contentedly straddling the waist of a generational trend. That’s deliberate, and it’s not because I’m a romantic. The majority of my financial analysis is not spent writing, but putting businesses under the microscope, interrogating them ruthlessly to identify only the strongest candidate.

But while writing this piece, I realized more and more that the most inevitable trends of our time lead back to Unity. The creator economy, blockchain, virtual worlds, AR/VR and the metaverse…

Unity is Rome, Mecca, “mile-zero” – the place where all these roads converge.

There is something NVIDIA-esque about Unity’s positioning, something more deliberate than coincidence or happenstance. If I have learned anything by studying NVIDIA CEO Jensen Huang, it is that proper positioning today is a wedge into the use-cases of tomorrow.

And as a science-fiction future accelerates towards us, Unity seems to be sailing, unperturbed by the changing landscape, controlling its own gravity. I will say it again, with resolution now, if you believe our future lives will become more digital, more virtual, rather than less, Unity stands to benefit the most. Unity is the world engine.

This is why Unity has become my fourth core holding, alongside my highest conviction picks. Unity has all the characteristics of a core holding — it is underestimated, perfectly positioned, and leading the charge to disrupt our digital tomorrow.

Stay convicted.

Tyler

Huge thanks to my (now) wife Jennifer for her saintlike patience and overall willingness to tolerate my prolonged editorial sessions. And to you, noble reader, 2 million experience points if you click any of the below buttons 🤓

As always, feel free to find me on Twitter to let me know what you liked and what you didn’t about this post.

Below are some excellent articles on Unity I read in preparation for today’s post. I believe each of these are worth a subscription to the respective writer in their own right:

1. Doug Clinton, Steve Van Sloun, Loup Ventures: Game Development Software: Picks and Shovels for the 3D Rush.

2. Doug Clinton, Steve Van Sloun, Loup Ventures: Unity: The Next Great Creative Software Company.

3. Mario Gabriele, The Generalist: Unity is Manifesting the Metaverse.

4. Max Motschwiller, Meritech Capital: Unity Software IPO | S-1 Breakdown

5. Matthew Ball: The Metaverse: What It Is, Where to Find it, Who Will Build It, and Fortnite.

6. Investquotes, The Global Investor: $U | Unity Deep Dive (Part 1)

7. Investquotes, The Global Investor: $U | Unity Deep Dive (Part 2)

8. Mazwood Cap, Musings by Maswood: Company Deep Dive: Unity Technologies.