In this piece, I’m evaluating two gaming stocks: Unity Software (U) and Roblox (RBLX), a mid-cap and large-cap company respectively. Following my investigation, I’ve landed on a neutral view for Unity and a bearish view for Roblox.
Unity Software develops video game software via a platform that provides solutions to create and monetize interactive, real-time 2D and 3D content for phones, tablets, PCs, consoles, and virtual reality devices. In addition to gaming, Unity Software also serves the architecture and construction industry, animation companies, and the design sector
Meanwhile, Roblox offers an online entertainment platform that allows users to interact with each other, explore, and develop immersive, user-generated and 3D content.
Shares of Unity Software have soared more than 35% over the past three months, with most of that coming in September. However, the stock is still deeply in the red by 47% year-to-date, and it’s lower by 29% over the past year.
Similarly, Roblox stock has surged 17% over the past three months. The shares are up marginally year to date but more than 50% over the last year.
Even though both stocks performed similarly over the last three months, there’s a significant gap in their valuations. Since neither company is profitable, I’ve used a price-to-sales ratio (P/S) to compare their valuations. I’ve also looked at their historical P/S ratios.
A Closer Look At Unity Software
At a P/S of 4.25x, Unity Software is trading at what some might call a depressed valuation considering its range of 2.6x to 6.7x over the past year. However, due to recent insider sales and stubborn quarterly losses, a wait-and-see approach might be best. I have a neutral view on Unity.
Unity Software did post its first profitable quarter on a non-GAAP basis in the fourth quarter of 2022. but that was almost two years ago. Following that, management also guided for full-year profitability for 2023 which they did manage on an adjusted basis. However, unadjusted or GAAP profitability remains out of Unity’s grasp. In fact, net income margins of -37.6% in 2023 and -38.5% in 2024 suggest the company may struggle further in attempting to achieve GAAP profitability.
Unity Stock-Based Compensation and Insider Selling
High stock-based compensation (SBC) levels drive a large variance between GAAP and non-GAAP results, at Unity, given that SBC is excluded from non-GAAP earnings. While Unity is a company posting less than $500 million in quarterly revenues, SBC has been $100 million or higher in each of the past 10 quarters.
Nonetheless, management continues to dance around the profitability issue, with the Q4 2023 earnings call transcript promising the ability to “scale in a profitable way.” On the Q2 2024 earnings call, they told investors that they had, “complete confidence that we have everything we need to achieve healthy, sustainable, and profitable growth”. Unity stock may be struggling as investors wait for hard results that measure up to management’s optimism.
Unity insiders, however, appear to be unloading shares into the recent stock price rally, with TipRanks reporting insider selling of $6.3 million over the past three months. These sales suggest insiders aren’t as optimistic about the company’s value as they might otherwise seem. In my view, the only redeeming qualities for Unity Software are its low valuation and non-GAAP profitability, which call for a wait-and-see approach when balanced against the other issues.
Wall Street’s View for U stock?
Unity Software has a Moderate Buy consensus rating based on seven Buys, seven Holds, and two Sell ratings assigned over the last three months. At $21.54, the average Unity Software stock price target is quite close to the latest trading price for U stock.
A Closer Look At Roblox
At a P/S of 8.85x, Roblox is trading at a premium to Unity Software and in the middle of its range of 6.7x to 11x over the last year. With its lack of even non-GAAP profitability and insider sales, I land on a bearish view.
First, Roblox’s net income margins have been -41.4% for 2022, -41.2% for 2023, and -34.1% over the last 12 months. Costs appear to be rising just as much as revenues. If this continues, the company can never be profitable on a GAAP basis. The EBITDA margins of -35.7%, -37.3%, and -30.8%, respectively, suggest the same thing.
Roblox Stock-Based Compensation and Insider Selling
Roblox also relies heavily on stock-based compensation. Over the last 12 months SBC amounted to $963.1 million, relative to $1.1 million in net losses. Stock-based compensation is an issue for many technology companies, and it seems Roblox is no different.
Additionally, the lack of even non-GAAP profitability puts Roblox significantly behind Unity Software in terms of maturity and development. There was no mention of profitability in the latest earnings release or on the earnings call.
Finally, Roblox insiders have also been unloading shares of the company recently, with $5.8 million of stock sales over the last three months. This doesn’t help generate investor optimism about the future.
What is the Price Target for RBLX stock?
Roblox has a Moderate Buy consensus rating based on 13 Buys, eight Holds, and one Sell rating assigned over the last three months. At $45.84, the average Roblox stock price target implies upside potential of about 5%.
Conclusion: Neutral on U, Bearish on RBLX
On one hand, both Unity Software and Roblox look hopelessly unprofitable on a GAAP basis with weak net margins. However, on the other hand, Roblox isn’t even profitable on a non-GAAP basis, and management doesn’t seem focused on profitability, in my view. Rather, Roblox stock appears to have been riding high on its series of non-GAAP losses-per-share beats.
Meanwhile, the biggest issue for Unity Software is that management has been dancing around this issue of profitability. At the current valuation, if they can push the company into GAAP profitability, I would become much more constructive on this stock. The problem is that we need to see actual progress in this area — rather than just repeated promises.
At the end of the day, Unity Software is the clear winner of this pairing due to management’s apparent focus on profitability, including through recent job cuts (slashing 25% of their staff), and its non-GAAP profitability.
