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Unity Software (U -17%) is amid a sell-the-news reaction today as it flirts with all-time lows reached after lackluster Q1 results in early May. Investors are clearly not pleased with the price tag on Unity's planned merger with app-monetization platform provider ironSource (IS +51%). Unity agreed to an all-stock deal, valuing ironSource at roughly $4.4 bln, a 74% premium to the 30-day average exchange ratio. Although an all-stock agreement, where each IS share will be exchanged for 0.1089 Unity shares, the company noted that the merger is highly accretive, estimated to deliver a run rate of $1 bln in adjusted EBITDA by FY24 and $200 mln in annual EBITDA synergies by year three.
One of the primary problems plaguing Unity in Q1 was monetization. Unity's monetization model focuses on pay-for-performance end-user acquisition, where advertisers pay based on set targets, such as the number of installs. However, due to a fault in Unity's Audience Pinpointer tool, which helps drive installs at scale, its accuracy was reduced in Q1. Meanwhile, Unity saw an approximately $110 mln hit to annual revenue in FY22 due to losing the value of a portion of its data after ingesting bad data from a large customer.
As a result, investors may be disappointed in Unity choosing to spend billions of dollars through an all-stock transaction to help improve monetization instead of working to fix and improve its own set of tools.
Furthermore, ironSource's near-term outlook is underwhelming. The company does operate in the black, posting earnings of $0.05 in Q1. However, revenue growth is expected to decelerate considerably. ironSource guided to Q2 revs of just $180-185 mln, translating to +35% growth at the midpoint, well below its previous quarterly rates of over +45%. Meanwhile, ironSource trimmed its FY22 sales outlook, going from +46% growth yr/yr at the midpoint to only +38%. The company pointed to the typical headwinds affecting most of its peers, such as seasonal trends and overall macroeconomic uncertainty, as the factors impeding future sales.
Overall, Unity's merger agreement with ironSource is facing severe criticism today. Also, even with the premium valuation, the merger is merely a consolation prize for ironSource shareholders, as the stock still trades around 75% below record highs set in September. With Unity trading at 8x forward sales, the company operates in priced-to-perfection territory given the current rising-rate environment. As such, paying a sizeable premium for an organization focused on monetization, which Unity has repeatedly noted is one of its strengths, will not help turn around its falling share price, which is now down over 75% on the year.
