Story Stocks^®

AppLovin (APP -6%) is not receiving much warmth from investors today after the company announced yesterday after the close that it does not intend to submit another proposal to combine with Unity Software (U -11%). Meanwhile, shares of Unity are sinking, although much of the move can be attributed to today's CPI data.

APP provides software for mobile app developers, particularly mobile game developers. The company aims to tackle marketing and monetization challenges faced by mobile app developers, making it a good fit for Unity, which provides developers with the tools necessary to build mobile video games. APP initially submitted an unsolicited proposal, which it has now withdrawn, to combine with Unity in a stock deal valued at roughly $20 bln. If Unity had agreed, it would have had to break off its pending ~$4.4 bln acquisition of ironSource (IS -4%), which provides similar services to APP. On a side note, we also believe that with APP not looking to submit a likely more palatable offering to Unity, it ups the likelihood of the IS merger closing.

The chances Unity would accept APP's merger proposal were slim, especially since it came just one month after Unity agreed to merge with IS. Nevertheless, after Unity unanimously decided against APP's proposal, investors sent APP's shares over 7% lower. Since then, the stock has struggled, trading down by around 30%.

• We think APP's initial proposal was made out of concern that IS combining with Unity would create a much tougher competitive landscape, explaining APP's sharp downward move since Unity's rejection.
• With Unity growing its monthly active end users by over 44% yr/yr in FY21 to approximately 3.9 bln, APP may find it difficult to entice users to use its platform over IS's given the sheer size of its reach with Unity.
• By adding IS, Unity becomes more attractive for developers looking for a one-stop shop to create apps and monetize and market them successfully, placing another hurdle in APP's way. APP may offer monetization and marketing tools, but it does not supply software for game development as Unity does.

Although the road ahead is looking considerably challenging for APP, at the very least, it can get back to business with the Unity proposal no longer hanging over its head. APP's latest Q2 earnings report, where it missed top and bottom line estimates and trimmed its FY22 sales outlook, spotlights the challenging environment for the mobile app ecosystem. APP expects the near term to be rife with headwinds but is focused on the one thing it can control: improving its software. This is where APP's competitive advantage lies. However, this advantage could start to get clipped by a fortified competitor in IS and Unity.