Unrequited Lovin

On Monday, Unity announced that its board has voted to reject the unsolicited merger proposal made by AppLovin a week earlier, maintaining its commitment to completing its previously-announced merger transaction with ironSource. Unity’s CEO, John Riccitiello, appeared on CNBC to discuss the decision (emphasis mine):

The clear conclusion is that the AppLovin proposal wasn’t likely to lead to a ‘Superior Proposal’, and we’re highly convicted for the positives of the ironSource merger, where we can do better by way of our customers and better by way our shareholders…with the ironSource deal, we think we do better with our customers, we think we do better with our shareholders. We present a balanced portfolio where about half of our business is related to monetization, but the heart and soul of the company, around content creation, is the other half of the business, and it’s really what drives things for us.

AppLovin’s proposal values Unity at a share price of $58.85, which represented a 20% premium over the previous day’s close at the time of the proposal but only represents a 10% premium as I write this. In addition, AppLovin shareholders would have ultimately controlled the combined company at 51% ownership, whereas Unity shareholders would own 73.5% of the combined Unity-ironSource entity. I found this piece and this piece from gaming industry expert Joost van Dreunen to be insightful in considering the AppLovin proposal to merge with (acquire) Unity.

It’s important in parsing AppLovin’s financial profile to specifically assess the growth of its software platform (ads platform). AppLovin’s overall year-over-year revenue growth for Q2 2022 was 16%, but its Software Platform business unit revenues grew by 118% while its Apps (first-party games) revenues shrank by 12%. Unity’s business is evolving differently: its Operate (advertising and monetization) business has receded from a Q4 2021 peak, whereas its Create (game engine and creator tools) business continues to grow.

The decline in AppLovin’s Apps business unit sits poignantly in juxtaposition with a feature of the Unity-ironSource merger that I didn’t fully appreciate at first pass: the combined Unity-ironSource company achieves a 50/50 revenue split across the Creation and Growth business units, which I take to be analogs to the Create and Operate business units for which Unity currently reports results. This is possible because revenues from ironSource’s Supersonic Games publishing business, under the proposed merger, would be booked under the Creation business unit.

AppLovin’s revenue currently skews heavily to its Apps business unit: for Q2, the Apps business generated $459MM of the company’s $776MM in total revenues, for 59%. By contrast, Unity’s Create business unit generated $121MM in Q2 on $297MM in total revenues, for roughly 41%. But Unity’s Create business unit is growing where its Operate business has struggled in the aftermath of Apple’s App Tracking Transparency (ATT) policy and the broader mobile marketing winter: Unity’s Create business unit grew year-over-year revenues by 66% in Q2, versus a 13% contraction for the Operate business.

It’s clear why Unity would pursue parity across these business units: adtech valuation multiples are much lower than platform valuation multiples. In delivering and supporting a genuine creator ecosystem — but especially one that services content formats beyond gaming, as Unity’s ambitions clearly project — Unity manifests more value than in merely operating an ad network. And the commercial prospect of operating a publishing business, which participates in the success of games versus merely facilitating their success with advertising sales, is compelling.

My initial take on the commercial justificatio of a Unity / ironSource merger still stands: a merger provides Unity with access to a scaled mediation platform that unlocks powerful competitive value when paired with Unity’s ad network. I’ve written about how mediation is the primary competitive front in the post-ATT mobile advertising landscape, and Unity lacks traction with mediation. Furthermore, as I write in this piece from 2018, demand platforms will necessarily consolidate as in-app bidding continues to gain share as a monetization mechanic. From my original analysis of the Unity / ironSource news:

My belief is that the union of these two companies will produce a whole that is greater than the sum of its parts: access to a scaled mediation platform will benefit Unity’s overall platform performance, but more than that, it will create a more formidable competitor to Applovin’s Max, enlarged meaningfully by Applovin’s recent acquisition of MoPub, by unifying those two solutions. Additionally, the merged company may be better suited, given the diverse product offerings boasted by ironSource, to provide better assistance to mobile game developers through live operations support (“LiveOps”) and monetization efficiency (eg. dynamic pricing, creative optimization, etc.).

This still stands, but Unity’s rejection of AppLovin’s proposal adds more context: clearly Unity doesn’t want to deviate from its commercial trajectory / corporate narrative, which is that it is a company that empowers and enables content creators. The best way to achieve this while buttressing the part of the business that delivers the most revenue is through the merger with ironSource. This is because, ironSource:

  • is profitable and growing;
  • features a scaled mediation platform that rounds out the broader Unity offering and provides a critical dimension of data for use in driving outcomes for advertisers;
  • runs a games publishing business that can augment Create business unit revenues but presents no conflict with Unity creators.

I emphasize the nature of Supersonic Games as a publishing business: ironSource, through Supersonic, does not create first-party games, and therefore it does not pose a conflict of interest with Unity’s engine customers. AppLovin’s Apps business is contracting, and the company announced last quarter that it is actively considering the divestment of some of its gaming assets, but nonetheless, AppLovin operates first-party games which would directly compete with customers of Unity’s gaming engine.

To my mind, the discord inherent in Unity’s provision of a game development engine while AppLovin operates first-party games, in combination with the very clear intention of Unity to achieve parity across its Create and Operate business units, elucidates Unity’s rejection of AppLovin’s (initial) proposal. If Unity were to merge with AppLovin, its Create business unit would not only adopt a conflict that could rupture its relationship with developers, but it would inherit a declining basket of revenues that could ultimately undermine the company’s goal of being recognized as a creator platform and not an ad tech company. In the medium to long term, merging with ironSource allows Unity to build the foundation of a scaled publishing business that marries creator technologies with distribution mechanics and exposes the combined company to the much more lucrative upside of scaled content sales.