Why are Unity and ironSource merging?

Today, Unity and ironSource announced that they will merge. Some highlights from the deal:

  • ironSource is being valued at $4.4BN in the transaction, which represents a 74% premium to the stock’s 30-day average exchange ratio;
  • Unity shareholders will own 73.5% of the combined company; ironSource shareholders will own 26.5% of the combined company;
  • Unity has raised its Q2 guidance slightly from what it announced in Q1 earnings but has reduced full-year guidance. ironSource reaffirms both its stated Q2 and full-year guidance;
  • The combined company is expected to reach a run rate of $1BN in adjusted EBITDA by the end of 2024 (assuming “end of” means Q4, this reads as $250MM in EBITDA in Q4 2024);
  • Two of Unity’s largest shareholders, Sequoia and Silver Lake, will commit a total of $1BN to the combined company through the purchase of convertible notes;
  • Unity’s board has approved a $2.5BN stock buyback program to be executed over 24 months after the close of the transaction.

More detail can be found in this press release and in this investor presentation from Unity.

This merger is a direct result of Apple’s App Tracking Transparency (ATT) privacy framework, which was rolled out in April 2021 but, for reasons that I unpack in the first article of the Mobile Marketing Winter series, only began to create perceptible impacts on the mobile advertising ecosystem in Q1 of this year. The stock prices of Unity and ironSource have fallen by 61% and 80%, respectively, from April 1st, before ATT was introduced in iOS 14.5, through yesterday, before the deal was announced.

ATT clearly isn’t exclusively responsible for these declines, but it certainly played a role. In its Q1 2022 earnings call, Unity revealed that a bug with its audience pinpointer product — its online advertising optimization engine — caused the company to miss its revenue target and issue weak Q2 guidance, leading to a sharp 30% drop in its stock price in after-hours trading. Unity stated unequivocally in its Q1 earnings call that the issue with its audience pinpointer tool was not directly related to ATT, but it surely was an indirect consequence, given that the audience pinpointer took on a prioritized role in the business (per the same call) following the introduction of ATT. While the Unity and ironSource stock prices were victims of the broader tech re-rating and sell-off that is currently gripping public markets, ATT has created frictions within the mobile advertising ecosystem that indisputably challenge these companies’ operating models.

So these companies face new headwinds. But why merge? I think a merger — but, to be clear, one party of the merger, Unity, retains a larger profile than the other in the combined company — was motivated by two strategic considerations:

  • Monetization, specifically, mediation. Unity was late to market with a mediation and in-app bidding product, whereas ironSource’s mediation platform, LevelPlay, was launched in 2019. Applovin acquired MoPub in October of last year (the same month that Unity announced its mediation platform) and quickly shuttered it, spending $210MM in developer bonuses to move MoPub customers over to its own Max mediation platform. This, to my mind, was a strategic masterstroke: as I argue in this piece, Applovin was able to aggregate a plurality, if not majority, of mobile in-game advertising supply, providing it with unparalleled access to data to use to the benefit of its demand customers. In this merger, the combined company lays claim to a scaled mediation platform with more potential to gain market share — read: aggregate supply — than either company could likely achieve on its own;
  • Profit. ironSource generated $59MM in Adjusted EBITDA in Q1 2022 on $190MM in revenues, for a 31% Adjusted EBITDA margin. Unity generated $320 million in revenues in Q1 2022 with a non-GAAP loss of $23MM for a non-GAAP operating margin of -7%. It’s important to note that Unity’s revenues from its advertising, monetization, and associated services, which it calls the “Operate” business unit, stood at $184MM for the quarter, or nearly 60% of the company’s overall revenue. Its game engine and associated services, which it calls the “Create” business unit, generated $116MM in revenue, or 36% of the company’s overall revenue, with Strategic Partnerships and “Other” filling in the remainder. The point is: ironSource is profitable, and Unity never has been: this merger addresses that in an environment in which public investors are re-evaluating the multiples they are willing to pay for tech stocks that don’t generate operating profit.

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.).

To my mind, Unity had lost sight of that recently with acquisitions like Weta Digital, for which it paid $1.65BN. Weta Digital’s addition to the company’s product suite supports a high-minded vision of Unity becoming a Metaverse engine or cinematic production tool but ignores the more pedestrian, immediate needs of mobile game developers and advertisers. ironSource, by contrast, has executed a spate of more directly relevant acquisitions that integrate seamlessly within its existing feature set.