Unity's Advertising Business Sees 10% Growth Potential, Says Morgan Stanley

Unity Software, a leading platform for creating and operating real-time 3D content, has garnered positive attention from Morgan Stanley regarding its advertising business. The firm's research report suggests that Unity's strategic restructuring and technological investments over the past 18 months have significantly enhanced the competitiveness of its advertising products, indicating a potential turning point for the business.

Morgan Stanley highlights three key drivers that could propel Unity's advertising business forward. Firstly, the company's new Vector advertising model, which was fully launched in May after nearly a year of development and testing, has already demonstrated its technical prowess. Leveraging Unity's scale, reach, and leadership in game engines, the Vector model's performance is expected to improve as advertising spending increases and model training accelerates.

Secondly, Unity's position as a global leader in mobile game engines provides it with unique user behavior data. The company has only recently begun utilizing this data for targeted advertising, which aligns with the positive feedback from clients. As more real-time game data is integrated, the performance of the Vector model is anticipated to further improve.

Thirdly, the adoption rate of Unity 6 is rapidly increasing, with nearly 50% of users having upgraded by the second quarter. This trend is expected to continue, with 80% of clients planning to upgrade. This not only bodes well for the Create department's subscription revenue growth in the second half of the year but also provides Unity Ads with a richer data source, thereby enhancing the return on ad spend (ROAS) for advertising clients.

Morgan Stanley also notes that while competitor AppLovin has seen strong growth in its advertising business, Unity's recovery suggests that the market can accommodate multiple winners. If the Vector model can offer differentiated insights, the overall size of the advertising market could expand, rather than being a zero-sum game.

Overall, Morgan Stanley remains bullish on Unity's commitment to its high-margin advertising network business and its unique data assets. The market's current skepticism about Unity's competitive position in the advertising sector presents an opportunity for significant upside in expectations and valuation. The firm maintains its "overweight" rating on Unity, with a target price of $25 per share, and suggests that in an optimistic scenario, the valuation could reach $40 per share, corresponding to a 10% annual growth rate in the advertising business.