Last month, Unity announced a merger agreement with ironSource. The deal is a significant consolidation effort in the development and monetization verticals of video games given the two parties’ core businesses:
The deal was an all-stock transaction and values ironSource at roughly $4.4b, down from ~$10b in January. For reference, Unity’s market cap is currently $14.2b, down from $42b at the start of 2022.
Just under four weeks after Unity’s offer to buy ironSource, AppLovin (a direct ironSource competitor) offered to buy Unity for $17.5b in an all-stock deal (which was an 18% premium at the time the offer was made). While this would have been a strong partnership, Unity’s board opposed the buyout offer and is recommending that Unity shareholders back the proposed buyout of ironSource (WSJ).
Why Did AppLovin Make This Bid?
Since AppLovin is restructuring (or even selling off) its apps business, partnering with Unity would give them the first-party data they had without the need to invest in its own apps division. This bid was also clearly a defensive move by AppLovin to try and shake up the deal between ironSource and Unity. AppLovin and ironSource are two of the best growth platforms for app developers, but neither has a seamless developer UA strategy.
Combined with Unity, the ironSource offering will become a significant strategic threat for AppLovin. Unity is the engine of choice for roughly 70% of all mobile developers (PocketGamer), and many of the most popular games are built with Unity. The combination of ironSource and Unity creates a compelling unified offering for developers.
According to Unity, the deal will bring together the Unity game engine, Unity Ads, and the rest of Unity Gaming Services (UGS) with ironSource’s best-in-class mediation and publishing platforms.This will give developers a seamless and interoperable way to build, grow, and monetize their creations across their lifecycle.
So, What’s Next for AppLovin?
It is possible that AppLovin makes another more compelling offer to Unity, likely focused on giving Unity more control over the new combined entity. Under the initial offer, Unity would only own 45% of the combined entity (vs 75% in the ironSource deal). Realistically, there is little more AppLovin can do without theoretically handing over the business to Unity.
Another major hurdle for AppLovin is the $150m termination fee (Reuters) that Unity would have to pay if they reneged on its agreement with ironSource (we think this is unlikely given $150m is ~13% of Unity’s $1.16b cash and cash equivalents).
If AppLovin does not submit another bid, we believe its business strategy should shift in one of two ways:
Strategy #1: Continue All-In on Software: AppLovin’s platform offers a full stack of software solutions including discovery, mediation, mobile measurement, and an ad exchange. In July 2018, AppLovin began acquiring and publishing its own mobile games (through wholly-owned Lion Studios) to build up first-party data that accelerated and improved the machine learning (ML) algorithms that power its software solutions. Over time and with third-party games onboarding to the platform (and sharing their data), AppLovin has weaned itself off the need for first-party data and decided to restructure its apps business. According to its CEO Adam Foroughi, they have acquired enough first-party data from its apps business to focus exclusively on building out their software capabilities.
For some context, AppLovin’s Software Platform generated $318m in revenue in Q2 2022 (+118% y/y) with 503 (+142% y/y) Software Platform Enterprise Clients (SPEC) (AppLovin).
Unity Create would have further diminished the need for AppLovin’s apps business. Unity Create would provide more first-party data (without the capital intensity of running AppLovin’s apps business) into the ML algorithms that power AppLovin’s recommendation engine, AXON. Although a deal with Unity was not reached, AppLovin still has a fantastic growth stack for developers. With the acquisitions of Adjust (mobile app measurement and marketing) and MoPub (mediation platform), combined with AppLovin’s in-app bidding tool, MAX, and AXON (ML recommendation engine); they have an opportunity to capitalize on the high-margin software business.
What will be interesting to watch is if Applovin’s models can continue to perform without more first-party data (given the changes to iOS and Android). AppLovin uses Contextual-Based Recommendation Ad Targeting which is only as powerful as the data powering the models. If AppLovin is expecting to decrease investment in UA for its apps business, the data will be difficult to acquire.
We believe the software business is the best option they have for continued growth, and we expect them to continue focusing on this segment. Similar to AppLovin’s strategy with MoPub and Adjust, we expect AppLovin to make additional major acquisitions. They will likely focus these acquisitions on more tools to get user-level data, potentially even moving into payments and distribution if this was ever opened up to third-parties on iOS and Android.
Strategy #2: Publisher-Focused Business: AppLovin has tools that almost no other publishers have in-house: a world-class growth and monetization platform. While this business is not as profitable as a software business, they already either own or have stakes in 14 studios (AppLovin Partner Studios). The success of any publisher business is reliant on supporting their studios with marketing and UA, an area where AppLovin excels.
One of the major benefits AppLovin has today on the publisher side is that they are mobile-native and have worked with all genres. With that expertise alongside its software business, they will continue to be an attractive partner for many developers and could actually build out a compelling mobile games business of first-party IP.
The reason why first-party data is so important is that “Apple is imbuing first-party data with an incredible value premium. The products that command the most first-party data will operate as autonomous content ecosystems, subsuming all content interaction and user interaction into their own properties and utilizing their first-party data for deep personalization” (Eric Seufert). Apple allows developers to do as they wish with first-party data so AppLovin can build out ad profiles for users across their games - they just cannot acquire any data from non-AppLovin companies to add to that user's profile (unless the user has opted-in to share data).
If AppLovin was to go after this market it would have to either revamp its strategy around UA for its studios or continue its spree of acquiring strong mobile games companies. The acquisition model is not an unrealistic strategy as AppLovin is larger than the vast majority of mobile games companies (public and private). With that being said, there are not many major IP acquisition opportunities on the market as most are owned by larger corporations. A point to note is that many could become on the market if they struggle with UA and monetization, which is where AppLovin has a competitive advantage.
There are two core issues, however. The first being the capital-intensive nature of publishing, a large reason behind their shift away from this model; software scales in ways that content production cannot. The second issue is that publishing is inherently competitive to its core software customers, other publishers. Though they were able to bootstrap their ML models leveraging this strategy, continuing to compete with your own customers breaks trust and promotes customer flight.
Takeaway: AppLovin clearly views the Unity + ironSource merger as a significant threat, which is why they made a bid to acquire Unity. In order for AppLovin to retain market share and keep growing, we believe AppLovin will double down on its software business (not its first-party IP business) and will be aggressive in pursuing value-add acquisitions (potentially even acquiring non-gaming companies) that provide additional data to fuel its ML models. The success of their software business (high margins) will allow them to remain a strong independent player in the gaming and app monetization space.