Has Unity's advertising business reached a turning point? Morgan Stanley bullish on three major drivers driving valuation reevaluation.

Morgan Stanley releases a report stating that it is bullish on the advertising prospects of Unity Software (U.US). The firm believes that Unity's strategic restructuring and technological investments over the past 18 months have significantly enhanced its competitive advantage in the advertising products, which may indicate a crucial turning point for the business. Morgan Stanley notes that recent feedback from Unity's advertising clients has shown a significant improvement in their advertising effectiveness, with installation and purchase conversion rates generally increasing by 15%-20%, consistent with the management's statements in the second quarter earnings report. Due to the high focus on return on advertising spend (ROAS) by advertising clients, Morgan Stanley expects that if Unity continues to provide efficient technology solutions, advertising budgets will further shift towards its platform. The firm emphasizes three main drivers that support this trend and are still in the early stages of development. Firstly, after nearly a year of development and testing, Unity's new Vector advertising model was fully launched in May and has shown its technical strength in just two months. With Unity's scale, coverage, and leading position in game engines, Vector's performance is expected to continue to improve with increased advertising spending and accelerated model training. Secondly, as the world's leading mobile game engine, Unity possesses unique user behavior data and has only recently begun to utilize this data for advertising targeting in the past 2-3 weeks. This aligns with improvements reported by clients, and as more real-time game data is input, Vector's performance will further enhance. Thirdly, the adoption rate of Unity 6 is rapidly increasing, approaching 50% in the second quarter, with 80% of clients planning to upgrade. This may not only bring subscription revenue growth to the Create department in the second half of the year but also provide richer data sources for Unity Ads, thereby improving advertising clients' ROAS. Regarding competitor AppLovin (APP.US), Morgan Stanley notes the company's strong recent growth in the advertising business but also believes that Unity's recovery suggests that the market can accommodate a multi-win situation. If the Vector model can provide differential insights, the overall size of the advertising market may expand, rather than a zero-sum game. In conclusion, Morgan Stanley continues to be bullish on Unity's investment in its high-profit advertising network business and the utilization of its unique data assets. Despite the general skepticism in the market about Unity's competitiveness in the advertising sector, this indicates significant potential for its expectations and valuation to increase significantly. The firm maintains a "hold" rating for Unity, with a target price of $25, and suggests that in a bullish scenario, the valuation could reach $40, corresponding to a 10% annual growth rate for the advertising business.