Investing in the Metaverse



What is the metaverse? Its full expression will be a persistent, immersive virtual reality. We will shop in the metaverse; we will hang out with friends; play games and sports; and learn about ancient Rome not by reading about it in a book, but by being there in person in a photorealistic Rome filled with non-player characters, like a video game. We will work in close collaboration with colleagues from around the world through lifelike avatars.


“The future is already here—it’s just not evenly distributed.” – William Gibson



Mark Zuckerberg is an early adopter. If you want to try this out, I highly recommend the virtual reality headset by Facebook, Oculus Quest, which has been flying off the shelves. I wrote about Facebook’s attempt to speed up the adoption of VR here).


The term “metaverse” was coined in the 1992 novel Snow Crash and its most picturesque representation is probably from the movie Ready Player One. If you’ve tried a VR headset, you’ll immediately understand the appeal: you’re not watching something; rather, you’re experiencing it, viscerally.


Around the time Facebook’s founder Mark Zuckerberg acquired Oculus in 2015, he wrote a memo arguing that Facebook should acquire the digital animation company and game engine maker Unity.


“Our vision is that VR / AR will be the next major computing platform after mobile in about 10 years. It can be even more ubiquitous than mobile - especially once we reach AR - since you can always have it on. It's more natural than mobile since it uses our normal human visual and gestural systems. It can even be more economical, because once you have a good VR / AR system, you no longer need to buy phones or TV's or many other physical objects - they can just become apps in a digital store.”


Zuck goes on to explain that strategically, Facebook is disadvantaged since it will always need to abide by the app store rules imposed by Google and Apple (which prevent Facebook from offering things like its own app store). Apple has been in trial about this recently.


He goes through the various pieces Facebook will have to either build or acquire in order to turn this vision—controlling the next computing platform—into a reality:


“This is why I am supportive of acquiring Unity, expecting we will acquire an AR company in the next few years and opportunistically acquiring VR app teams […] we’re considering investing billions of dollars into Unity over the next decade.


“If we don't own Unity, then at best we can incentivize them to prioritize doing this for us and everything will just move more slowly, but at worst someone may acquire them and block this from happening at all or with us.


“Unity will increase the adoption of key platform services like avatar / content marketplace and app distribution store. We will achieve this by integrating these services with Unity to make them both superior and easier to use.


“As an example of superiority, if we want to make sure our avatars or identity systems work really well in Unity, we’ll easily be able to do that. No one else building a competing avatar system will be able to modify the Unity engine that everyone uses to support their services in a first-class way.”


The whole memo is worth reading; ever since I read it, I too have wanted to own Unity. It’s a duopoly, alongside Unreal, in what’s known as a “game engine,” the collection of design tools, physics simulation, animation, and everything else needed to build a modern game.


Who uses Unity? Companies like BMW and Skanska, tech giants like Tencent, game creators like Niantic, and even movie directors like Jon Favreau and James Cameron.


The company was founded in a small Copenhagen apartment in 2004 by David Helgason, Nicholas Francis, and Joachim Ante. Helgason is currently one of Unity’s directors and Ante the Chief Technology Officer. The company’s mission is to enable more people to be creators; in one executive’s words, “the 3D operating system of the world.”


In textbook Innovator’s Dilemma fashion, Unity’s first customers were independent game developers who were fine with a less sophisticated product. Over time, that product improved and became the gold standard.


Today, Unity’s main competition is Unreal Engine (owned by privately held Epic Games) and homegrown game engines, which, given the massive investments needed to keep their tooling up to date, are increasingly going obsolete.


Whereas Unreal is more focused on AAA titles for PCs and consoles, Unity dominates on mobile and virtual reality, which is a key area of investment for Facebook. About 71 percent of the top 1,000 mobile games were made with Unity, and 60 percent of all augmented and virtual reality content is built on Unity. Flowing out of this are 3 billion monthly active end users, that is, players who consumed content created or operated with Unity.


Unity’s two divisions—Create Solutions and Operate Solutions—give customers different on-ramps. Create—about 1/3 of revenues—is sold through monthly subscriptions ranging from free for personal and student use all the way to thousands of dollars per seat for enterprise. As the name implies, Create includes the tools needed to script, design and develop real-time games and experiences.


Operate Solutions is monetized through a revenue-share and usage-based model. Customers can run their games on Unity’s infrastructure and take advantage of Unity’s tools for acquiring and retaining customers (ads, in-app purchases) and maximizing lifetime value. For example, Unity offers a service it calls “GameTune” which delivers “data science as a service” and allows customers to optimize gamer engagement by “changing game progression speed, in-app purchase bundles and difficulty settings.” Because Unity has huge scale—they capture and analyze 50 billion in-app events per day, across 20 platforms—they can offer the best ROI in the industry. As Unity gets bigger, the case for continuing to run on proprietary systems becomes more tenuous.


Unity’s 1.5 million monthly active creators themselves are very engaged; those on the Unity Pro tier spend about five hours per day working on Unity. The company runs on a mix of third-party infrastructure—AWS and GCP—as well as its own datacenters. This gives end users more flexibility on cost and performance when running real-time games.


As Unity’s creative tools become more photorealistic and lifelike, the market expands. Companies like BMW might choose to use Unity rather than time-consuming photo shoots for their marketing. Building information management systems can be placed into virtual reality. Expensive on-location filmmaking and green screens are replaced with LED walls. Today, there are a number of applications for Unity completely outside of gaming.


CEO John Riccitiello explains:


“My strong view is real-time 3D is going to be without doubt the largest form of media on the planet. Most games are built that way today. But very few of the movies that you watch, very little of the social media. You don't go to your doctor and look at a real-time 3D model of your heart, you should. I can give you dozens upon dozens upon dozens of use cases that will move into the arena of real-time 3D.


“And if I start framing for you what I see on the horizon with some of the hardware, you will believe me even more. So I believe we have a market that will double, double and double again. And I believe we have an opportunity to establish for Unity north of a 75% or 80% market share in the fullness of time. And that the best use of our mine time and the best use of our investment is to build towards that outcome.”


Unity today can be considered infrastructure software for the rise of 3D worlds—including the metaverse—and its competitive advantages keep improving as the company grows the market, replaces homegrown game engines, and reinvests to develop both the Create and Operate sides of the business.


John Riccitiello, who was hand-picked by Unity’s founders as Unity’s CEO in 2014, was previously the COO of gaming giant Electronic Arts and co-founder of a private equity firm. He believes the company can grow revenues at 30 percent per year over the long term:


“Our vision is to ensure Unity is a once-in-a-generation company, a true platform that enables creation and operation of real-time 3D applications at extreme scale. We envision a world where we have hundreds of millions of creators on our platform, from consumer creators, to professionals in gaming and dozens of industries. By executing on this vision, we believe we can build a company that delivers revenue growth of approximately 30% over the long run.”


Unity is still in heavy investment mode and is inching towards cash flow breakeven. Over time, we expect the company to generate high free cash flow margins.

We began acquiring shares of Unity shortly after the IPO in September of last year, and with the benefit of two quarters of earnings after the IPO, our underwriting seems on track to deliver very attractive long-term returns (in the high teens or low 20s in terms of compounded return).


Our next investment in the coming metaverse is Roblox.


Founded in the same year as Unity by David Baszucki and Erik Cassel, Roblox is about 3x larger than Unity in terms of bookings (a better measure of revenues in Roblox’s case). In 2013, Cassel sadly passed away from cancer.


I’ve also been interested in owning this company for a while, and in October I reached out to CFO Mike Guthrie to find out if they were interested in raising more capital. Earlier in February, the venture firm a16z led a $150m round at a valuation of $4 billion. A year and a month later, Roblox went public at ten times that valuation. Now you understand my interest in investing in private companies!


Unrequited LinkedIn request


The only similarities between Roblox and Unity are the founding year and the metaverse theme. Rather than infrastructure software, Roblox is a self-contained universe of experiences (they used to be called games, but with the Epic trial, Roblox changed all the references).


When you open up Roblox, you see a kaleidoscope of games experiences:

These experiences—20 million of them, 13 million of which were experienced by users in 2020—were created by Roblox’s 1.25 million developers and consumed by its 43 million daily active users. They all live inside a tight ecosystem with its own currency, Robux (the exchange rate is set by Roblox). Customers can buy a-la-carte or subscribe; subscribing gets you more Robux for the buck.

DAUs are split almost evenly between ages over 13 and under, although the “over” group has been growing nearly twice as fast. One of the questions about Roblox was whether kids would simply “graduate” and move to other games, like Fortnite, but the data shows there are plenty of older players joining Roblox, which is a key metric to monitor for future growth.


Given the importance of developers to Roblox’s ecosystem, the company sets aside a large portion of revenues to compensate them for creating and animating the various experiences. Developers earn Robux for creating experiences and avatars and use Robux to either reinvest in the Roblox ecosystem or cash out into real-world currency.


Roblox has placed a big emphasis on safety. In the chat, it’s impossible to curse (Roblox blocks foul language). There is extensive human and automated review of everything from audio files to images and videos. Last year, the company responded to over 11 million customer inquiries and had a human respond to safety issues within ten minutes of submission.


Roblox is already massively profitable and gushing free cash flow. Our long-term model for Roblox takes into account the growth of daily active users (currently at 44 million) and the average bookings per DAU (we expect about $67 this year, and much more in the future). Baszucki’s vision is immense, and as the team continues to execute, Roblox is well-positioned to be an enormous beneficiary of the rise of social gaming and the creative economy in the age of the metaverse.


We began acquiring shares of Roblox shortly after the IPO in March of this year and believe it could generate long-term compounded returns of at least 20 percent for our partnership.


An ultimate vision of the metaverse will involve lifelike avatars, and the industry is working hard at getting there. The improvements in gaming engines neatly summarized in this sequence of Lara Croft avatars from 1996 to 2018:

This year, Unreal Engine released its MetaHuman Creator, “a cloud-based app for creating high-fidelity digital humans in minutes.” Watch this 3-minute video to get a sense of where the state of the art is. We are very close, or perhaps already at the point, of being able to create digital avatars that are indistinguishable from reality.


This is Roblox’s vision. Baszucki, Roblox’s founder, has said that eventually Roblox experiences will resemble those of a “first-run movie.”