Duolingo, Growth Is A Language
Duolingo is a well-known app for learning languages, but less so as an investment. This is a shame in my opinion, because the business model they operate is very good. They are about 80% subscription-based. After the latest earnings call, the stock price collapsed, at some point being down as much as 30%, so let’s dive straight into this business and see what they are all about!
Before starting to go too deep, let’s first give a glimpse of the revenue growth because that has been very impressive, and very steady. As Duolingo has only been a publicly traded company since 2019, we can only see its 5-year growth. In 2019, the company had revenues of $70.76 million for the full year, compared to $531.1 million in 2023. As of Q1’24, the company had an annualized revenue number of $670.2, million without any growth. The growth this company has seen, means that the 5-year annual growth rate comes in at 49.65%. and without any further incremental revenues, growth for ‘24 would be 26%, which is really rather impressive.
These revenues are fun but how does it measure up for profitability? Because revenues are not all that matter in my opinion. The company has been consistently cash flow positive since Q1’22, with the switch to positive net income being made in Q2’23. In the latest quarter, Q1’24, Duolingo had a free cash flow margin of 47.5%, and an operating margin of 9.81%
- What Services Does Duolingo Offer?
It may come as a surprise but Duolingo, as mentioned, offers language courses. They manage their business with KPIs such as Monthly Active Users, Daily Active Users, Paid Subscribers, Subscription Bookings, and Total Bookings.
In order to improve the learning experience, Duolingo uses AI to scan the data of more than a billion exercises that are completed every day. The learning on this platform is so profound that, according to their own annual filing, two independent semester-long studies found that users who were learning English on Duolingo outperformed students who were learning the language in the traditional classroom setting.
Users of the app do not have to pay, they will not be limited in any way in their ability to use the app, however, with a free account you will see an ad after each completed lesson. The paid subscription makes it ad-free. In terms of paid subscribers, about 8% of the users on the platform have a paid subscription.
In terms of product mix, we know that about 18% of the subscriptions are on the family plan, which sees favorable trends in stickiness as it has a larger retention rate. The Duolingo Max subscription is still very small
The platform offers a few versions, you may have gotten it from the section above already, but Duolingo offers a free version, Super Duolingo, and Duolingo Max
Super Duolingo costs about $6.99 in the US, while Duolingo Max will cost a user $15. The family plan will set you back $10 per month but is billed annually at $119.99.
Duolingo Max is only available for people with French and Spanish lessons, you will also need to have an IOS operating system, and this is only experimented with in 6 countries. The addition to the Max platform is the use of AI to make it more involving and conversational.
- Who are the Executives?
Luis Von Ahn, Co-Founder, and CEO
Von Ahn finished his studies in mathematics at Duke University in 2000, before getting into a PhD program at Carnegie Mellon University in that same year. In 2005 he got his PhD in Computer Science and in 2007 von Ahn started his first company, reCAPTCHA, which he left in 2009. Than in 2011, he co-founded Duolingo.
Severin Hacker, Co-Founder, and CTO
Hacker has a background in computer science as well, just like Luis von Ahn. This is also their link. Hacker got his BSc in Zürich, before starting his PhD program in computer science at Carnegie Mellon University in 2007, which he completed in 2014. As co-founder, Hacker has been involved with Duolingo since 2011.
Matthew Skaruppa
Skaruppa has been with Duolingo since 2020, when he joined from Goldman Sachs. Before his experience at the investment bank, he worked at KKR, and Bain & Co.
- What about the balance sheet?
The balance sheet is looking impressive, with more than double the assets in comparison to liabilities. When we look at the individual line items, we can see that cash and cash equivalents went up, not very shocking for a company that is cashflow positive without any debt. What is not seen as often is that accounts receivables have actually ticked down.
- Bull Arguments, Bear Arguments and Conclusion
Bull Arguments
- 90% market share online language learning
Okay, maybe not really in that way. According to their own estimates, Duolingo holds 90% market share over Daily Active Users (DUA’s) I find that quite impressive to be honest, and it’s due to the way in which Duolingo tries to gamify language learning with the uses of streaks for example.
- High free cash flow margins
Duolingo prints a lot of cash for a company of its size, this is something more common to tech companies, and something that offers future potential for high profits and stock buy-backs.
- Can develop the family plan as this has never really been done
The family plan offers great value for Duolingo, and where it sees decent stickiness. The thing with this plan is, is that is was never really developed. It didn’t, or doesn’t even allow for a main account that can monitor progress in the other accounts. This is starting to change as now an actual team is allocated towards the development of this product.
- New markets
When I talk about new markets, what I mean is the expansion into math and music. These are new opportunities in which Duolingo is experimenting, and it adds to the experience of an overall educational app. Together with the family plan mentioned above, I think it ties families up to the app as I can see many families wanting a way for their children to develop their math and language skills, and the musical aspect is a good addition to it. As of now, these products are only available on IOS when the language installed on the phone is English, Spanish, French, or German. For now, Duolingo is also not seeing any meaningful revenue from it, but my opinion is that it will be a great value add for family plans.
- Use of AI
Duolingo is one of the companies that really benefits from AI. This is because the creation of new lessons is now done cheaper, and way faster. This means that they don’t have to generate revenues from it in some weird way, they can cut loads of costs and improve the businss in a faster way.
Bear Arguments
- Valuation
Duolingo is constantly trading at a premium to what I see as the value of the business. This is a risk as the stock is already highly volatile, combined with the increased valuation can bring out some fireworks. This also happened after the latest earnings when the stock fell from $245, to a low of $175, an almost 30% drop.
- Limited TAM
With mobile language learning comes a limited TAM. This industry is nothing like selling iPhones or cloud storage so Duolingo will never come close to being worth a trillion dollars. Also not 100 billion in its current form. We have a stock here with a somewhat limited upside, even though this upside limit is far from reached.
- Low conversion in a market like India
A downside to the business is the lack of conversion in the Indian market, as this would be a huge opportunity. Subscription prices in this market are already lowered but as the company says, the Indian market doesn’t like subscription models. That is not completely how they say it but it is what it comes down to. They do say it as “we see other companies that offer subscriptions struggle in India as well, we experiment to increase conversion”.
- Conclusion
I really like this stock and the way in which it operates. I also believe the company has a true moat, and I will explain why in a second. I also really like the way in which the business is set up, and if you listen to the earnings call, it seems as if the company possesses a nice working environment. But having said that, we have to look at the stock which is extremely highly valued, and this is something I don’t love. I also mentioned this in a recent edition of the Morning Market Feed, when the stock got an analyst upgrade and jumped 8% back up. But let me explain why I think this company has a moat before I tell you in what price range I see the stock going towards fair value.
The moat for Duolingo can in my opinion be found in the network effects of the business. The company does very well with marketing on TikTok, but has diversified away from this platform due to risks in the United States. The company also works with Reels, and YouTube shorts which are relatively similar. Through these efforts, which are not promoted as an important side note, the company generates by their own estimate about 1/3 of new accounts, the other 2/3 come in through word of mouth. People are brought in by friends and family and the company attributes this to having a very good, and involving product. Duolingo is starting to become a Verb, quite like Google, but let’s not run away with the idea too much because the levels at which this is, is of course very different still. But as I am explaining why I think this company has a moat, that is something that weighs in on the equation.
As for the valuation. Duolingo trades at a 205PE, and 120F/PE. Even as I am not one to shy away for paying a premium for the best businesses, this is extreme, but also maybe not the best way to look at the company as they just turned profitable. So what about the price to sales? Here we come to 16.5, still very high but better than a 205PE, so we are going somewhere. The price to book is at 12.15, which is due to the fact that Duolingo is incredibly asset light, but this is still not cheap either. Finally we can look at the free cash flow yield. The company has been free cash flow positive for slightly longer than net profitable, and here we see a 2.25% yield. This looks much better, and on this metric, the stock doesn’t seem that over-valued at all. This is however only one metric and cherry picking isn’t really that great of a strategy in investing, so let’s see where all numbers get in better balance.
Because when we look at the stock around $150, the F/PE would drop to about 89.8, still very high, but the price to sales would come down to 11.63. This seems more reasonable but still on the higher end. It would however also mean that the free cash flow yield would jump to about 3.5%, something that is extremely high for a company with the growth Duolingo has.
Putting this pieces together means that I would gain interest at the $150, to $160 range. This would also mean that the drop after earnings posted an opportunity if you were willing to pay a slight premium to the above mentioned price range.
DISCLAIMER:
I do not give buy and sell recommendations, the value range range given is based on my analysis, but for you to have a good understanding of the business you read about in this article, you will have to do your own analysis. The value range given in this article does not mean I will buy this stock at this price range.
Buying or selling a stock will always be your own decision and we are not liable for any decisions you make regarding this.
