2023-10-02 12:42:42 ET
Summary
- Duolingo exhibits impressive growth. Also, Duolingo's gamified approach and personalized learning experiences, driven by AI, enhance its appeal to users.
- While Duolingo's growth rates remain robust and profitability is promising, careful consideration of user retention and competitive risks is essential.
- Altogether, I argue that investors would do well to consider Duolingo stock.
Investment Thesis
Duolingo, Inc. ( DUOL ) provides users with engaging learning experiences.
Duolingo is delivering very strong growth. And yet, frankly speaking, this investment thesis isn't blemish-free. The big question that looms large is this, does Duolingo have a moat? And even as I shed light on this question, I argue that I believe there's a lot to be excited about here.
Although, realistically, the stock is far from cheap at approximately 70x forward free cash flow. Nonetheless, I find myself bullish on Duolingo's prospects.
Duolingo's Near-Term Prospects
Duolingo is a technology-driven education platform with a goal to provide education globally and make it accessible to everyone.
They aim to address the inequality in education by offering high-quality learning opportunities to individuals, regardless of their economic background. Duolingo primarily focuses on language learning, offering courses in over 40 languages through its flagship app, which if you've tried, you'll know it's both fun and effective.
Their gamification features and personalized learning experiences help users speak. Additionally, Duolingo offers the Duolingo English Test, an online and affordable assessment of English proficiency, which is often accepted by educational institutions.
They are committed to data-driven optimization, leveraging advanced AI and machine learning to enhance the learning experience.
Moving on, Duolingo continues to focus on enhancing its language learning platform with AI-driven features like Duolingo Max to improve content, which is expected to retain its growing user base.
Moreover, as they refine these features and expand their content offerings, it's likely to drive further engagement and conversions on their freemium model. Additionally, their ability to tap into the lucrative advanced learner market, particularly for English courses, represents a significant near-term growth opportunity.
Also, Duolingo's strong brand recognition, organic word-of-mouth growth, and readiness to experiment with marketing strategies, as seen with its engagement on emerging social platforms like Threads ( META ), points to adaptability in capturing new users.
Now, we're moving to the crux of the investment thesis. Duolingo's prospects in non-English-speaking countries are both promising and challenging. On the positive side, these regions represent a vast untapped market for language learning. The company has made significant strides in offering courses in various languages, making them accessible to a global audience. Additionally, the freemium model serves as a valuable entry point, allowing users to engage with the platform at no cost. This approach has helped Duolingo gain traction and user loyalty in many countries.
However, convincing users to pay for premium content, especially in regions where there is a reluctance to do so, presents a challenge. In some countries, there are often cultural (and of course economic) factors that make users less likely to subscribe, even if the price is adjusted for local GDP per capita.
This leads me to believe that Duolingo will need to strategize and experiment with pricing and marketing approaches tailored to these specific markets. Success in these regions will require a combination of effective monetization strategies, localization efforts, and a deep understanding of the unique needs and preferences of users in non-English-speaking countries.
Next, let's discuss its financials.
Revenue Growth Rates Remain Very Strong
As you can see above, Duolingo's freemium business model of attracting free users and converting them to paid subscribers is expected to continue being very successful.
Unlike countless other consumer-facing businesses that I follow, Duolingo's growth rates are showing no substantial slowdown.
Accordingly, Duolingo has, in fact, raised its guidance for this year. Furthermore, this is a very reassuring growth story in this highly profitable business. And with this framework in mind, let's get to its valuation.
DUOL Stock Valuation - Reasonably Priced
Duolingo succeeds in growing its business without much need for capex. Therefore, given its guidance for 2023 for around $78 million of EBITDA at the high end, I'm inclined to believe that this business could end up printing $115 million of EBITDA next year.
This leaves the business priced at 70x forward free cash flow. Typically, I would shun a stock with such a high premium. However, Duolingo is debt-free, with substantial cash. What's more, given that the business is so profitable, it's possible that in the coming year or two, Duolingo could make a needle-moving acquisition that would add another revenue vertical to its business.
Altogether, I'm optimistic about its prospects. Even though I recognize that the investment thesis is not blemish-free.
Indeed, let's take a moment to think beyond the bull case. Let's, indirectly, ask this question: does Duolingo have a moat?
Risk Factors To Think About:
Note, that the online language learning industry is highly competitive with low switching costs. There's a continuous emergence of new language-learning products.
Moreover, the availability of numerous free language learning opportunities, including online platforms, presents a challenge. If Duolingo cannot convince users to choose its premium offerings over free alternatives, that could pose a significant headwind.
How much are its customers susceptible to a weakening economy? Will users who already pay for countless other subscription services be inclined to continue paying for a language platform against a weak backdrop?
And perhaps, the most important consideration. How long will a user continue to pay for Duolingo? At some point, the user either learns the language well enough or the user gets bored and churns out. The lifetime of this user is not like a lifetime user on Netflix ( NFLX ) or Spotify ( SPOT ).
The Bottom Line
I believe that Duolingo, while showing very strong growth, faces certain challenges in its investment thesis. For example, the non-English-speaking markets hold promise but also challenges, as convincing users to pay for premium content can be difficult in regions where reluctance to do so exists due to cultural and economic factors. Success in these markets will require tailored pricing and marketing strategies.
That being said, Duolingo's growth rates remain robust. However, we must keep in mind the highly competitive nature of the online language learning industry, with low switching costs and the presence of numerous free alternatives, which poses a risk to its growth.
Despite these challenges, Duolingo's debt-free status and profitability offer optimism, with the potential for future acquisitions to diversify revenue streams.
For further details see:
Duolingo's Impressive Growth Trajectory And More