Duolingo, Inc. develops a language-learning website and mobile app in the United States and China. The company offers courses in 40 different languages, including Spanish, English, French, Japanese, German, Italian, Chinese, Portuguese, and others. It also provides a digital language proficiency assessment exam. The company was incorporated in 2011 and is headquartered in Pittsburgh, Pennsylvania. The company is publicly listed on NASDAQ under the ticker “DUOL”.
Most of us are probably well aware of the application called “Duolingo”, as most of us dream of learning another language with the minimum effort and time needed. The app has improved a lot over the last few years and it succeeded into making learning a new language a fun activity, thanks to the “gamification” of the entire process. We aren’t the only ones to like this app, though: in fact, it is rated 4.5 stars on the Google Play Store and 4.6 stars in the Apple App Store. Furthermore, it has been already downloaded more than 500 million times, a record difficult to achieve for such a niche-specific application, and boasts more than 40 million monthly active learners.
One important thing to keep in mind is that Duolingo is a mission-driven company, meaning that everything the company does is driven by the mission of developing the best education in the world and make it universally available. Therefore, the company is not spending its resources on short-term gains like performance marketing, but instead it’s taking the long view and continually improves its products and its brand. As long-term investors, we couldn’t be happier.
During 2021, the company achieved user growth in all its metrics: daily active users increased by 18% compared to the year before, reaching 9.6 million; monthly active users increased too by 10%, reaching 40.5 million; paid subscribers increased by 56% on a year-over-year basis, reaching 2.5 million. Revenues and bookings increased too, both by 55% compared to the year before. Despite profitability being nowhere in sight, the company has all the resources to experiment and grow revenues. As of the end of 2021, the company has $553 million in cash and cash equivalents, which should be enough to keep the company going for a while as it works on increasing revenues and figuring out how to improve profit margins. However, at some point the company is going to have to take a hard look at its cost structure, and implement cost saving initiatives if it is to attain solid profitability. Otherwise, in order to be profitable, the company may have to improve the in-app monetization, with the risk of losing users. At the moment, only roughly 6% of Duolingo’s users are paying customers, but the company is already doing something about it: indeed, in 2021 it introduced the Family Plan subscription package, which allows up to six members to enjoy the premium benefits of Duolingo Plus. This initiative may help Duolingo further grow paid subscribers and retain them better.
The company has a strategy consisting in five elements: grow users, teach better, grow subscribers, become the proficiency standard, expand beyond language learning. Indeed, the more active users Duolingo has, the more paying users it will have, meaning higher revenues that can be invested into becoming the proficiency standard, which in turns will attract even more users.
While the language learning is a huge market opportunity with an estimated total addressable market of 1.8 billion people, the general learning market is even higher. For this very reason, as the company looks to 2022 and beyond, it plans to expand in other areas of education. Recently, the company announced plans to launch a math app by the end of 2022. Another channel of new user growth for the company is Duolingo for Schools product, a free tool that helps language teachers track the progress of their students who use the Duolingo app. During 2021, the company launched an entirely redesigned version of the product, which helped grow adoption in classrooms across the world. Considering that the main skill of the company is making learning accessible and fun, it isn’t hard to see Duolingo becoming a general education hub for independent learners in the future.
To improve its teaching, the company redesigned about 3,000 lessons across the numerous courses, so to teach more comprehensively and ensure that Duolingo’s curricula align more closely with international language teaching standards. Also, new features were released to make learners’ conversational skills improve. Furthermore, to improve how Duolingo teaches languages with non-Roman writing systems, like Japanese, Hebrew, Arabic and Russian, the company developed completely new lessons and exercise types that focus entirely on teaching letters or characters. Since the Asian languages are among the world’s fastest growing languages to learn, this was especially important.
The subscription growth is a little trickier, since none of Duolingo’s learning content is behind a paywall and thus anyone can download the app, use it as long as they like, and complete any of the offered courses free of charge. This strategy however made the company able to reach more than 42 million monthly active users. The deal of subscription reside in the ad-free experience and some additional features that enrich the learning journey. The company is continuously running A/B tests to increase the number of subscribers and improve the paid experience: during 2021, the share of paid subscribers went up from 4% to 6% of monthly active users, allowing the company to deliver better engagement and education, and financially supporting the operations. One important achievement of the company in 2021, in terms of growing subscribers, was the success of the New Year’s promotion, which ran from December 28th through January 31st, that has beaten all the management expectations and increased in a meaningful way the new subscribers.
There were some progress also in the fourth point of the company’s strategy, becoming the proficiency standard. Indeed, over the past two years the Duolingo English Test (DET) has seen a rapid adoption as the pandemic accelerated the acceptance of online assessments. The DET costs only $49, opposed to the over $200 of the other English tests, and it is made to be taken on a computer, from anywhere, in a reasonable amount of time. During fourth quarter of 2021, the Irish government announced that it would begin accepting DET for student visas: this is an important announcement, as it confirms the validity of the test and makes its adoption grow faster.
In conclusion, Duolingo is both a great app and company, and we like its mission to help provide affordable education to the world. It experienced incredible revenue growth, but costs remain high and profitability seems to be a dream. While most of the money is being reinvested into R&D, the company may have to further monetize its app, with all the relative consequent risks, or to restructure costs, thing that appears to be impossible at the moment. At the right valuation, this company may be a great addition to a long-term investment portfolio, but shouldn’t be taken too much under consideration by risk-adverse investors.
The company adopted a freemium business model, which means that it allows users to access the content for free, and charges a subcription for additional features. Duolingo intentionally doesn’t put its learning content behind a paywall, so that anyone can download the Duolingo app and see if they like it without paying anything. Learners who use Duolingo for free see an ad at the end of each lesson, whereas learners who purchase Duolingo Plus, the premium subscription, enjoy an ad-free experience and access to additional features. This models enable significant user scale. Duolingo has different producs:
- The Duolingo Language Learning App, which is the world’s most popular way to learn languages. Accessible for free, as of December 2021 it offers courses in over 40 languages.
- Duolingo Plus, which offers learners additional features to enhance their learning experience. Duolingo Plus costs $6.99 per month. In 2021, was launched a family plan, which includes up to six subscribers under one annual plan for $119.99.
- Duolingo English Test (DET). Launched in 2016, the DET is an online, on-demand, high-stakes English proficiency assessment. The test is “computer adaptive”, meaning it gets harder or easier depending on the performance of the test taker, and can be completed in less than an hour. As of December 2021, it generally costs $49 per test.
- Duolingo for Schools, that is a free, web-based tool that aims to make it easier for teachers to use the Duolingo platform in a structured learning environment, like a classroom.
- Duolingo ABC, which was launched in 2020, is a free app that teaches children aged three to six early literacy skills. It was developed by learning experts, it is alligned with the Common Core State Standards and it is designed based on reccomendations by the National Reading Panel.
Measuring the company’s competitive position by downloads, active users and brand awareness, Duolingo has little competition. However, learners have a variety of options when choosing to learn a language. Indeed, the company competes for learners’ time, attention, and share of wallet not only with other online and app-based language learning platforms but also with offline forms of language learning. Furthermore, because of the extensibility of the Duolingo platform beyond language learning, the company also competes with language learning assessment providers and literacy platforms.
The main online competitors are other learning platforms, such as Skillshare, Udemy, Coursera, Memrise, Babbel, HelloTalk, Italki. With the exception of Udemy and Coursera, all of these are private companies, meaning that we cannot access their data. It is rumored that Babbel is planning for its IPO, but nothing’s confirmed yet.
However, there are some factors from which Duolingo will benefit more than its competitors. First of all, mobile-first behaviors are reshaping industries in all categories, ranging from retail to music to dating. Consumers are increasingly gravitating to mobile, app-based experiences. Next, the shift towards online learning is accelerating, mainly due to the disruption experienced over the last two years. Then, consumers are increasingly accustomed to the highly engaging design of social media apps and mobile games: it’s easy to think that consumers turning to online learning will not only prefer the convenience and control that mobile apps provide, but also expect experiences to be highly engaging. Finally, there is a growing adoption of subscription models globally, further enabling the shift towards mobile experiences. As subscriptions increase in popularity across all categories, consumers will also gravitate towards subscription models in online learning.
We evaluated the company using our discounted cash flow model. The model relies on the past 3 years worth of financial statements data in order to estimate the future growth of the company. Each company is valuated in a slightly different way, and in this specific case we estimated the future free cash flows for the next 20 years by estimating line by line each of the three main financial statements.
We made some assumptions in order to valuate the company:
- The terminal growth rate is 4.00%;
- The total shares outstanding are 38.63 millions;
- The effective tax rate will be constant at the average U.S. corporate tax rate, meaning 21%;
- The United States 10-year treasury bond yield will reach 2.50% by the end of 2022;
- The risk premium is 8.00%;
We used those assumptions to model the weighted average cost of capital, which resulted equal to 13.58%, and to estimate the future revenue growth and free cash flows. We estimated a fair value of $83.93, meaning that according to our valuation there is a possible downside in the stock price of 12.25%. Therefore, we give the company a “underweight” rating.
A lot of factors could influence the valuation, including but not limited to economic policies, markets development and real economic growth: therefore, we will update this valuation at the start of the next quarter. Also, it is important to keep in mind that to get to this valuation, we modeled the growth expansion considering an average CAGR over the next 20 years of 21.91%. Considering the extraordinary amount of growth included in this target, any miss in revenue will affect dramatically the valuation. For example, we estimated a growth of 45% in revenues in 2022: lowering it to just 42%, our fair value estimate would decline as low as $67.66 per share. It’s important to be aware of this fact, as an investor could easily see sharp drops if the management announced worse-than-expected results or any kind of news that could affect negatively the growth of the company.