Duolingo: On the Road to Massive Profitability (NASDAQ: DUOL)

High Growth Duolingo (NASDAQ: DUOL) is the most popular language learning platform. The online education market continues to grow, and Duolingo is growing with it. Duolingo was founded in 2011 and already has over 49 million monthly active users. Duolingo stock is down 50% from its all-time high in September 2021. The company has one of the best balance sheets I have ever seen. Thanks to very high margins, Duolingo is on the way to massive profitability. In my opinion, DUOL shares can represent an interesting opportunity for long-term investors.

The Duolingo story

Duolingo’s mission is to “develop the best education in the world and make it universally available”.

Most of you have probably heard of Duolingo before, as their app has more than 575 million downloads.

For those of you who don’t know what Duolingo is, simply put: Duolingo is a platform where users can learn over 40 languages ​​in an efficient and fun way. More 13 million users use the app daily. Currently, the company does not have a competitor that even comes close in terms of market capitalization and number of downloads. When someone asks about online language learning, most people think of Duolingo. This is a very big competitive advantage of Duolingo.

The company was founded in 2011 by Severin Hacker and Luis von Ahn. Severin Hacker is still with the company and is its CTO. Luis von Ahn is also still with the company as CEO.

Both run the business on a day-to-day basis and are both owners more than 8% of the company, which is very positive.

Users really love Duolingo. This is also shown by reviews on the App Store, where Duolingo has 4.7/5 stars.

The business model

Now let’s focus on how Duolingo makes money.

The company has several sources of income. The first way DUOL makes the most money is the premium version of Duolingo. The company also has a free plan, but it has far fewer features than the premium plan.

The premium plan is called Duolingo Plus and costs $6.99 per month for individuals. The company currently has 3.3 million subscribers. DUOL also offers a family plan where you can have up to 6 accounts and it costs $9.99.

Then there are the advertisements. Advertisers pay DUOL to have their ads appear on the Duolingo app.

If you use the app for free, you will see ads in Duolingo. The premium version does not contain ads, which is another advantage. DUOL has over 49 million monthly active users and most of them do not have a premium version. Thanks to this, Duolingo can serve ads to tens of millions of users, and the company is already making a lot of money from it.

Another way for the company to earn money is by organizing events.

Hosts organize paid lessons where users can practice the language they are learning with other Duolingo users. Users discuss various topics with each other in the language they are currently learning. These classes are led by hosts.

Classes are mostly conducted via Zoom and often cost between $10 and $15. Most of the money users pay for courses goes to the host, but Duolingo takes a small fee from the amounts paid. It’s another way to make money.

And last but not least, there is The Duolingo English test (DET), which is an online English proficiency test that you can take from home. The DET covers four basic English skills: speaking, listening, writing and reading. This is a very detailed test of your knowledge of English. This exam is primarily intended for applicants for employment and college education. It is also for people who want to prove their knowledge of English. DET costs $49 and has a lot of potential in my opinion.

Duolingo & Growth

Now let’s see what strategies will the management use to grow the business.

The first strategy is simply to increase the number of monthly active users. The market opportunity is still there as there are over 1.8 billion language learners around the world. Active monthly user growth is absolutely essential for DUOL. When you become an active user, you can then purchase multiple products from Duolingo, which is very important for the company.

Another business growth strategy is simply a better product.

With a better platform – I mean mainly more content for users to learn, there will be a better chance that a user who has already paid for the premium version will remain a regular customer for many years. This will mean more revenue for DUOL. Product improvement is very important for business growth.

Then there is the Duolingo English test.

I have mentioned it before and the reason users should choose this test to prove their English knowledge is the price. The Duolingo English test costs $49 while most similar tests cost over $200. Since Duolingo has hundreds of millions of users, chances are they will buy DET because of its cheap price. Users take the test at home, which is also a plus.

In my opinion, DET represents a very big opportunity for Duolingo.

A still unknown strategy that the management wants to use to develop the platform is education to more topics than simply learning languages. Like math for example. Duolingo already has an application for learning other skills such as learning letters and reading, thanks to which Duolingo could also be used by children aged 5 and over, who do not usually use Duolingo at this age. Duolingo’s opportunity for multi-subject education is truly enormous, and we’re talking about a tens of billions of dollars opportunity here.

Finances are perfect

Now let’s take a look at Duolingo’s finances.

In Q2 2022, DUOL achieved a turnover of $88.39 million, up 50.3% year-on-year. It’s very fast growing. As for the gross margins, they are really high, since they were 73% in the 2nd quarter of this year. Overall, the company lost $15 million in net profit. DUOL can afford such quarterly losses because its balance sheet is very strong. What many investors don’t realize is that Duolingo spends twice as much money per quarter on research and development as it does on marketing. Last quarter, the company spent $34 million on R&D, while only $15 on S&M. Most companies do the exact opposite. The CEO of Duolingo himself said: “the reason they stand out from the competition is that they focus on the product.” And that’s exactly what company management does and what I love about Duolingo so much. one of the best I’ve seen. The company has total assets of $701 million and $591 million of that is cash. Overall they have total liabilities of $172 million and $0 of long-term debt If management wanted to, it could pay off all of its liabilities tomorrow and still have $419 in cash Duolingo has a very good balance sheet.

Evaluation

Now let’s focus on the valuation of the company. Currently, Duolingo has a market capitalization of $3.8 billion. Subtracting the company’s cash position, Duolingo has an enterprise value of approximately $3.2 billion.

This means DUOL is currently trading at a FY 22 EV/Revenue of 8.9x.

I personally agree that the shares of the company are not cheap. But you should keep in mind that DUOL is growing very fast as the business is expected to grow from 45% in FY 22. DUOL is currently trading at a FY 23 EV/Revenue of 6.8x.

It’s much more reasonable. I don’t own any DUOL shares yet and I don’t plan to buy Duolingo at the current valuation. But if the stock drops below $75, then it will be much more attractive to me personally and I will seriously start thinking about buying.

Risks

Now let’s take a look at the risks of Duolingo. The first risk associated with investing in DUOL is the current non-profitability of the company. Duolingo loses around $60-70 million a year. DUOL is not yet expected to be profitable between 2022 and 2024. Despite the fact that Duolingo is on track to make a profit, the company is still losing money and that is a risk. That’s why I’ll be watching the company’s results closely. I’ll be keeping an eye out as Duolingo moves closer to profitability each year. The other risk I need to talk about is the current valuation of the company. That’s why I won’t buy DUOL shares for now despite my love for the company itself. Currently, Duolingo has a market capitalization of $3.8 billion. The enterprise value is approximately $3.2 billion.

DUOL is currently trading at FY 22 EV/Revenue of 8.9x. Because Duolingo isn’t yet profitable, this valuation really isn’t cheap. If a company misses earnings by even a few percent, for example, or if forecasts are reduced, stocks could well drop a few tens of percent in a matter of days depending on current market sentiment. Even after a drop like that, stocks won’t be completely cheap and that’s probably the biggest risk Duolingo has right now.

Catalyst

What many investors don’t realize is that Duolingo could be taken over by another company.

The 3 companies that could potentially buy DUOL in my opinion are Apple (AAPL), Microsoft (MSFT) and Google (GOOGL). For each of the companies mentioned, Duolingo would be a good addition to their business. I certainly wouldn’t buy DUOL just because there’s a chance that a company might acquire it, but the likelihood of one of these larger companies buying Duolingo isn’t entirely negligible.

Conclusion

Duolingo is a fast-growing founder-led company. The company has one of the best balance sheets I have ever seen. Duolingo’s business model is great and what I love about the company is that they are very focused on making the best product. This is also why the company is so successful. The only reason I’m not going to buy DUOL stock right now is because of its valuation.

Right now, I don’t find the risk/reward ratio very attractive. But if the stock drops below $75, then I’m going to start thinking very seriously about buying. But in the meantime, I’ll be watching Duolingo closely, and I certainly think that if the shares are bought at the right price, they can produce very attractive returns for long-term investors.