**NOTE: Purely Personal Opinion.**
# Introduction:
DUOL is a freemium app that offers language learning in a gamified form. It is the largest language learning app by subscriber in the market and the only one which can be used almost entirely free. Management’s path forward is well defined, releasing an additional tier that utilizes generative AI to personalize the learning experience and leveraging off any future AI development to help with their business. Management has identified 3 broad areas that they are working on (1) how well they teach, (2) how well they monetize and (3) how well they retain.
# Investment Thesis 1:
***Advantageous Business Model***
DUOL is free to use as compared to their competitors, this easy access to DUOL may be advantageous as 67% of people want their language learning app to be free ([SOURCE](https://civicscience.com/the-word-on-language-learning-apps-whats-behind-their-growing-popularity/#:~:text=Single%2Dlanguage%20speakers%20are%20likely,become%20fluent%20in%20another%20language)). Their close competitors such as Rosetta Stone, Babbel and Busuu all require a monthly subscription. DUOL is currently the only language learning app to be able to offer their services for free (excluding in-app purchases) as they are supplemented by their advertising arm of the business. DUOL is the only one able to set up a significant advertising arm due to their very high Monthly Active Users (MAU).
# Investment Thesis 2:
***Strong Word of Mouth Advertising***
With the largest MAU out of all of their competitors this advantage snowballs on its own, DUOL is able to save a significant portion on advertising as their MAU helps DUOL to advertise. By posting their “streaks” or achievements e.g. year in review it helps to spread the word for DUOL. “80% of Duolingo’s users were acquired through word of mouth” ([SOURCE](https://www.adexchanger.com/strategy/organic-marketing-is-duolingos-lingua-franca/))
# REVENUE:
DUOL’s management has recognized 2 sources of revenue (1) “Bookings” and (2) Revenue. The difference is that Bookings represent the total potential revenue that can be collected from subscribers, whereas revenue is when DUOL has actually given the goods and services and can recognize revenue. I believe that in my forecast I should forecast revenue rather than bookings as subscription revenue is not actual revenue in pocket yet, subscribers could cancel at any point of time so I will apply the conservatism principle here.
For Monthly Active Users(MAU), I’ll use Q4 of each year’s numbers.
To Forecast MAU, I believe that DUOL’s subscriber growth trajectory will be similar to other subscription based model e.g. NFLX. They will experience explosive growth followed by mediocre growth as they switch to focusing on monetizing existing MAU. As DUOL has just started catching on, I assume that the high growth period will be 5 years followed by mediocre growth of 2 years before tapering to slow growth for the rest of my forecast. High growth Y/Y was taking historic trends, mediocre and slow growth is taking about half of the previous phase’s Y/Y.
For Paid Subscribers, I’ll use Q4 of each year’s numbers.
To Forecast Paid Subscribers, I took it as a %MAU. Opting for less granularity, I assumed that they follow historic trends and only had a meager increase. The reason for a meager increase is because I believe that consumers taste and preference for subscription remains more or less the same throughout my forecast.
To Forecast Monthly Revenue/Paid subscribers, I’ll assume that the first 2 years the declining trend will continue as management has stated that they “lowered pricing — prices in several countries to get our prices more in line with each country’s GDP per capita.” – Q4 2022 Earnings Conference. After the 2 years, as the economy begins picking up I’ll assume a modest growth in monthly revenue/paid subscribers. And given that DUOL max will be developed and released to a greater extent I’ll assume that this helps the Y/Y as well. Overall Monthly Revenue/Paid Subscribers from 2020 had only a CAGR of 0.8% for my base case which I believe is realistic.
# COST:
***Cost of Goods Sold***
DUOL’s 2022 10-K has stated that COGS mainly comes from “third-party payment processing fees charged by various distribution channels”. Apple charges a 30% fee for app purchases. DUOL’s gross margins are slightly above this 30% fee at 73% mainly because there are other revenue sources that circumvent the app store e.g. Advertising. Opting for less granularity I’d forecast gross margins at 70% overtime as DUOL’s revenue sources becomes mainly subscription.
***Operating Cost***
R&D, the fluctuations in R&D will follow the CapEX cycle of 3 years of being half of historic average and 3 years of ramping up to scale for monetization before tapering off.
Marketing, DUOL has stated that most of their advertisement is organic meaning that they don’t create ad campaigns but rather other users of a social media platform create content about DUOL. I’d assume that DUOL follows historic averages.
G&A, “We expect that our general and administrative expenses will increase in absolute dollars as our business grows. However, we expect that our general and administrative expenses will remain steady or decrease as a percentage of our revenues as our revenues grow faster than these expenses over the long-term.” – 2022 Q4 10-K. I assume that the nominal amount for G&A grows at a meager rate before holding it constant at the end of the monetization phase.
# CAPEX:
Management wants to capitalize past R&D, “to continue to compound the returns we’ve seen from our past R&D investments, so we don’t plan to hire as many people as we did last year.” – Q4 2022 Earnings Conference. So I’d assume that CapEX has 3 years of being half of historic average and 3 years of ramping up to scale for monetization before becoming capital efficient.
# Change in NWC Schedule:
***Day A/R and A/P***
I don’t think that there is much room for DUOL to improve day A/R given that most of their receivables are from the AppStore and PlayStore. And management also has stated their intent to not shift payment methodology off the Stores according to the 2022 Q4 Earnings conference. I assumed the same will happen for Day A/P.
***Deferred Cost of Revenue and Revenue***
Forecasted as a % of revenue, it’s hard to predict which customers will or will not pay so I opted for less granularity.
***Others***
Forecasted as a % of revenue, I opted for less granularity.
# WACC:
***Cost of Equity***
RFR (1M Avg) = 3.82%
Market Beta ([SOURCE](https://finance.yahoo.com/quote/DUOL/)) = 0.36
Earnings Yield (1M Avg) = 3.98%
S&P 500 (1M Avg) = $4467.72
Growth Forecast ([SOURCE](https://www.reuters.com/markets/us/credit-suisse-ups-sp-500-year-end-forecast-4700-2023-07-18/#:~:text=The%20S%26P%20500%20is%20currently,company%20earnings%20and%20to%20buybacks))
4050 = (4700 x 3.98%) / (1+R) + (4700 x (1+7%)) x 3.98% / (1+R)\^2 + (5029 x 3.98%) x (1 + 2%) / (R – 2%) / (1+R)\^3
R = 9.12%
ERP = 5.30%
COE = 5.73%
***Cost of Debt***
DUOL does not have a bond rating, neither can I use a synthetic rating as DUOL has a negative EBIT. So the best case scenario here is to use management’s discount rate for debt. ([SOURCE](https://imgur.com/a/y2RuXSG))
COD taken to be 6.92%
Marginal Tax Rate = 21%
After Tax COD = 5.47%
Weightage
Management has broken down operating lease ([SOURCE](https://imgur.com/a/95wZU0H))
Assuming that 2022 is lease cost is the only interest expense going forward.
MV Debt = 60.4M
Average Stock Price (1M Avg) = $123.40
Shares O/S = 40.6M
MV Equity = 5010.0M
%Equity = 98.8%
%Debt = 1.2%
WACC = 5.73%
# SANITY CHECK:
([SOURCE](https://imgur.com/a/vQV7JAj))
Worse Case: Subscriber Y/Y 9% CAGR
Base Case: Subscriber Y/Y 12% CAGR
Best Case: Subscriber Y/Y 15% CAGR
Under the base case scenario, DUOL will be reinvesting a very large sum (inclusive of R&D) for below historic ROIC by a significant margin. And I’m assuming a Y/Y CAGR of 12% for subscriber growth compared to 2022’s 40+% Y/Y. I do believe that my assumptions are realistic.
# CONCLUSION:
Ultimately, I value DUOL at $192.29 in my base case. I do believe that management has a clear direction in which they wish to take the firm in and have held true to their belief in AI since the very beginning. I believe that the language learning app is a product where consumers want it to be low maintenance i.e. Logging in daily to continue the streak without having to break the bank. With competitors product having a subscription model it stresses the consumer out having to “make their moneys worth”.
DCF Base Case: \[[SOURCE](https://imgur.com/a/H8xP7hU)\]
DCF Worst Case: \[[SOURCE](https://imgur.com/a/EdjaUiR)\]
DCF Best Case: \[[SOURCE](https://imgur.com/a/KiIDqO3)\]
