Duolingo, Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Duolingo, Inc. is a technology company that operates a freemium language learning platform, offering courses in 40 languages to approximately 74 million monthly active users, supplemented by its Duolingo English Test which is primarily an English proficiency test.

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The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

The core offering of Duolingo is a freemium, mobile-first language learning platform that offers interactive and gamified language courses across 40 different languages. They also have a paid subscription, which is their main source of revenue, along with advertising.

Duolingo’s moat can be categorized as a network effect moat (a narrow one) and an intangible assets moat (which isn’t that significant). The main advantage from a network effect is that it has amassed a lot of learners on the platform, and a large dataset of information on their effectiveness, which they can use to improve the experience for new and old users. With an economic moat, a large number of learners can help make the platform more effective, useful, and in-turn attract even more learners. This is very important because that means all of that learning and data collection is very hard for a new entrant to replicate. Regarding intangible assets, Duolingo has built up the most popular brand in online language learning, and its products are recognized and familiar to the general public, giving them some degree of pricing power and competitive advantage, but this by itself isn’t too significant. Based on all of that, we are going to give the moat a rating of 3 out of 5, as it is moderately durable, has a small element of strength in brand recognition, and good strength in the network effect with its size, and data-collection.

Legitimate risks to Duolingo’s moat and resilience:

  1. Competition: The language learning industry is competitive, with many companies offering similar services. These competitors may offer similar features, better pricing or higher engagement, which could take away from Duolingo’s business.
  2. Technological changes: New tech such as AI could change the way people learn a language or the competitive landscape, potentially leaving Duolingo behind. In particular, AI language-learning tools could make Duolingo’s offerings less relevant. This is a bigger risk as AI technology has advanced substantially since their initial creation.
  3. Changing consumer preferences: Changes in consumer tastes and preferences or how people approach language learning could affect Duolingo’s growth. If users favor a certain format or feature that Duolingo doesn’t support, they could move to a competitor. The rise of generative AI learning methods also poses risk to this.
  4. Platform Dependence: Duolingo’s app distribution relies heavily on Apple and Google. Changes in the relationship with these third party platforms or changes in their marketplace policies could hurt the business. For example, a change in the amount of revenue Apple or Google take would directly hurt the business.
  5. Data Privacy and Security: Data breaches or privacy violations are serious risks for Duolingo. If their system is compromised, there would be loss of personally identifiable information, leading to fines, class action lawsuits, government penalties, loss of users, and brand damage.

The company’s resilience stems from its substantial user base, which would be hard to steal away completely, it’s focus on data and its gamified way of learning, which have some degree of sticking power with its users, and its brand.

Duolingo is a freemium service which provides language education. Its revenue is primarily driven by subscription revenue (where users pay a premium for additional features) and advertising revenue (which comes from offering advertising to free users). Geographically, a large portion of their revenue (almost 50%) comes from the US and the rest comes from international. They have a strong brand in the language education space which is used heavily across all of their operations, and most likely acts as one of the main drivers for organic user acquisition.

The biggest portion of Duolingo’s revenue comes from its subscriptions, 71% in the latest reports, where they sell premium access to the service, giving users advantages such as unlimited hearts and no ads. Also, as of the latest reports, daily active users have increased 65% year over year.

Financials are a little harder to analyze given the fact that the company is still young, but based on the last few quarterly reports, it does seem like it is on the right track. They have grown revenue by 40-45% consistently, but this growth rate is showing signs of slowing, but, its gross profits, adjusted EBITDA, and free cash flow have also gone up. Although all three key metrics have continued to increase steadily, the company still isn’t able to generate positive net income. This, in particular, is something to look into. They have also had a significant increase in operating expenses, primarily because of Sales and Marketing, which increased by a bit over 30% since last year. Research and Development is also increasing steadily and is a significant portion of the expenses. They seem to be targeting growth over profitability as of right now, which is why management seems more comfortable with lower overall profitability and a consistent rate of losses. It is also important to note, that the total cash on hand is almost $800 million, implying that they won’t run into liquidity issues any time soon. For a young, growing company, having a large cash stockpile can be helpful for future research, development, and for growing the business.

The understandability of this business is average. The main part of their revenue model is quite simple and easy to understand, which includes a freemium subscription and advertising model. However, the accounting for different operating expenses, goodwill and intangibles, and some parts of their subscriber base is relatively complex to truly understand. Therefore the final rating is a 2 out of 5.

Duolingo’s balance sheet is in a healthy state, giving it a 4 out of 5. Although they are still unprofitable and continue to make losses, they have a very sizable cash and cash equivalents position (almost $800 million), and also little to no debt, which means that the company is in a strong financial position with a very high likelihood of surviving through any downturns in the market.

Recent concerns and controversies: The company is currently undergoing scrutiny as it has had numerous class-action lawsuits against it for their use of customer data for targeted advertisement and the use of data with third parties without consent. Many of these class-action lawsuits are pending for settlement. Management has made public that this won’t impact their business, and they have already taken steps to become more transparent in their practices, so they are likely to solve these issues with settlement. Another concern is that management is starting to give forecasts that seem overly optimistic. Analysts are becoming weary of the company’s management as it struggles to deliver on its guidance and forecasts, for the coming years, it is likely that growth might slow and their costs of acquisition might increase.

This covers everything asked in the requirements.