Cautious AI Adoption And Margin Pressure Will Eventually Support A More Resilient Learning Platform

Catalysts

About D2L

D2L provides a cloud based learning platform, including its Brightspace LMS and AI driven tools, for education institutions and corporate training providers.

What are the underlying business or industry changes driving this perspective?

• Higher education and corporate ARR in combination is growing at 10% year over year and management reports winning more than 50% of competitive deals. However, the recent period of subdued North American higher education activity means any slowdown in institutions revisiting legacy systems could limit the conversion of this pipeline into subscription revenue and ARR.
• AI is a clear focus for customers and Lumi has reached more than US$2 million in ARR with very large year over year adoption among deployed users. However, institutions are still mostly taking a cautious, incremental approach, which could restrain the pace of upsell and delay any meaningful lift in net margins from higher value AI modules.
• International ARR growth is running above 15% and the company is adding universities and professional institutes abroad. However, execution risk around expanding sales capacity and local product fit could slow that expansion and temper the impact on total revenue growth and earnings.
• Corporate learning and employee upskilling are areas of increasing focus for CEOs globally and D2L is building out a dedicated go to market effort. However, gaps in administrative features versus incumbent corporate platforms may lengthen sales cycles and cap near term contribution to ARR and overall margin mix.
• Management is investing in a database technology migration that is expected to support higher efficiency over time and free cash flow is already US$32.2 million year to date with no debt. However, the current drag on gross margin from duplicate infrastructure could persist longer than planned and weigh on adjusted EBITDA and earnings until the migration is fully complete.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more pessimistic perspective on D2L compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming D2L's revenue will grow by 8.2% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 3.3% today to 17.7% in 3 years time.
• The bearish analysts expect earnings to reach $49.6 million (and earnings per share of $0.89) by about July 2029, up from $7.4 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $62.6 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 8.7x on those 2029 earnings, down from 55.6x today. This future PE is lower than the current PE for the CA Consumer Services industry at 14.3x.
• The bearish analysts expect the number of shares outstanding to decline by 0.67% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.45%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The higher churn in U.S. K-12, combined with a shift back toward more traditional classroom models and at least one known large customer planning to move to a competitor, could signal a structurally smaller role for digital learning in parts of that market over time. This may weigh on ARR and total revenue.
• The current drag on gross margin from the database technology migration, which lowered adjusted gross margin to 67.8% in Q3, could last longer than management anticipates or fail to deliver the expected efficiency gains. This could put sustained pressure on gross margin and adjusted EBITDA.
• The Lumi AI product is still early, with customers often starting with limited deployments and procurement cycles taking time. If institutions remain cautious or adoption plateaus after initial trials, the AI upsell story may not translate into a material uplift in ARR and net margins.
• Corporate learning and international markets are areas of focus, but they require ongoing product investment, added go to market capacity and closing administrative feature gaps versus incumbent corporate platforms. If these efforts do not convert the current strong pipeline into closed deals at scale, ARR growth and earnings could fall short of expectations.
• The push to become the next generation learning platform involves higher product and market expansion spend. If the expected operating leverage does not materialise while adjusted EBITDA margins stay around 15%, investors may reassess the risk and reward trade off, which could weigh on earnings growth and compress the valuation multiple.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for D2L is CA$9.5, which represents up to two standard deviations below the consensus price target of CA$12.95. This valuation is based on what can be assumed as the expectations of D2L's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$15.03, and the most bearish reporting a price target of just CA$9.5.
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be $281.0 million, earnings will come to $49.6 million, and it would be trading on a PE ratio of 8.7x, assuming you use a discount rate of 6.5%.
• Given the current share price of CA$10.68, the analyst price target of CA$9.5 is 12.4% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.