Generative AI Investments Will Drive User Engagement And Efficiency In Language Learning

Key Takeaways

• Investment in generative AI and automation aims to enhance product engagement and efficiency, improving net margins and driving subscription revenue growth.
  
• Expanding English content and regional marketing is expected to boost international market share and sustain user growth.
  
• Heavy reliance on AI features and word-of-mouth growth may hamper revenue scaling, as costly tiers deter conversions in lower-income regions.

Catalysts

Operates as a mobile learning platform in the United States, the United Kingdom, and internationally.

• Duolingo is heavily investing in generative AI and automation to enhance product engagement and efficiency, which is expected to improve net margins over time.
  
• The introduction of the Duolingo Max tier, especially with the AI-powered Video Call feature, is anticipated to drive significant subscription revenue growth as it is rolled out to more users, particularly English learners who show strong demand for conversational practice.
  
• Duolingo is committed to expanding its intermediate and advanced English learning content, positioning itself to capture more revenue from a market where 80% of global language learning spend is focused on English.
  
• The expansion of regional marketing managers in various countries is expected to drive user growth and improve localized product adoption, which can enhance revenue and market share internationally.
  
• Ongoing product improvements, including social marketing and feature enhancements, are expected to sustain high DAU growth, contributing to higher future bookings and revenue, with an aim to significantly grow the overall subscriber base.

Duolingo Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Duolingo's revenue will grow by 30.8% annually over the next 3 years.
• Analysts assume that profit margins will increase from 12.6% today to 16.9% in 3 years time.
• Analysts expect earnings to reach $260.6 million (and earnings per share of $5.62) by about December 2027, up from $86.8 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $169.7 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 72.8x on those 2027 earnings, down from 179.4x today. This future PE is greater than the current PE for the US Consumer Services industry at 19.7x.
• Analysts expect the number of shares outstanding to grow by 1.79% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.27%, as per the Simply Wall St company report.

Duolingo Future Earnings Per Share Growth

Risks

• The announcement highlights increased costs related to generative AI and content amortization, which could pressure gross margins even if gross profit dollars rise, potentially impacting net margins.
  
• Despite cross-geography marketing efforts, Duolingo's growth strategy heavily relies on word of mouth, which, while cost-effective, is not the fastest method of growth, potentially affecting future revenue scaling speed.
  
• The rollout of Duolingo Max with AI features is significant, but there's uncertainty regarding how quickly it will stabilize and whether it will effectively convert free users to paying subscribers, impacting long-term revenue and earnings.
  
• The company acknowledges higher learnability and engagement for English learners with AI features, but expensive subscription tiers may limit conversion in lower-income regions, affecting revenue potential from a significant user segment.
  
• Dependent on the continual improvement and rollout of new features like Video Call with Lily to maintain user engagement and growth, which if unsuccessful, could affect user retention and therefore revenue streams.

Valuation

• The analysts have a consensus price target of $343.7 for Duolingo based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $425.0, and the most bearish reporting a price target of just $200.27.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $1.5 billion, earnings will come to $260.6 million, and it would be trading on a PE ratio of 72.8x, assuming you use a discount rate of 6.3%.
• Given the current share price of $354.04, the analyst's price target of $343.7 is 3.0% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• 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.