Latest / The Dutch Investors / #82 | Will Duolingo get disrupted? The rise and fall of the green owl w/ Secret Sauce Investing

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#82 | Will Duolingo get disrupted? The rise and fall of the green owl w/ Secret Sauce Investing · The Dutch Investors

• 0:00
  SPEAKER_00: Duolingo, the world's largest educational app, was founded in 2011 by Luis von Aan, now the CEO, and Severin Hacker, the CTO.
• 0:11
  SPEAKER_00: At the time, Von Aan was a computer science professor and Hacker was his student.
• 0:16
  SPEAKER_00: It was during this period that the vision of Duolingo emerged, a platform to provide better education worldwide.
• 0:26
  SPEAKER_00: Duolingo's mission is simple: to develop the best education in the world and make it universally available.
• 0:34
  SPEAKER_00: In this episode, Sunny from Secret Source Investing and I discuss the rise of Duolingo, some of the fundamentals, the existential risk and opportunities of AI, and our thoughts on the potential disruption and declining stock price.
• 0:49
  SPEAKER_00: I'm very excited and let's dig in.
• 1:16
  SPEAKER_00: But uh today, the Green Owl.
• 1:18
  SPEAKER_01: Yes, the Green Owl.
• 1:20
  SPEAKER_01: I've been subtitled this as like the bird is the word.
• 1:24
  SPEAKER_01: Yeah.
• 1:24
  SPEAKER_01: Do you use Duolingo yourself?
• 1:27
  SPEAKER_01: So, Steam, I said I was gonna share a surprise with you before we started the podcast, and I wanted to do this whilst we were recording, so you're genuinely surprised.
• 1:35
  SPEAKER_01: So I wanted to share this.
• 1:37
  SPEAKER_01: Can you see this?
• 1:38
  SPEAKER_01: That's uh a 300 streak.
• 1:41
  SPEAKER_01: So yeah, I've so I have had a 300-day streak on Duolingo.
• 1:45
  SPEAKER_01: Um, unfortunately, this was back in 2021 during COVID.
• 1:50
  SPEAKER_01: But for me, this is a product that I have been familiar with as a user and also have tracked um as a potential investor as well.
• 1:59
  SPEAKER_01: So uh am I correct in saying that you don't use it anymore or in preparation for this podcast, I actually started using the chess app because we had discussed it in some of our uh WhatsApp messages, and I thought it'd be quite interesting because prior to really digging deep on the app, I wasn't aware that the chess in the mask sections even existed.
• 2:23
  SPEAKER_00: I see, I see.
• 2:24
  SPEAKER_00: Yeah, we uh as an educator we use uh Duolingo quite a lot.
• 2:29
  SPEAKER_00: So whether it's for chess, while I prefer physical chess with a realboard or chess.com, I think it's more specialized for chess, but it's definitely getting pretty solid, especially if you want to learn it.
• 2:41
  SPEAKER_00: They now added music, they have added math, which is still pretty bad to be honest.
• 2:46
  SPEAKER_00: It's very simple, but they are expanding uh into different courses and uh and subjects, so that's interesting that it's not just languages anymore, and we'll get to the opportunities and risks later.
• 2:58
  SPEAKER_00: And uh, I'm I'm curious to hear your thoughts.
• 3:01
  SPEAKER_00: But Sonny, can you take us through Duolingo?
• 3:05
  SPEAKER_00: I I suppose some or most will know what the company sort of is, but maybe just the market size, uh the company size, some of the growth metrics.
• 3:16
  SPEAKER_00: Can you take us through that?
• 3:18
  SPEAKER_01: Yeah, of course.
• 3:19
  SPEAKER_01: So I think what's interesting is I actually have to have a live view right now of the Duolingo share price because whilst I've been researching this over the past month, I feel like the share prices continue to dip.
• 3:30
  SPEAKER_01: So it's changed all my metrics on an almost daily basis.
• 3:33
  SPEAKER_01: So if we just jump into it right now, um Duolingo as as a company and as a share, uh it's it's actually uh down uh eight eight and a half percent today.
• 3:45
  SPEAKER_01: So quite uh quite an interesting day to be doing a deep dive on it.
• 3:50
  SPEAKER_01: Um the company has been trading um since 2021.
• 3:56
  SPEAKER_01: The the almost bowled up a little bit share price-wise in 2021 before coming back down to Earth in 2022, um, but since sort of company high or highs of about$530 a share, they've since dropped by about 77%, and so sort of back down to 120.
• 4:13
  SPEAKER_01: So we're sitting with a uh$5.6 billion company, and it's it's returned about a minus three K here since the IPO back in 2021.
• 4:24
  SPEAKER_01: You know, that's interesting as well because on a fundamental basis, it's an interesting business.
• 4:29
  SPEAKER_01: I mean, revenue-wise, over the past five years, growth has been has been 60% uh annually, and that is you know, alongside 72% gross margins and 40% net margins.
• 4:42
  SPEAKER_01: Um I mean I'll I'll certainly offer a bit more seam, but you know, I'll just give you a chance to jump in here and and offer your insight and oversight.
• 4:50
  SPEAKER_00: Yeah, it's uh it's a company we actually analyzed back in June of 2024.
• 4:56
  SPEAKER_00: Uh, one of our analysts, uh Bauke, has owned the company for I believe close to three years, four years.
• 5:05
  SPEAKER_00: I think when it dropped to like sixty dollars, seventy or eighty dollars back in uh 2022, and he picked up some shares, he was at one point up over 500%, and now he's just uh I believe up like 30.
• 5:24
  SPEAKER_00: So things can change rapidly.
• 5:26
  SPEAKER_00: And if you look at the current stock price, it means that at one point the market cap was closer to like 40 billion dollars, and it's at six today.
• 5:38
  SPEAKER_00: What a what a drop! And it's not because of the fundamentals necessarily.
• 5:43
  SPEAKER_00: If you look at most of the important KPIs and metrics, they're performing very well, but it's mostly of investors' fear of disruption than uh AI.
• 5:56
  SPEAKER_01: So I think we're seeing that widely across the market as well.
• 6:00
  SPEAKER_01: Um but on a on uh just another interesting basis.
• 6:03
  SPEAKER_01: I mean, Duolingo, as of the most recent quarter, has about 50 million or 55.5 million daily active users.
• 6:11
  SPEAKER_01: I mean, that's up 36% year on year in terms of paid subscribers.
• 6:16
  SPEAKER_01: That's now sitting at 11.5.
• 6:18
  SPEAKER_01: Um, I mean, Duolingo is a company that, for all intents and purposes, you feel like the the share price should be exploding.
• 6:26
  SPEAKER_01: Um but as you uh exactly have rightly touched on, that's not the case with the market right now.
• 6:32
  SPEAKER_00: So let's play a little game before we jump into uh some of our uh thesis, risks, and opportunities.
• 6:39
  SPEAKER_00: Let's play a game of uh agree or disagree, and you can expand on uh or explain why you agree or disagree.
• 6:46
  SPEAKER_00: Duolingo is just an app and can be easily disrupted.
• 6:50
  SPEAKER_01: I think we're we're almost jumping to the end here because I I'm still undecided upon this.
• 6:56
  SPEAKER_01: Uh I almost think I should just give you a yes or no answer, but this is such a hard question that for reasons that we all come on to, I'm going to lean more towards no, but I can see the obvious picture in which this is a yes.
• 7:12
  SPEAKER_01: What's your take?
• 7:15
  SPEAKER_00: I'm still undecided as well, but I think it's more towards agree, and I think uh that will be a good conversation to see uh why we think that.
• 7:26
  SPEAKER_00: Next one.
• 7:27
  SPEAKER_00: The Duolingo in 10 years from now is not just language learning, math, music, or chess, but an overall learning platform for all kinds of courses like biology, history, programming, maybe AI, etc.
• 7:44
  SPEAKER_01: I'm also gonna go with disagree with that one.
• 7:47
  SPEAKER_01: And again, that will maybe conclude in my thesis at the end as to why I don't think that.
• 7:52
  SPEAKER_00: Okay.
• 7:54
  SPEAKER_00: Duolingo will return to the$500 stock price eventually.
• 8:00
  SPEAKER_00: I'm gonna say yes to that one.
• 8:02
  SPEAKER_00: Okay.
• 8:04
  SPEAKER_00: Um, I'm unsure.
• 8:06
  SPEAKER_00: We'll see.
• 8:07
  SPEAKER_00: AirPods and life translation will disrupt Duolingo completely.
• 8:12
  SPEAKER_01: I'm not gonna agree with completely, but I absolutely agree.
• 8:15
  SPEAKER_01: I think there's a risk that that could uh disrupt Duolingo partially.
• 8:21
  SPEAKER_00: Last one, last one, and then we'll we'll jump into it.
• 8:25
  SPEAKER_00: AI is more of a tailwind instead of a headwind for Duolingo.
• 8:30
  SPEAKER_01: That one I'm heavily in agreement with, and I think that's probably why we're doing this podcast.
• 8:35
  SPEAKER_00: All right.
• 8:35
  SPEAKER_00: I think those will be uh some hot takes, and we'll I will definitely keep these in mind and I'll I'll ask these questions again five or ten years from now.
• 8:44
  SPEAKER_00: So I'll put them in my uh Google calendar now.
• 8:47
  SPEAKER_00: So, Sonny, take us through how Duolingo makes its money, and uh, I'll jump into some of the fundamentals and uh give you my reasoning as to why I think the stock is dropping, and then we'll uh have a conversation about why we think it's either more of a headwind or tailwind.
• 9:05
  SPEAKER_01: Perfect.
• 9:06
  SPEAKER_01: So Duolingo is, I'm sure everyone listening to this podcast is aware as an app.
• 9:11
  SPEAKER_01: And Duolingo is something that I really, you know, I actually really enjoyed researching this company, whether that be um the investor presentations they had or even the just relatively straightforward access to numbers that made a lot of sense.
• 9:25
  SPEAKER_01: There's only a handful of companies that I've uh that I've enjoyed that are very relatively simplistic for investors to sort of gain access to those fundamentals, such as Adobe was one that when I researched, and another one that we researched, was Games Workshop.
• 9:41
  SPEAKER_01: First of all, thank you to the management for making it relatively easy to sort of get into this.
• 9:45
  SPEAKER_01: But as an app, Duolingo is a freemium product.
• 9:48
  SPEAKER_01: What this means is it means that most of the content is accessible for free users, but a small cohort, around about 10%, um, are our subscribers.
• 9:59
  SPEAKER_01: So they are essentially funding or subsidizing the app for the rest of the users.
• 10:05
  SPEAKER_01: So, in terms of subscriptions, I'll just jump into these.
• 10:09
  SPEAKER_01: Um, they make up about 81% of uh of core revenue.
• 10:14
  SPEAKER_01: Now that's paid to the uh more premium version, which is Super Duolingo, and this ultimately removes ads, you know, unlocks additional features, and also offers users the chance to make unlimited mistakes.
• 10:27
  SPEAKER_01: Um they get a lot of uh additional benefits as well in terms of review exercises, speaking and listening modules, and also a lot more readerboard access as well.
• 10:38
  SPEAKER_01: So all of this content is in addition to the free uh freemium product, but it effectively means that the user is more bought into the app.
• 10:47
  SPEAKER_00: When you look at like the KPIs, some of the KPIs are pretty well known, for example, um monthly active users or daily active users, just like uh a Meta, for example, is a pretty good uh KPI to track.
• 11:03
  SPEAKER_00: They have grown at a 32 and 48% kegger since going public.
• 11:11
  SPEAKER_00: Paid subscribers 55% annually, total bookings 55% annually.
• 11:18
  SPEAKER_00: If you look at the KPIs and you haven't looked at the stock price yet, you wouldn't believe that the stock dropped 75%.
• 11:27
  SPEAKER_00: So, why is the stock dropping?
• 11:29
  SPEAKER_00: Before I give you my thoughts on why it's dropping, why do you think the fundamentals reflect such a different story from the stock price?
• 11:38
  SPEAKER_01: So I think Sim, just before we jump onto that, um I'll just run through a few more of the revenue tiers, if that's okay.
• 11:47
  SPEAKER_01: Go for it.
• 11:48
  SPEAKER_01: Um yeah, so so just I think we we touched on Super Duolingo and subscriptions, but I think it's important to um the next part of our conversation, which is very much the fact that Duolingo Max was introduced in 2023.
• 12:01
  SPEAKER_01: Now this is a higher tier plan offering, and so only has a smaller portion of user base and is more expensive.
• 12:07
  SPEAKER_01: So if you compare that to the likes of um of Super Duolingo, Super Duolingo comes in around about£5 or closer to$10 per month, whereas Duolingo Max is quite a bit more expensive than that.
• 12:22
  SPEAKER_01: Now, all of the pricing was not entirely obvious from an outside user, but what uh is interesting about Duolingo Max is the fact that in terms of the the sort of features that it offers, this is the most um this is the uh tier that has the most AI generatively powered capabilities.
• 12:42
  SPEAKER_01: So this is where Duolingo introduced lots of AI tutors and for role-play scenarios and for personalized feedback, and it only accounts for about 9% of subscribers.
• 12:52
  SPEAKER_01: However, it's also worth noting that it's built on OpenAI's uh Chat GPT 4.
• 12:58
  SPEAKER_01: Just a few more points as well, just to cover off.
• 13:01
  SPEAKER_01: Um, there's two additional revenue streams that Duolingo do have, one of which is advertising.
• 13:06
  SPEAKER_01: So if you if you did play with uh any of the Duolingo apps when you were doing your research for this, you'll you may have seen occasional ads pop up.
• 13:14
  SPEAKER_01: So I mean uh advertising is about 7.3% of revenue, which is obviously relatively small in comparison to subscriptions.
• 13:22
  SPEAKER_01: And lastly, there's also the Duolingo English test.
• 13:25
  SPEAKER_01: Did you see this or sort of as an educator who speaks excellent English?
• 13:28
  SPEAKER_01: Are you familiar with this?
• 13:30
  SPEAKER_00: Yes, I'm quite familiar with it.
• 13:32
  SPEAKER_00: We we don't use it.
• 13:34
  SPEAKER_00: I don't know any schools nearby that use it.
• 13:38
  SPEAKER_00: We use more of the of the language learning.
• 13:41
  SPEAKER_00: Uh you know, we we take the English test ourselves.
• 13:44
  SPEAKER_00: It is a formal certification.
• 13:46
  SPEAKER_00: I I believe it costs around$55 or something.
• 13:50
  SPEAKER_00: So it's a lot more affordable than most other certifications.
• 13:54
  SPEAKER_00: There are much cheaper alternatives as well.
• 13:57
  SPEAKER_00: So I don't know why you would choose this one.
• 13:59
  SPEAKER_00: Maybe it's I believe Duolingo claims that their test stands out for uh the low cost and quick score availability and acceptance by by universities, universities worldwide.
• 14:11
  SPEAKER_00: But I don't know, they can say that, but uh I can't really confirm or uh yeah.
• 14:18
  SPEAKER_01: I mean you're you'll be the expert expert here, but just in terms of of my research, what I did find was um you know rather than something that takes hours or days, this is something that's conducted in a sort of 45 to 60 minute session online, and it's reportedly um accepted by 99 of the top 100 universities, including all Ivy League colleges.
• 14:41
  SPEAKER_01: So there is a lot of credibility behind it.
• 14:43
  SPEAKER_01: Um and obviously it probably just is uh almost uh you know unrelated business in comparison to the app.
• 14:50
  SPEAKER_01: Yeah, but but yeah.
• 14:52
  SPEAKER_00: It will not be a meaningful part of revenue.
• 14:56
  SPEAKER_00: Uh you can get the international English test for like 10 pounds, or you can get the uh EF EFSET for completely free, and they are also accepted by most universities.
• 15:08
  SPEAKER_00: So uh yeah, I don't know what's the differential here.
• 15:12
  SPEAKER_01: Yeah, so I mean we're only only looking at six percent of revenue, which is a tiny amount in comparison to the rest of the product.
• 15:19
  SPEAKER_01: So, with that, should we jump on to obviously we we jumped into initially the the reason as to why Duolingo is dropping in price?
• 15:27
  SPEAKER_01: Should we move on to that?
• 15:29
  SPEAKER_00: Yeah, like I said, if you just glanced at Duolingo's top line numbers and KPIs, you you'd think they are printing money, they are highly profitable.
• 15:40
  SPEAKER_00: It's a love the business model, it has almost no capex, very low user acquisition costs, but the stock market is a fickle beast, and even with 50 even with 50 million people checking in with the passive aggressive aisle every day, people are uh are scared of the AI and disruption risk.
• 16:01
  SPEAKER_00: So if you ask me, I think it comes down to three things.
• 16:07
  SPEAKER_00: Um first one was uh guidance, Q4 guidance wasn't really what investors hoped for because they signaled a deceleration in daily active users.
• 16:20
  SPEAKER_00: And if you're spoiled with 50% growth and it drops to, I don't know, 30%, investors don't like that, and they will re-evaluate the evaluation.
• 16:30
  SPEAKER_00: Another reason is the risk of AI disruption, it's Duolingo's future, but it's also its Achilles heal.
• 16:38
  SPEAKER_00: Like you mentioned, you have the video call with Lily, and but they are also quite expensive to run.
• 16:43
  SPEAKER_00: Like you mentioned, they are run on open AI's models, they are not cheap, and management even admitted that generative AI and hosting costs are pressuring gross margins, and there is a fear that as the app gets smarter, it also gets more expensive to maintain, eating into those uh software margins.
• 17:05
  SPEAKER_00: And lastly, related to AI and disruption, there is a lingering bearish how do I say this, sentiment that generative AI makes language apps redundant if a user can just have a fluid real-time conversation with Gemini, ChatGPT, uh for free, uh, the market and investors wonder why they would pay for Duolingo$30 a month.
• 17:38
  SPEAKER_00: And while Duolingo argues that they're more of like a habit engine, and that's the real mode, and I can see their point.
• 17:46
  SPEAKER_00: I'm also wary that Duolingo can become a sort of a rapper for companies that you know they rely on third-party AI companies like OpenAI, and yeah, it's uh relies on other companies, which is something I never really like.
• 18:01
  SPEAKER_00: Sort of a middleman they're in between.
• 18:03
  SPEAKER_01: Yeah, I would I would agree with most of that.
• 18:05
  SPEAKER_01: I think the narrative has certainly shifted, but let's not forget the market we're in that for the last 12 months or so, or sort of just the the prior year, if we want to call it that, high stocks have have largely been driving up the market.
• 18:22
  SPEAKER_01: Um and this year we're now finding SaaS businesses in particular have been especially armed by the blowback that actually AI is going to entirely disrupt all of these products.
• 18:34
  SPEAKER_01: All we need to do is is look through um a lot of the the Nasdaq right now.
• 18:40
  SPEAKER_01: I think I mentioned Adobe already.
• 18:43
  SPEAKER_01: I've I've been keeping one eye on that.
• 18:44
  SPEAKER_01: That's another stock that's been considerably uh pulled back.
• 18:49
  SPEAKER_01: Even and I do appreciate there's other things going on, but the likes of uh Netflix, it has, you know, I think we're we're down about 40% from all-time highs.
• 18:58
  SPEAKER_01: So there is also the element of the market has been more deeply affected over the last month or so.
• 19:05
  SPEAKER_01: Um I think we've we've talked about this on other podcasts about the fact that the majority of the time the stock market is effectively at all-time highs.
• 19:14
  SPEAKER_01: However, I think a little bit of the um air is coming out of the balloon, so to speak.
• 19:19
  SPEAKER_01: So for me, the the narrative with around Duolingo is yes, there is probably slow uh slowing of um subscriptions or increases in sowing sort of daily active users.
• 19:30
  SPEAKER_01: However, there is the consideration it's probably in all likelihood going to be overblown, in my estimate.
• 19:38
  SPEAKER_00: Can you tell me why you think AI is more of a tailwind?
• 19:42
  SPEAKER_00: And I'd I'd like to hear some of your the opportunities you see, um, and I'll tell you what I think.
• 19:50
  SPEAKER_01: So I think in terms of AI, uh, and the reason I think the threat is largely overblown, is that everyone is treating AI or if we and particularly sort of pull out the LLMs, you know, the chat GPTs and the Gemini's of the world.
• 20:06
  SPEAKER_01: We are currently treating all of these models like they're going to solve every single problem that um you know, whether it be languages and education through to design, healthcare, everything is is being unseated by AI just out.
• 20:23
  SPEAKER_01: That's certainly not to say that some of these threats aren't real, but the reason for me, or the reason I think this is largely overblown, especially in Duolingo's case, is the fact that Duolingo as an app really exists.
• 20:37
  SPEAKER_01: Not because it's set to replace education, it's going to replace teachers, but in fact because users are effectively productively wasting time.
• 20:46
  SPEAKER_01: So that is something that's that's been called out.
• 20:48
  SPEAKER_01: Um so for me, I think there will be those apps and interruptures of software that are layers built on top of ChatGPT and um and Gemini that are probably at serious risk of the likes of OpenAI or or Google changing the procedures.
• 21:06
  SPEAKER_01: But for me, Duolingo exists in the sense that it has these users who are effectively productively wasting time, so they're choosing to go on it every day rather than essentially needing to go on it.
• 21:19
  SPEAKER_01: Um and with that same, how do I phrase this?
• 21:22
  SPEAKER_01: But it be the cause there is not virality to Duolingo in the sense of it hasn't exploded overnight, yes, they've had strong growth, but you have this base where actually it's like a throwback to um it's like a throwback to when Google tried to uh create social networking.
• 21:41
  SPEAKER_01: That's my feeling that if we see replication from AI companies of language products, that is the um that's not the risk.
• 21:52
  SPEAKER_01: I think the risk totally totally on board with it is the fact that yes, there could be instant translation.
• 21:59
  SPEAKER_01: That's probably Where the risk lies more than anything.
• 22:01
  SPEAKER_01: But Duolingo's ultimate use case is not the fact that it is educating long-term users, it's the fact that users are productively wasting time on the app.
• 22:13
  SPEAKER_01: Now, I'd like to hear what you think of that because that's a bit conflated from my side.
• 22:17
  SPEAKER_01: And what do you mean by wasting time?
• 22:20
  SPEAKER_01: Think of it in the sense of um productively scrolling.
• 22:24
  SPEAKER_01: So when one user chooses to scroll through TikTok, another is spending a handful of minutes each day using Duolingo.
• 22:34
  SPEAKER_00: So the opportunity is that it's better than mindlessly scrolling through the other ones, or what's the what's the opportunity there?
• 22:42
  SPEAKER_01: I'm not I'm not um sort of saying I'm advocating that duolingo um is is better or worse than any of these, but in my view, duolingo looks looks closer to something like a TikTok or a Candy Crush than it does an educational app.
• 23:02
  SPEAKER_01: That's my main takeaway from my research.
• 23:05
  SPEAKER_00: Yeah, I agree that Duolingo competes not just solely with language learning apps.
• 23:10
  SPEAKER_00: I mean they they compete for people's attention, right?
• 23:13
  SPEAKER_00: With addictive apps, whether that's Instagram or TikTok.
• 23:17
  SPEAKER_00: You know, the thing I struggle with is I think I'm a pretty good reference.
• 23:22
  SPEAKER_00: I would call myself a lifelong learner.
• 23:24
  SPEAKER_00: I love learning new things.
• 23:26
  SPEAKER_00: I have used Duolingo for for years.
• 23:30
  SPEAKER_00: Never paid though, but I've used Duolingo for years.
• 23:33
  SPEAKER_00: I love learning new languages.
• 23:36
  SPEAKER_00: Um I'm uh I'm an avid chess player, although I don't use chess on Duolingo but uh somewhere else.
• 23:44
  SPEAKER_00: But when I ask myself, do I want to learn a language when I can just use ChatGPT and have a conversation that way or translate it through my AirPods, or you know, at the end of the day, people either need to pay for a subscription, so they need to have enough value from the app to pay for it, or they need to make it free and make a lot of money from advertising.
• 24:15
  SPEAKER_00: But you know, the advertising really pushed me off the application.
• 24:21
  SPEAKER_00: I I found it so extremely annoying.
• 24:24
  SPEAKER_00: And if they want to make education universally available, I mean, sure, but those advertisements and the way they are working with the energy model and the hearts model, it I don't know.
• 24:37
  SPEAKER_00: There's uh this is Duolingo is such a puzzle to me.
• 24:41
  SPEAKER_00: It's such a puzzle because I can I can see so many great things with the company.
• 24:47
  SPEAKER_00: I love the the mission.
• 24:48
  SPEAKER_00: I the business model is easy to understand, all the metrics look great, but if I if I put the applications from one to ten from all the subscriptions I have, which one would I remove?
• 25:02
  SPEAKER_00: I think Duolingo would be the first to go.
• 25:04
  SPEAKER_00: I think my my top three would probably be like a Spotify, a Netflix, and uh an Amazon Prime.
• 25:12
  SPEAKER_00: Duolingo probably doesn't even make it to the top 10.
• 25:15
  SPEAKER_01: Yeah, I I think you've nailed that.
• 25:17
  SPEAKER_01: So I think I'm I'm gonna come back in with maybe more of a positive piece of why the app can be enabled with um with AI.
• 25:26
  SPEAKER_01: But I think to summarize what you've just touched on, is Duolingo is not some frictionless subscription business like Netflix.
• 25:34
  SPEAKER_01: Um and it it's impossible for the app to convert its entire user base into paying subscribers.
• 25:40
  SPEAKER_01: So if it did do that, it effectively destroys the funnel which makes it valuable, which is the freemium users.
• 25:47
  SPEAKER_01: Um the freemium model is an absolute necessity because without those 90% of free users, um basically eliminating the primary source of paid users.
• 25:58
  SPEAKER_01: But again, we've got to remember that dualingo, in my view, anyway, is certainly not competing with with other YMLage apps, it's competing for users' time and attention with likes of TikTok and Instagram.
• 26:11
  SPEAKER_01: Um you know, as the company and management have noted, that churned users, you know, they don't switch to rival apps, they basically just stop learning altogether and stop and go back to scrolling.
• 26:21
  SPEAKER_01: In fact, I'm the prime example of that based on doing my research and practicing chess and sort of going back to Duolingo for this podcast.
• 26:29
  SPEAKER_01: Because once I stopped using the app, that was it.
• 26:32
  SPEAKER_01: I didn't I didn't go back to another competitor app.
• 26:35
  SPEAKER_01: Ultimately, it's they are competing and with those with those uh you know attention apps.
• 26:42
  SPEAKER_01: I I think Duolingo's it, you're you're absolutely spot on.
• 26:45
  SPEAKER_01: I've I've called that paradox because for any app and something that convinces users effectively to spend two minutes a day tapping through educational exercises, it shouldn't be able to produce the level of monetization, financial performance that it has.
• 27:02
  SPEAKER_01: I mean, free cash flow margins are approaching 30%, return on equity is near 40%, and revenue is still growing above 40% despite already reaching meaningful scale.
• 27:15
  SPEAKER_01: So what it's what's achieved in terms of only turning profitable in the last couple of years is absolutely phenomenal.
• 27:22
  SPEAKER_01: It's it shouldn't make sense.
• 27:24
  SPEAKER_01: You've you've called it a puzzle, I've called it a paradox.
• 27:27
  SPEAKER_01: There's just something that we can't get our head around, um, with the fact that we have an app here that if you had it's a great it's a great business school study because I think if you took the numbers and showed it to a classroom and then you took the product, they it would never be matched up.
• 27:46
  SPEAKER_00: You know, and the base rates are against Duolingo, right?
• 27:49
  SPEAKER_00: On on average, games, and let's be honest, they're an educational app, but they're using gamification, a big word in for educators.
• 27:58
  SPEAKER_00: It's uh they don't stay popular very long, usually.
• 28:02
  SPEAKER_00: Uh there is high turnover, very low switching costs.
• 28:05
  SPEAKER_00: There are a couple psychological tricks, right?
• 28:07
  SPEAKER_00: With streaks, and uh I have a couple friends around me and colleagues that are.
• 28:12
  SPEAKER_00: I mean, one of them has like a 1400-day Duolingo streak and is starting to get annoyed by what Duolingo is doing.
• 28:21
  SPEAKER_00: The AI lessons aren't as well designed, and maybe it's a bit anecdotal evidence, so always gotta be careful with what you're hearing around you.
• 28:33
  SPEAKER_00: I mean, that's not the whole stir story, but you know, if Duolingo fails to retain users, attract new users, convert users, and don't quote me on the exact numbers I'm I'm I'm saying here, but I read somewhere that like the 80% of the Duolingo users, paid Duolingo users, use the app for like a couple of seconds, like 23 to 46 seconds or something like that.
• 29:04
  SPEAKER_00: And uh like the I believe they call the Wills, like the top 20%, uh make up the the majority of all time spent of on Duolingo.
• 29:15
  SPEAKER_00: So I mean those 80%, if you just use the app for below a minute, let's say, I mean, how hard is it to switch or just leave?
• 29:24
  SPEAKER_00: Or yeah.
• 29:26
  SPEAKER_01: So I think what's interesting, Seam, is that effectively um AI it there's it's creating uncertainty, uncertainties for the business and the app, but both ends of the spectrum.
• 29:38
  SPEAKER_01: At the lower end, obviously, of course, as we've already touched on, it raises questions around whether translation or instant translation will disrupt the if we call them the sort of more affluent consumer who still needs to learn learn a language at all, ultimately the ones who are subsidizing the rest of the users.
• 29:55
  SPEAKER_01: However, at the at the other end, duolingual effectively becomes more powerful than human tutors could ever be, and it's scaled out to learners who could never afford that tutoring.
• 30:08
  SPEAKER_01: I mean, there is there's always going to be the wealthy tourist who wants to visit Europe, um, who maybe wants to go to say Venice or Rome and wants to have a few words of Italian.
• 30:20
  SPEAKER_01: But on the other side of that, it's also empowering Brazilians, Indonesians, Chinese students who are learning languages or upward mobility throughout society.
• 30:31
  SPEAKER_01: And yes, I I recognize that it's the wealthier tourists who actually can generate more income.
• 30:39
  SPEAKER_01: But in actual fact, the total addressful market, inclusive of those who are looking, uh you know, as I see that, are looking for that upward social mobility, that's uh that's a cohort that's larger and effectively more economically motivated.
• 30:55
  SPEAKER_00: Yeah, I agree.
• 30:56
  SPEAKER_00: You mentioned like the size of Duolingo and how many users they have, and sort of the network effect, I suppose, is the uh overhanging word here, but a network effect is uh is a massive competitive advantage, don't get me wrong, but it's also double-sided.
• 31:15
  SPEAKER_00: We used to have this social network like the Dutch Facebook, it was called Hives, and almost every single Dutch person used it, and almost overnight the entire platform disappeared because friends left and it can become a snowball effect.
• 31:36
  SPEAKER_00: The same goes for Duolingo, and I think the network effect here is a lot more fragile compared to like an Instagram, for example, which is has a lot more lock-in, if you ask me.
• 31:47
  SPEAKER_00: You can save certain videos, which if you leave, you'll never find again.
• 31:51
  SPEAKER_00: You have friends following you, you have a lot of pictures and videos.
• 31:55
  SPEAKER_00: The network effect of Duolingo can go against them just as hard.
• 32:01
  SPEAKER_00: If your friends start leaving, if your curriculum or the lessons aren't as well as you hoped they would be, or the app becomes less enjoyable because of the advertisements, for example.
• 32:13
  SPEAKER_00: This will have like this this network effect of people leaving and going somewhere else.
• 32:19
  SPEAKER_00: Another one, I mean, I can keep going, but the rapper risk that's that's what I call it.
• 32:23
  SPEAKER_00: Duolingo is like a middleman, they are paying open AI for the model.
• 32:29
  SPEAKER_00: I mean, just imagine Amazon just invested like 40 billion into open AI.
• 32:34
  SPEAKER_00: Just imagine if Amazon launches its own little version of like an AI language app or a tutor app or whatever it may be.
• 32:45
  SPEAKER_00: They are competing against their own engine room.
• 32:49
  SPEAKER_00: Look at what happened to Czech, for example, when AI became more readily available.
• 32:56
  SPEAKER_00: We are talking about learning, commoditization of expertise, and Czech.
• 33:00
  SPEAKER_00: I mean, investors started worrying that Duolingo will maybe suffer the same fate as Czech, where AI made the core product, which is what we're talking about, feel redundant.
• 33:12
  SPEAKER_00: I mean.
• 33:13
  SPEAKER_01: So, so see, um I mean a few points to to unpack, because I think we're we're certainly arguing from different sides of the fence.
• 33:20
  SPEAKER_01: Um, but I think first and foremost, to to consider sort of the use of LLMs and especially ChatGPT.
• 33:27
  SPEAKER_01: But from what I, you know, from my research, um, I think uh Duolingo is in fact is one of, if not the top token user for OpenAI.
• 33:38
  SPEAKER_01: Did you come across that in your research?
• 33:39
  SPEAKER_01: No.
• 33:40
  SPEAKER_01: In terms of embedding their generative models into tutoring and content production, largely going to uh Duolingo Max.
• 33:48
  SPEAKER_01: Now, I did uh did a bit of a uh deep dive into sort of podcasts that Louis Van has been on.
• 33:55
  SPEAKER_01: And what was interesting, I mean, first of all, this guy is incredibly intelligent.
• 33:58
  SPEAKER_01: I think it's one like the MacArthur Genius Grant.
• 34:02
  SPEAKER_01: And what uh there was a point here which he touched on the fact that yes, Duolingo Max is incorporating OpenAI's uh user tokens.
• 34:13
  SPEAKER_01: However, in terms of what he covered, was the fact that actually those costs are being covered based on the higher cost of Duolingo Max, so it's not putting the same strain on gross margins as it would if it was just rolled out across the the app.
• 34:31
  SPEAKER_01: Largely that um a lot of that uh AI power is for Duolingo Max only, and the users are effectively paying for that uh open AI uh access.
• 34:43
  SPEAKER_01: So, I mean that that was my first one in terms of in terms of that.
• 34:47
  SPEAKER_01: And um second of all, I think there's there's an element as well of obviously AI empowerment, you know, rather than viewing AI as a threat for education and language learning, there is an element that actually AI could enable Duolingo to ultimately scale to something that was was maybe thought previously thought impossible.
• 35:09
  SPEAKER_01: Um and and we've got to remember as well, you know, the company's been building towards this for years.
• 35:13
  SPEAKER_01: It has uh an adaptive learning engine called BirdBrain, which it originally launched in 2020.
• 35:18
  SPEAKER_01: So this is AI, and the threat of AI is not something new to the company.
• 35:24
  SPEAKER_01: Um, and I mean Bird Brain that adjusted to the difficulty in real time by estimating the user's proficiency and changed the complexity around the exercise.
• 35:36
  SPEAKER_01: So there's also a bit of the fact that in terms of in terms of the long-term bet, the dual lingo and management have talked a lot about they used real-person tutors, but they recognized this wasn't scalable.
• 35:49
  SPEAKER_01: So actually, that shift to AI and that those real-time conversations could create something that actually we can't see right now, we can't see around the corner, but there is an element of scaling duolingo beyond the app.
• 36:04
  SPEAKER_01: And again, I'm not convinced that duolingo's next step is into some online educational institution.
• 36:12
  SPEAKER_01: I still compare duolingo to something closer to a Candy Crush or a TikTok, but there is an element here where actually serious learners could have an experience far beyond something that duolingo um currently offers.
• 36:27
  SPEAKER_01: And then I'm gonna also chip in here with the fact that we've got to remember that duolingo is maybe one of the only companies on earth that's sitting with this educational data set at this scale.
• 36:40
  SPEAKER_01: You know, this is not just right and wrong answers, but this is user behavior, patterns, you know, the dwell time.
• 36:47
  SPEAKER_01: There's so many things here that that you know, AI companies or companies that are moving into AI, AI, Google, and Facebook, that they've got this instant, instant data mine that they can draw on.
• 37:00
  SPEAKER_01: I mean, how much data can YouTube offer Google and Gemini?
• 37:04
  SPEAKER_01: So Duolingo, to a certain extent, for me, is in the fact that actually there is opportunity if we consider, which the market seems to be considering, that Duolingo is effectively done.
• 37:16
  SPEAKER_01: Um we've got to remember there's actually an arguable data mode and a tutoring that could be real opportunities for the company.
• 37:29
  SPEAKER_00: Well, I would love to hear your uh ending thoughts on uh Duolingo.
• 37:34
  SPEAKER_00: So uh is it a company you own, you want to own?
• 37:38
  SPEAKER_00: Um, do you think it's more of a headwind or tailwind?
• 37:41
  SPEAKER_00: Maybe your uh ending thoughts on uh Duolingo.
• 37:44
  SPEAKER_00: I'd love to know.
• 37:45
  SPEAKER_01: Okay, we've got a little bit here as well to jump into.
• 37:48
  SPEAKER_01: But for me, seem it's a paradox.
• 37:51
  SPEAKER_01: I'm gonna repeat myself because I'm still uncertain.
• 37:54
  SPEAKER_01: I always thought when I played with Duolingo on and got my streak up to uh 300 that I'd like to own the business, but actually I'm I'm probably glad I didn't do that.
• 38:06
  SPEAKER_01: In terms of Duolingo now, there's absolutely no doubt it's an exceptional business.
• 38:10
  SPEAKER_01: And we've got to remember that this is a company that's sitting with no debt, it's it's sitting with about a billion dollars of cash on the balance sheet, something we've not even touched on.
• 38:20
  SPEAKER_01: The fact that it's you know it's coming up to close to 20% of their market cap.
• 38:26
  SPEAKER_01: Um but again, I I I can't see dual lingo becoming this institutional platform.
• 38:31
  SPEAKER_01: And in fact, when it comes to, I mean, you'll have the the insight here, but when it comes to these institutional institutions that university students attend that are charging hundreds of thousands of dollars per year, if anything, these are the institutions that are more at risk of educational AI disruption than something like duolingo that has teams of um engineers who are who are sort of well suited to weathering this storm.
• 38:58
  SPEAKER_01: You know, I think we've got to remember that there's obviously the interest in observation that it's turned gamification to something productive because again, I'm gonna hit home by that message that it's taking on TikTok and Instagram, it's not um it's not competing with other language apps.
• 39:14
  SPEAKER_01: So probably for for my closing thoughts, does it have a moat?
• 39:18
  SPEAKER_01: Now, again, we've already touched on the fact there's little um intrinsic virality, and I think you hit the nail on the head with your comment that if all your subscriptions, Duolingo, was on there and you had to cancel one, it would probably most likely be Duolingo.
• 39:35
  SPEAKER_01: Completely agree.
• 39:36
  SPEAKER_01: But again, I think that that lack of virality also makes it harder for that well-funded competitor, Google Translate being the perfect example, Amazon we've already touched on, to just move into that demographic overnight.
• 39:48
  SPEAKER_01: That the durable moat actually works both ways.
• 39:52
  SPEAKER_01: So is it or what does the next steps look like for duolingo with AI?
• 39:59
  SPEAKER_01: You know, is it AI disruption or is it AI empowerment?
• 40:02
  SPEAKER_01: And for me, I think there is a point at which Duolingo as a business becomes so cheap that you cannot ignore it.
• 40:11
  SPEAKER_01: Now, are we there yet?
• 40:13
  SPEAKER_01: I'm not sure.
• 40:14
  SPEAKER_01: But what I would say is Duolingo is in a position you've got, you know, we've got to remember that it can effectively self-fund itself.
• 40:23
  SPEAKER_01: It's not relying on debt, it's not having to pay down debt, it's not having to raise existing capital or raise new capital, sorry, and dilute existing shareholders.
• 40:31
  SPEAKER_01: Duolingo is an app that is going to be around for the long-term future.
• 40:37
  SPEAKER_01: You know, there's it's it's got fantastic financial metrics.
• 40:41
  SPEAKER_01: So what I or my closing thought ultimately is that Duolingo, assuming the share price gets cheap enough, has excellent upside opportunity for future investors who are potentially willing to take that risk.
• 40:57
  SPEAKER_00: Yeah, you know, to add to your ending thoughts, don't get me wrong, there is a lot to like about Duolingo.
• 41:06
  SPEAKER_00: They have, we haven't even touched on the culture, but they have a very unique culture.
• 41:11
  SPEAKER_00: They have excellent management, founder led, with skin in the game.
• 41:16
  SPEAKER_00: They usually have a very long-term view.
• 41:19
  SPEAKER_00: They have around 90% market share in language learning.
• 41:22
  SPEAKER_00: They are market leader, like you mentioned before.
• 41:25
  SPEAKER_00: They have a very strong data set, very unique, one of a kind, excellent financials, and the current valuation for sure is a lot more attractive than uh a couple months ago.
• 41:36
  SPEAKER_00: So why am I still uh I wouldn't say bearish.
• 41:40
  SPEAKER_00: I'm I'm not bearish on Duolingo.
• 41:42
  SPEAKER_00: I will put Duolingo on the too hard pal for now, and not because of the business itself.
• 41:49
  SPEAKER_00: The business itself is not hard, but they operate in this disruptible, in certain, highly innovative industry.
• 41:58
  SPEAKER_00: It's not it's not that I think Duolingo won't be here five years from now.
• 42:01
  SPEAKER_00: I think they'll be here, but I just don't want to apply the mental effort and energy to figure this one out just yet.
• 42:09
  SPEAKER_00: The range of potential outcomes is extremely wide for this company.
• 42:15
  SPEAKER_00: From universal educational app to just a niche hobby where people just learn languages for fun and then just a couple with a couple users paying for the subscription.
• 42:27
  SPEAKER_00: I mean, they're they're fighting against companies like Google, OpenAI, Apple, many others.
• 42:33
  SPEAKER_00: They're fighting new upcoming technologies.
• 42:38
  SPEAKER_00: And when I did the research, there is this quote that Buffett once said, and I think that that would be a good way to end this.
• 42:46
  SPEAKER_00: And as Buffett once said, was you don't get extra points for jumping over seven foot bars when there are one foot bars to step over elsewhere, and I think that's how I stand with Duolingo and the risk of AI.
• 43:03
  SPEAKER_01: With Duolingo seemed, it brought me back to a phrase.
• 43:06
  SPEAKER_01: So I I once, as an aside, I once went to uh a business accelerator and there was a few training days, and something's always stuck with me is that they talked about the fact that your business is either oxygen, as in people cannot survive without it, it's aspirin, as in your solving a pain point, or it's jewellery, it's just a nice to have.
• 43:28
  SPEAKER_01: Quite obviously, the businesses that are jewellery are net aren't necessarily the best businesses, and for me, the thing that I took away with Duolingo was it's not oxygen, but people don't need it to survive.
• 43:42
  SPEAKER_01: It's not um it's not aspirin, it's not solving a pain point.
• 43:46
  SPEAKER_01: It probably falls more into that jewellery category.
• 43:50
  SPEAKER_01: However, I can see Duolingo transitioning because the uh products that we have talked about at line today, as well, the likes of Instagram and TikTok.
• 44:00
  SPEAKER_01: Products, if they disappear tomorrow, people would be upset.
• 44:03
  SPEAKER_01: But they're not oxygen or aspirin either.
• 44:05
  SPEAKER_01: People don't need them to survive.
• 44:07
  SPEAKER_01: So I'll just finish up with the fact that for me, as a on a bullish take, but not as a shareholder, the fact that it's absolutely dual and go to generating more than enough cash to fund its own reinvention.
• 44:20
  SPEAKER_01: If something goes wrong, which there is a likelihood I think we both agreed on, could be disrupted, it has time to find to reinvent itself.
• 44:29
  SPEAKER_01: It's willing to spend heavily on RD.
• 44:33
  SPEAKER_01: That comes in at around 35% of revenue, particularly funding AI.
• 44:41
  SPEAKER_01: And so this is this is a founder-led business, but an incredibly intelligent team who are technically competent with this massive installed user base.
• 44:52
  SPEAKER_01: It has real data advantages to lean on that can support its pursuit of effectively becoming this international AI tutor, you know, if that's what is.
• 45:05
  SPEAKER_01: But with all of that, what it does line up for the company is the fact that it's going to get much more, how did I phrase this?
• 45:13
  SPEAKER_01: Much it's going to get much more shots on goal than the market is maybe pricing it.
• 45:19
  SPEAKER_00: Good analogy and uh great points to end this episode on.
• 45:24
  SPEAKER_00: Thank you so much again, Sonny, for coming on the show.
• 45:28
  SPEAKER_00: Always appreciated you coming here.
• 45:30
  SPEAKER_00: Check out Sunny's Substack, Secret Salls Investing.
• 45:34
  SPEAKER_00: Link will be in the show notes.
• 45:36
  SPEAKER_00: And we'll see you in the next one.
• 45:39
  SPEAKER_00: Bye everybody.
• 45:40
  SPEAKER_00: Thanks, Steam.