Market is about to learn what Duolingo is actually about.

About 2 weeks ago, I invested 2m into SaaS stocks, after rebalancing, $800k of that is now in Duolingo stock following the reaction to its earnings report.

The so-called ‘SaaSpocalypse’ implies most software stocks will get disrupted by AI or get cheaper as software gets commoditised. In this bear case, it is the businesses that iterate on AI and sit on the data needed to run AI apps that are said to win.

Duolingo is currently a front-runner in both the bull and bear case, yet it’s trading as if it has already lost.

First, let’s go through the basics. Duolingo has a market cap of 5 billion dollars, 1.3 billion of which is cash on its account, leaving an enterprise value of 3.7 billion. Is that expensive? I think it’s dirt cheap.

Duolingo makes 1.1B in revenue per year, with a gross profit of 800 million and net income of 400 million, which translates into free cash flow. Once you take out the 120 million in stock based compensation (if you want to be conservative), that leaves a clear 280 million EPS net of SBC, which gives DUOL a 13x net FCF valuation.

That on its own is already not expensive for a subscription business that is incredibly sticky, however Duolingo is actually growing its user base by 20% per quarter, that is escape velocity and it has now hit over 50 million daily active users.

So if the tech is sound, why is Duolingo trading at such a discount, down nearly 80% from its highs?

The answer is surprisingly in a misinterpretation by the market of the adopted strategy. Seeing that the market was being swept by AI, Duolingo decided to transform its business from a short term cash cow, to a larger player in the education space for the long term.

Its key move has been to target a growing DAU base and hit 100 million people using Duolingo every day by 2028 – an ambitious 2x goal. In order to achieve that, the company said it would remove some friction and not focus on getting a proportional transition of monetization at the same time, which is why DAUs are up 20% and monetization is up 11%, the same is expected for next quarter after which monetization is expected to catch up.

In the AI era, this will allow Duolingo to grow its data set on user behaviour and users themselves, making it actually a much more solid player in the space as data is what AI relies on to run. That is why in part Duolingo has expanded its language courses to new categories and has added video calls where you can speak with an AI to practice voice speech.

To sum up:
– Duolingo is at the same time not at risk of AI disruption – it is actually using AI to build better products.
– Its business is actually growing, not slowing down, while at the same time being valued as if it was pressing out tail end cash.
– The adopted strategy will make Duolingo succeed in the AI space, not trail, yet it is being priced as if it wasn’t.

I had shares before earnings but I’ve 4x my position, bringing my share cost down to about 102 and will likely derisk my position by 50% once we hit 115-120 to manage risk and will hold remainder until my target of 200. Ultimately I think stock can reach 300+