Duolingo: playing for the endgame

As with any investment, your capital is at risk.

"When you see a good move – wait – look for a better one." 

– Emanuel Lasker, six-time World Chess Champion

The game of chess has much to teach the long-term investor. Above all, it requires patience, adaptability, and a knowledge that every move should be made with the endgame in mind. Beginners react to what’s on the board. Masters play for the position they want in twenty moves' time.

This is also the case at LTGG, where we deliberately set ourselves against the short-term horizons of the market, in the hope that by stepping back, we can consider opportunities that barely register on today’s share price.

And as any player will tell you, the game of chess is also highly addictive. The latest addition to the LTGG portfolio, Duolingo, knows this well. The app that turned language-learning into a game has also just launched a new chess feature.

Playfulness is at the core of Duolingo’s runaway success. And it is through chess that we can see the outlines of its compelling investment case.

Controlling the centre

Even amateur players know the key to any chess match is gaining control of the centre. Duolingo sits squarely in the centre of the language learning market.

Within a year of launch in 2012, it shot to the top of the education app charts, where it has remained as the most downloaded education app in the world. Over the last 5 years, the number of monthly active users has increased by 30 per cent a year, to more than 130 million. The company’s closest competitors are about one-tenth of the size.

And yet, there is plenty more space on the board to play for. There are an estimated 1.5 billion language learners worldwide, and the global digital learning market is projected to be worth over $100bn by 2030.

The key to Duolingo’s success has been making learning fun: turning it into a game and tapping users’ competitive instincts with “streaks” – rewards for returning day after day.

That stickiness is crucial for the app’s ability to convert free users into paying subscribers. As the overall number of users shot up, the proportion who chose to pay also rose markedly, from 4 per cent in 2020 to over 8 per cent today.

Adaptability

Adaptability is as vital in business as it is in chess, and Duolingo has demonstrated this repeatedly. Its early expansion into different languages has been followed by new ventures in maths, music (and yes, chess!) all of which could one day contribute meaningfully to revenues.

It’s worth noting that the chess feature grew to 1 million daily active users in just a month – something it took other offerings like maths a year to achieve. And when it comes to adaptability and planning for the future, a company’s culture is critical.

Duolingo is mission-driven. Many employees turned down higher-paying roles elsewhere for the opportunity to help make education accessible to all.

We’ve engaged extensively with founder and CEO Luis von Ahn, who recently shared with us his “biggest fear”: that one day the company would prioritise its share price over its mission. Long-term thinking is central to Duolingo’s identity, and they are willing to trade short-term optics for a durable advantage.

Beneficiary of AI, not a victim

In 1997, IBM’s Deep Blue defeated world chess champion Garry Kasparov, seemingly settling the question of man versus machine. The lasting lesson came afterwards: players embraced AI not as a replacement but as a training partner, using engines to improve faster and play better. Far from diminishing the game, AI elevated it.

We see a similar dynamic at play with Duolingo. Since its peak in May, the share price has fallen sharply, partly due to fears that AI translation will make language learning obsolete. But what if such fears are misplaced?

Ever since it launched in 2012, there has always been a perceived threat to Duolingo’s business model from ever-improving translation tools. But the app’s value lies in learning and retention, rather than just comprehension and translation.

Most of Duolingo’s paid users are learning a language for practical reasons: to integrate into a culture, to get a job, or simply for the pure enjoyment and achievement it brings. These use cases are unlikely to be fatally undermined by AI.

And Duolingo is effectively harnessing AI to become a coach, not a substitute. The Duolingo Max subscription tier now includes an AI assistant who can hone your new conversational skills over a video call, as well as provide individual feedback on your progress. It is proving very popular. It is also opening doors in traditionally hard-to-reach markets.

Until now, most of Duolingo’s subscription revenue has come from developed nations. In many emerging markets, ad-supported usage has been the dominant trend. But give people something worth paying for, as Max is now doing (where it might make the difference in someone getting a job), and they may come in droves.

Moreover, Duolingo’s user base has thus far tended to consist of beginner and intermediate users. As its AI functions improve, they could also begin to capture more serious learners.

Upside

Even if we were to assume user growth slows from around 30 per cent to 25 per cent a year by 2030, we can envision a plausible scenario where Duolingo reaches around 400 million users – about a quarter of the estimated number of language learners worldwide.

If we suppose Max reaches its full potential, the number of paid subscribers could feasibly more than double to reach 20 to 25 per cent of total users (it’s already growing over 40 per cent per year). Even if the average revenue per user were to decrease to reflect a more diverse international subscriber base, it is feasible that total revenues reach $6-7bn a year by 2030, and margins continue to expand.

In such a scenario, we wouldn’t need exuberant valuation multiples to reach a 5x case. And that’s without factoring in any extra revenue for the more nascent functions of maths, music and chess.

Returning to the wisdom of the great chess grandmaster Emanuel Lasker above, at LTGG, we had been interested in Duolingo for some time. It has been held elsewhere at Baillie Gifford since its IPO in 2021. But as recently as January this year, it had struggled to clear the high hurdle for entry into the portfolio.

So, we waited. Our conviction in the strength of the company’s long-term fundamentals has since increased, while the market’s view has grown more fearful. Unhurried, we made our move.

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