Duolingo: User Growth Under Pressure, High Ecosystem Stickiness Alleviates Monetization Concerns

$Duolingo(DUOL.US) released its Q2 2025 earnings after the market closed on August 6th, Eastern Time. Prior to the earnings report, the market was concerned about the decline in active users. Although the actual MAU showed weakness, the user retention was high, and the paid conversion rate increased, resulting in revenue exceeding expectations.

Key Points of the Earnings:

1. AI Public Opinion Turmoil Affected Customer Acquisition: In the second quarter, Duolingo faced negative AI public opinion (April executives claimed AI-first, coupled with controversy over voice actor pay cuts, and the official account's sarcastic response, causing public dissatisfaction). To protect its brand image, the company temporarily reduced exaggerated social media marketing, especially in North America, leading to a decline in active users in the US.

Meanwhile, the surge in active users due to the "Dead Duo" event naturally declined after the event.

However, the company mentioned that customer acquisition in China was impressive, mainly due to the collaboration with Luckin Coffee. Ultimately, the monthly active users in the second quarter were 128 million, with a sequential loss of 19 million, confirming the main concerns before the earnings report.

2. High Retention Among Existing Users: The second quarter DAU reached 47.7 million, with DAU/MAU continuing to rise to 37%, comparable to most social platforms, reflecting the strong stability of the platform's ecosystem. At the beginning of the year, the company further expanded the "Energy" plan coverage for the free version, which may have also boosted activity, and will continue to expand to more regional markets in the second half of the year.

The Energy plan has two main changes compared to the previous Heart plan: one is that making mistakes deducts energy/hearts, and the other is that answering correctly can reduce deductions or reward energy.

This clearly extends the point of interest decay for users and enhances their enjoyment. On the surface, increasing the heart value constraint for free users allows them to experience longer, which may reduce the impulse for users to subscribe for unlimited hearts in the short term. However, from the perspective of user lifecycle value, duration or retention (DAU/MAU) is the real key factor for final paid conversion. Duolingo's changes are beneficial to both indicators, so Dolphin Research believes that regardless of short-term fluctuations, the total value will ultimately increase.

Additionally, the development of new courses will naturally increase the retention of existing users, such as the chess course launched in the second quarter, which had over 1 million DAU by the end of Q2 2025, currently only on iOS, and will be promoted to the Android platform within the year.

3. Increased Paid Conversion: Paid conversion generally follows DAU fluctuations, so although MAU declined sequentially, DAU growth still drove final paid conversion. The average paid rate in the second quarter increased to 8.7%, with MAX penetration among total subscribers at 8%, up from 7% last quarter but clearly below expectations (market expectations were for a penetration rate of 9%). The company explained that video conversations are still challenging for beginners, and adjustments are being made.

4. Gradual Impact of Price Increases: Duolingo raised prices by 10% to 15% in multiple regions in the first quarter, and the second quarter saw some impact on average paid revenue, with a year-on-year growth rate of 5.5%, accelerating compared to the first quarter. Although sequentially, it is still declining.

Besides seasonal fluctuations, another factor is that many annual paid members renew at the end of the year. Another factor is the faster expansion of low-ticket international markets, such as Asia. Especially in China, although the Super price discount is not significant, the MAX feature has not yet been launched in China, so average paid revenue may be lower than in the mature North American market.

The company stated that future average paid revenue will maintain a low single-digit year-on-year growth, with a focus on guiding users to upgrade their paid subscriptions.

5. Guidance Raised, But Implies Slower Growth in the Second Half: Both third-quarter and full-year revenue guidance were raised due to strong second-quarter revenue. However, a minor flaw is that according to the new full-year revenue guidance, the implied minimum growth rate for the second half is 28%, significantly slower than the nearly 40% level in the first half, suggesting possible deliberate conservatism in the guidance.

6. Gross Margin Begins to Benefit from AI: The second quarter gross margin improved by 1pct sequentially. Although there are still some mismatches in AI investment (MAX product) output, the second quarter saw a decrease in AI computing power, improving gross margin, and this trend is expected to continue.

Regarding the introduction of third-party payments within Apple, the company stated that it is underway, but due to the high number of annual paid users, even if adjustments are made in Q3, the actual revenue that can be recognized within the year is only for one quarter, Q4, so the improvement in annual profit margin is not yet significant.

Additionally, introducing external payments will also cause some short-term conversion friction (users may abandon payment when redirected to other platforms), requiring a transition period (depending on the company's pace of introducing and promoting third-party payments). Dolphin Research expectssignificant improvement by the end of the year.

7. Light Assets, High Cash Flow: Free cash flow in the second quarter grew by 86.32 million, accounting for 34% of total revenue. A good business model generally does not have many cash flow issues, and a 34% cash flow revenue ratio is enough to demonstrate Duolingo's code minting machine capability.

8. Overview of Key Financial Indicators

Dolphin Research's View

Duolingo, with its growth valuation, faces the potential risk of AI replacement in the long-term logic, making short-term user metrics the biggest factor affecting stock price changes.

However, user numbers can be tracked by third-party platforms, and before the earnings report, the "downward adjustment of user growth expectations" had already been priced into the continuously declining stock price—down 35% in two months. Therefore, when a report with "expected" poor user numbers but significantly exceeded expectations in revenue and profit is released, along with management explaining the "short-term disturbance reasons" for user weakness in the conference call—intentionally reducing marketing activities and changing social media interactions to avoid further user resentment—the market showed signs of "bad news being fully priced in."

The current valuation of 17.8 billion (up 13% on the day after the earnings) has returned to the market value before the surge at the beginning of the year due to the TikTok Refugee and Dead Duo events stimulating user growth. However, new users have been retained, which also boosts Duolingo's performance. The difference lies in the short-term AI public opinion-induced fluctuations, which eliminated some valuation premium.

Based on current expectations, the current market value of 18 billion corresponds to an expected 42x EV/EBITDA in 2026 (1.32 billion revenue, 30% yoy, 32% EBITDA profit margin), still reflecting the valuation of a high-growth platform. However, considering the increased penetration of the Energy plan in the second half, Apple's third-party payment, and the marginal easing of AI public opinion impact, there is a positive trend from an operational standpoint. The company's official guidance is not overly optimistic, leaving room for further earnings beats, potentially increasing valuation space.

In terms of space, Dolphin Research's valuation range can be referenced: based on the DCF model, under different expectation scenarios, with a discount rate of 12.5%, the neutral to optimistic range is 160 to 255 billion USD (key indicators of the terminal assumptions are shown below). It is important to note that although the stock price has already fallen by 35% due to poor Q1 user growth, in the short term, market value fluctuations will still be highly sensitive to user numbers, so it is advisable to leave some safety margin based on individual risk preferences.