If you had a strong desire to learn Portuguese, you could spend some time in Mozambique, try to find a course at your local community college, immerse yourself in a Berlitz class, or pick up the yellow box from Rosetta Stone (NYSE: RST). The company has built a strong reputation for teaching new languages relatively painlessly and affordably, making it the brand-name leader without rival. As Fool co-founder David Gardner says, "I can't find the Pepsi to Rosetta Stone's Coke. There's no comparable competitor."

That's a large part of the reason David thinks the company -- which shoots to make learning a language fun, easy, and effective -- has the potential to be a 10-bagger. It shares many of the characteristics of some of David's very best recommendations, specifically:

  • It has a purpose and a mission that is important and relevant.
  • It is an undisputed leader in its field.
  • It has created a brand and identity that resonates directly with consumers.

The company started with an idea and developed an innovative solution. Instead of parsing sentences, conjugating verbs, and memorizing vocabulary lists, the millions of people who use Rosetta Stone software learn through something the company calls dynamic immersion, which incorporates images, text, and sounds to teach using the natural language learning ability we had as kids.

And the 8-year-old company would seem to have its greatest opportunity ahead of it. It's just starting to develop its international presence. Fully 95% of its 2008 revenue came from the U.S., even though the U.S. accounted for only $2 billion of the $32 billion spent worldwide in 2007 on language self-study.

With an average sales price of $355, Rosetta Stone's software makes learning a foreign language relatively affordable for motivated learners, but it still carries a high gross margin north of 85%. With that kind of margin and strong organic growth potential -- both internationally and domestically in what remains a relatively fractured market -- Rosetta Stone should be able to grow profits as it gains scale.

Grandes empresas ("big business" in Portuguese)
And that's just on the individual consumer side. Many organizations see expanded language skills as a competitive advantage and incorporate Rosetta Stone programs into their training and development. Arcelor Mittal (NYSE: MT), the world's leading steel company, has a presence in more than 60 countries and a diverse workforce.

"We have people relocated to foreign countries, and three or four months before going, they register with Rosetta Stone," said Vincent Maurin, ArcelorMittal's e-Academy lead. "They are able to learn more of the language before they go, and they arrive with the ability to hold basic conversations."

Thomson Reuters (NYSE: TRI) offers 29 languages to more than 50,000 learners around the world, with no restriction on which language employees can study.

And InterContinental Hotels Group (NYSE: IHG) offers Rosetta Stone as a way of bolstering the hotelier's customer service. "[I]t is important that we promote access to tools and resources that can narrow the communication gap with customers, clients, stakeholders, and team members," said Gary Whitney, VP of global hotel learning at IHG.

For personal, corporate, and governmental customers, Rosetta Stone's innovative origins remain today as the company constantly seeks to build features that allow it to make the learning process easier, more fun, and more accessible for its lovers of language. While Berlitz stretches only as far as audio CDs, a Rosetta Stone package of Level 1 and 2 Portuguese -- retailing for $399 and designed to build intermediate-level conversational skills -- comes with interactive software, an audio companion for your MP3 player, a headset and microphone for use with its speech-recognition software, live online sessions, games, access to its community, and a mobile companion for learning on an iPhone or iPad Touch. The idea behind the product extensions -- a subscription model the company tags Version 4 Totale -- is to build more engaging and longer-term relationships with its customers.

What to watch
But not everything is sol e pirulitos ("sunshine and lollipops" in Portuguese) for Rosetta Stone. The company, which went public in April 2009, took a hit later that year, when it canceled a secondary offering and lowered earnings guidance, citing ill-spent sales and marketing costs and higher-than-expected product development expenses -- not exactly the quick jump off the public starting blocks that analysts like to see.

More recently, the company's CFO resigned and the COO followed him out the door, raising some questions in David's mind about Rosetta Stone's culture. While he likes CEO Tom Adams (who has been running the company since 2003 and is still under 40), David wants to see a sense of stability and maturity among the leadership, along with a shift away from its unfortunate approach of overpromising and underdelivering on its financial results.

Overall, though, Rosetta Stone's biggest gambles on the table seem to be good ones. Though available on the market for only two weeks before the end of its third quarter, Version 4 Totale subscriptions accounted for 19% of total revenue for the quarter, a very promising trend. And its foray into the rest of the world is playing out in the early stages like the huge opportunity it initially appeared to be. International sales for the third quarter increased by 119% from the same period the previous year, yet revenue from outside the U.S. still makes up only 17% of total revenue. Turns out a lot of folks around the world want to learn English.

With a vast advantage in brand recognition, an evolving business model that appears to be paying off on two significant fronts, and a world of people who want to communicate with more people than they can in any one language, Rosetta Stone is definitely worth keeping an eye on.

Catalysts

  • Keep an eye on turmoil in the management suite. Two high-profile departures make a line; three could indicate a trend.
  • Monitor the progress of international and subscription services. The company has plotted a big chunk of its future on these bets, so make sure the growth continues on both fronts.
  • Management has made a habit of disappointing the market, and its stock performance has been whiplashed as a result. There's a reasonable chance that shares will take another hit at some point, which could present a buying opportunity for what remains, despite management missteps, an outstanding business.

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Roger Friedman doesn't own shares of any of the companies mentioned, but they’re now on his watchlist. Rosetta Stone is a Motley Fool Stock Advisor recommendation. Coca-Cola is a Motley Fool Inside Value selection and a Motley Fool Global Gains pick. Coca-Cola and PepsiCo are Motley Fool Income Investor selections. Motley Fool Options has recommended a diagonal call position on PepsiCo. The Fool owns shares of Coca-Cola. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.