Better Buy: Olo vs. Toast

The initial public offering (IPO) class of 2021 has had a tough time in the markets. Shares of many 2021 IPOs are down more than 40%, 50% or even 60% from the prices at which they went public. Olo (OLO 0.92%) and Toast (TOST -0.16%) are no exception, dropping 74% and 67% respectively since their IPO dates.

That said, both are thriving in the restaurant software industry. Toast and Olo are rivals in this area, with Olo providing back-end software tools to optimize digital ordering and Toast covering all of a restaurant’s digital applications, from point-of-sale services to payroll. So which one seems to be the best buy for investors looking to get into this industry? Let’s find out.

The case of Olo

Olo focuses on a specific problem for restaurants: digital ordering. Many restaurants lack the technology infrastructure to scale digital ordering operations, which could leave a bad taste in customers’ mouths. Olo simplifies this and also provides digital solutions for any ordering method, from drive-thru to delivery.

The company has seen impressive adoption, with 600 brands and 82,000 locations using Olo’s tools. The growth of the company’s turnover is also not a challenge. Olo has a compound annual revenue growth rate (CAGR) of 67% from 2018 to 2021, and a CAGR of 31% over the same period.

One of the possible reasons why Olo has been so successful is its unique sales strategy. It targets businesses and sells its services at the corporate level. Once it’s integrated into the head office, the other sites follow suit (at little or no cost to Olo). This strategy has resulted in relatively low sales expenses: in the second quarter of 2022, only 20% of Olo’s revenues were devoted to marketing, much less than the 38% devoted to research and development.

Olo’s marketing spend is low, but not enough to achieve profitability. Over the past 12 months, the company has lost over $36 million, representing a loss margin of 22%. Olo is also showing negative free cash flow: the company’s cash burn over the past 12 months was $6.8 million. That said, its balance sheet has nearly $387 million in cash. This should allow Olo to burn some cash for a while before it becomes a problem.

With strong growth and rapid adoption, Olo’s unique selling model seems to be paying off. Additionally, the company’s multi-channel offering could allow restaurant chains to rapidly increase their use of Olo’s services, suggesting that the company could grow across new and existing chains.

That said, Toast has a similar offering, and the company’s broader product suite might be a reason for Toast to overtake Olo.

The case of Toast

While Olo primarily focuses on ordering food, Toast’s toolkit is much more comprehensive. Not only does Toast provide point-of-sale products, but it basically offers everything a restaurant might need, from payroll services to equity loans to online ordering. This gives the business two advantages: there is more room for a restaurant to expand its use of Toast, and it creates high switching costs.

That said, Toast still has a smaller scale than Olo in terms of total locations, with 68,000 in Q2 2022. However, these restaurants rely more on Toast – it generated $675 million in revenue in Q2, a jump by 58% per year – on-year. This is significantly more than the $45.6 million generated by Olo during the same period.

Like Olo, Toast is not profitable. The company posted a gross margin of just 16%, down since its IPO. As a result, Toast lost $54 million and burned $30 million in free cash flow in the second quarter.

The best buy?

Although it has grown more slowly than its counterpart and is much smaller in terms of revenue, Olo seems to be the best buy today. The company is a leader in terms of scale and its very effective sales strategy seems to allow it to maintain its first place. Additionally, while both companies are not profitable, Olo seems to have more leeway, giving it more time before it becomes profitable.

And that’s leaving aside the evaluation. Although Toast is cheaper based on the price to sales ratio, the price to gross profit ratio is probably the best metric for valuing these companies. On that front, Olo is more reasonable at 10x gross profit, compared to Toast’s valuation of 26x.

With its unique sales strategy and greater potential, Olo seems like the best company to keep for the long term.

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