Summary
- Olo facilitates digital ordering and helps restaurants to wrestle back direct customer relationships from marketplaces.
- Revenue & Gross Margins expanded over the past few years, but margins might begin to stagnate with limited scope of product offerings.
- The acquisition of Wisley was not a cheap deal, and it remains to be seen how it value-adds to Olo’s portfolio.
Business Overview
Olo (NYSE:OLO) is a company that’s facilitating online ordering (that’s also how its name was derived) for restaurants. It was started in 2005 with the aim of lessening waiting times, by allowing consumers to order from their phones in advance for in-store pickups. The company now generates revenue mainly through 3 modules:
- Ordering. Olo’s white-label platform allows restaurants to set up their online presence for consumers to order direct. Monthly subscription-based revenue from restaurants.
- Dispatch. A delivery-as-a-service (“DaaS”) offering which lets restaurants tap into a pool of external delivery service providers (“DSPs”) when orders come through their website. Transactions-based revenue from restaurants.
- Rails. A centralized orders and menu management service across multiple ordering channels (Marketplaces, direct online orders, etc.). Transactions-based revenue from restaurants & marketplaces when orders originated from them.
Owning the Customer Relationship
The modules were designed to give power back to the restaurants. For restaurants that don’t have their own delivery riders, the rising popularity of deliveries has led to them relying on marketplaces to fulfil that demand. It’s common to see restaurants having such tags on their door, pushing guests to order from these high-commissions marketplaces for deliveries.
As a result, restaurants will not be able to get any details of the guests that placed the orders since those will be shown under the respective marketplaces. Furthermore, menu prices will usually be increased to compensate for the marketplaces’ commissions. Worst of all, each marketplace comes with its individual terminal, with employees manually keying in every order into their Point-of-Sale (“POS”) system. This complicates the whole ordering process and increases the chances of inputting wrong orders, even more so in times of labor shortage.
With Olo’s Dispatch, restaurants only need to pay for delivery fees as quoted from the external DSPs when guests place a delivery order through their own website/app.
This allows restaurants to retain the customer relationship while possibly lowering prices. Olo even came up with a comparison calculator for restaurants to gauge whether it will be better shifting from marketplaces to Dispatch. Furthermore, the increasing regulatory spotlight on marketplaces may play into Olo’s hands.
For restaurants that still wish to rely on incremental sales from marketplaces, Rails can be used to ease the load on employees. Orders from different channels can be consolidated into the restaurants’ POS system, and menu changes made from the same system will be applied throughout.
Relationship with DoorDash & Marketplaces
DoorDash (DASH) is a partner with Olo since 2017. DoorDash is the largest digital ordering aggregator on Olo, and has always been the majority contributor of Rail’s revenue, even taking up significant revenue share.
It was thus a concern when DoorDash sued Olo in Mar’21 over overcharging issues. The lawsuit was quickly settled in the following month, with an extension to their multi-year agreement and Olo providing a $25 million letter of credit to DoorDash.
This event highlighted the value Olo brings to the marketplaces. Marketplaces rely on restaurants to generate revenue. In a highly competitive industry, they can’t afford to be left out of Olo’s platform when restaurants are streamlining ordering processes through Olo.
On the other hand, CEO Singh of PAR Technology (PAR) mentioned that marketplaces are not going away in a recent interview. PAR is an Olo partner and it is providing POS hardware and software to Tier-1 quick-service restaurants (“QSRs”). For PAR’s overview, click here.
The amount of capital DoorDash & Uber (UBER) have access to is much larger than restaurants themselves. Hence, they can always think of ways to bring back customers. Taking this into consideration, settlement of the lawsuit is actually a win-win situation.
Financials
Olo’s revenue has been increasing every year, with a huge rise in 2020. This is attributed to the pandemic bringing more awareness to the need for digital ordering. In 2021, quarterly revenue growth slowed down as more return to in-person dining.
Gross profit margins also experienced a rise during the same year as the percentage of customers using all 3 modules increased from 44% in 2019 to 71% in 2020. However, there seems to be a normalizing of margins towards 78% in 2021. Some new customers began with just 1 module, which is also reflected in the decreasing Average Revenue Per User (“ARPU”) with more active sites.
Despite the slowing of growth, Net Revenue Retention (“NRR”) has been above 120% for the previous 3 quarters.
It will be an interesting metric to monitor as it seems impossible for digital ordering volumes to keep growing every year. Olo also has to develop more modules either organically or through acquisitions to be able to keep up its growth.
Limited Addressable Market
CEO Noah Glass mentioned during Q2’21 earnings call regarding the market Olo is targeting:
But delivery is just 8% of the overall transactions in the industry or was at least in Q2, meaning that 92% is nondelivery. And when we look at digital, what you see is that of the total, digital delivery is just 6%, whereas digital overall is 17%. So the other 11% is coming from nondelivery digital. And the breakdown of that is 10% of total is takeout. And now, for the first time, we’re seeing 1% on-premise.
As mentioned above, Olo’s value proposition is facilitating digital ordering. Olo would still have some runway to capture more of the digital portion, and it’s doing so through offering table-specific QR codes for in-person dining.
However, it’s hard to totally eliminate employees manually taking orders from guests in many restaurants (other than Quick Service Restaurants (“QSRs”)). After all, restaurants are not factories that simply mass-produce goods and deliver them out. Human interaction is part of the dining experience which helps in building up relationships with guests, and order-taking is usually the ice-breaker.
Wisely Acquisition
Olo acquired Wisely, a customer intelligence company, in Oct’21. The rationale for acquiring Wisely comes down to “ABCD” – Always Be Collecting Dots. This term was coined by Olo’s director Danny Meyer, who is a renowned restaurateur & also the founder of Shake Shack (SHAK). From his book Setting the Table:
Dots are information. The more information you collect, the more frequently you can make meaningful connections that can make other people feel good and give you an edge in business. Using whatever information I’ve collected to gather guests together in a spirit of shared experience is what I call connecting the dots. The information is there. You just have to choose to look.
Guests interact with restaurants through multiple touchpoints – reservations, digital orders, payments, loyalty apps, and even through connecting to in-house Wi-Fi. All these interactions create data trails that can be unified under Wisely’s Customer Data Platform (“CDP”), creating a personalized profile for each guest. Restaurants will thus be able to cater to their guests’ needs, increasing guests’ satisfaction and driving more future visits.
Acquisition Price
The deal was closed at $187 million, in a cash-plus-stock deal.
With management giving Q4 guidance for $1 million of Wisely’s revenue in 2 months of Q4, we estimate Wisely annual run-rate to be about $6 million at the point of acquisition. At first look, the deal might not look cheap as the multiple paid seems to be high for a small company, even with similar margin profiles as Olo and 95% subscription revenue.
By looking into the portion paid with shares, it appears to be good capital allocation by not using all-cash (they have almost $600 million of cash at the end of Q3). Olo’s share price at that point was trading at similar high multiples.
Despite that, the overall price paid is still on the higher side. The jury is still out on how effective the cross-sell motion will be, and whether it will be a significant growth accelerator.
Valuation
Since Olo is already generating Free Cash Flow (“FCF”), we are using a 5 year Discounted Cash Flow (“DCF”) valuation method, and bringing it back to present value. For the valuation, there are a few variables and hence assumptions that we would have to make.
A 10% discount rate is used based on the historical compound annual growth rate of the SPDR S&P 500 Trust ETF. By choosing to invest in Olo, we want to make sure that it can provide a growth rate that is higher than the index, otherwise, we are better off investing in the index instead.
For the share dilution, an assumption of 5% due to its recent IPO might result vesting of share-based compensation over the next few years.
At the core of any business, it is to generate FCF for long-term sustainability. As of the trailing 12 months (“TTM”), Olo has an FCF margin of 30%. We assume a conservative estimate of maintaining a 25% FCF margin run rate for the next 5 years, due to possibilities of re-investments to accelerate their growth.
Olo’s revenue growth rate as of Q3’21 was about 35%. We are also factoring in a 5% decline in the growth rates as revenue gets bigger and slowing down of digital ordering growth..
The last variable to consider is the multiple that we are willing to pay for Olo. Olo current margins & growth profiles seem to mirror those of a mature B2B subscription software business. Referencing the FCF multiple of Salesforce (CRM), which is around 40-50x for the past 3 years, we have applied a lower 35x multiple at the end of year 5 due to it serving a more niche market.
Based on the above assumptions, we have derived an enterprise value of about $17. Adding $3.96 cash per share, the total intrinsic value per share is about $21. At 24th Jan’22 closing price of $15.5, there is an implied upside of 35%. This is without incorporating the possible acquisitions Olo might consider due to its large cash reserves, which is at 25% of its current market cap.
Conclusion
Restaurants are realizing the need for having an online presence and digital ordering since the lockdown days during the onset of COVID. Even though marketplaces helped to keep their business afloat then, the high commissions charged will always be a concern. Olo is acting as the “savior” to wrestle back the direct-to-customer relationship while reducing the reliance on marketplaces by offering DaaS through Dispatch. The acquisition of Wisely will also enhance the hospitality provided by restaurants, which will drive higher guests’ lifetime values.
Nonetheless, the company might want to tap on its huge cash reserves for acquisitions to expand its product offerings. Digital ordering and delivery are only small parts of a large restaurant value chain.