Zipcar, Inc.: Steer Clear of the “Winner’s Curse” (Part 2)

Published Tue, Apr 26th, 2011   Louis Basenese, Chief Investment Strategist

If I asked you to invest in my business that’s lost money for a decade and might never turn a profit, would you be interested?

I didn’t think so.

So why in the world are investors clamoring to get a piece of car-sharing company, Zipcar, Inc. (Nasdaq: ZIP)?

The stock has blasted a staggering 56% higher since its initial public offering (IPO) on April 14. And yet, if you take the time to read the company’s IPO prospectus, you immediately get smacked in the face with this tidbit:

“We have experienced net losses in each year since our inception [in 2000]. We do not know if our business operations will become profitable.”

As I warned yesterday, the only explanation is that investors are buying into the hype, not the actual fundamentals. Because when you look under the hood, it’s clear that Zipcar is nothing more than a lemon.

Losses, Losses… and More Losses
If you’re unfamiliar with Zipcar’s business model, it provides the “freedom of wheels when you want them.” Its 560,000 members, called “Zipsters,” can rent the cars by the hour or day, with both gas and insurance included. And the company boasts a fleet of over 8,000 Zipcars, spread across major metropolitan areas and college campuses.

In short, Zipcar is really just a rental car company with a clever PR campaign.

And apparently, that’s all it takes to dupe investors into buying shares. Please don’t be similarly misled.

This is anything but a growth stock. The truth is, Zipcar has spent a decade trying to turn a profit – with no success. And upon closer examination, it appears the business is actually going in reverse.

Yes, sales rose by an impressive 41.8% over the past year. However, expenses jumped by 40.2%. And losses more than tripled to $14.5 million.

In other words, management is spending way more money than the company is taking in. That might work for the U.S. government for prolonged periods of time, but Wall Street seldom tolerates it.

What’s more troubling is the fact that the outlook for the company is similarly bleak. More losses lie ahead.

Five Reasons Why Zipcar Will Struggle to Turn a Profit

Here are five reasons why Zipcar faces an uphill battle:

1. Limited Market Opportunity:
Zipcar estimates that there are currently 10 million potential customers within a short walk of a Zipcar. Yet management has only been able to penetrate 5% to 10% of that market. So even if the company expands from its current list of 14 metropolitan areas to the 100 potential markets that it’s identified, the amount of potential customers remains limited.

2. No Scalability:
Zipcar’s prospectus doesn’t hesitate to brag about its “proprietary and scalable technology platform.” But the software isn’t the main driver of the business like it is for a company like OpenTable (Nasdaq: OPEN). Adding new members doesn’t mean just adding a new user to a software program. It means more cars, more parking spaces, more insurance and more gas. The company even acknowledges this itself…

3. Capital Intensive and Low Margin:
As Zipcar expands into new markets, it needs to “make significant investments in vehicles and parking.” Even after the company absorbs the “significant upfront fixed costs,” there’s no guarantee that enough demand will exist to recoup the investment.

Not to mention, the business is notoriously low margin. Net margins check in at less than 10% for rental car companies. And soaring gas prices promise to squeeze those margins even more.

You don’t need a doctorate to figure out that a business requiring massive expenditures to make minimal profits isn’t an attractive business. And it’s certainly not a business that warrants a premium valuation.

4. Not a True Cost Saver:
Zipcar bills its services as “a cost-saving alternative to car ownership.” But it’s not exactly cheap. Five to six days of rentals per month can run up to $400. And one-day rates, although all-inclusive, can end up being more expensive than a traditional car rental. It might be easy to sell customers on convenience, but cost ultimately determines how long customers stick around.

5. Serious Threat of New Entrants:
Zipcar’s first-mover advantage promises to be short-lived. Think about it. Zipcar might have a fleet of 8,000 cars, but traditional rental car companies have fleets in the hundreds of thousands. They also boast a much better infrastructure. All they have to do is flip a few switches and they can compete directly with Zipcar.

Indeed, Hertz Global Holdings (NYSE: HTZ) is already jumping into the fray with its “Connect” car-sharing program. When the competition really heats up, expect price wars to follow, which promises to put more downward pressure on Zipcar’s margins.

Growth is Never Worth This Much
In the end, even if Zipcar boasted strong profit growth, its valuation is completely out of touch with reality. It’s a classic example of the winner’s curse that I mentioned yesterday – investors bidding more for an item than it’s worth.

Here’s the kicker: At current prices, Zipcar carries a market capitalization of $1.1 billion. Yet the entire car-sharing market was only worth $253 million in 2009, according to Frost & Sullivan.

That means Zipcar shares are currently trading at roughly four times the current value of the total car-sharing market and at about one-third of the expected market value by 2020.

Even if Zipcar controlled 100% of the market (which it doesn’t), that’s too steep a price to pay.

Bottom line: Since share prices ultimately follow earnings – and Zipcar has none – it shouldn’t be long before shares hit the skids. So don’t be fooled by the initial rally. Like all overhyped IPOs, it promises to be short-lived and followed by hefty losses.

Ahead of the tape,

Louis Basenese