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Why Avis’ Acquisition of Zipcar Will Run Both Companies Off the Road

At first glance, Avis Budget Group’s (CAR) acquisition of car-sharing upstart Zipcar (ZIP) looks like a savvy move for both companies.

Having lost out to Hertz (HTZ) in the battle for Dollar Thrifty last November, the Zipcar deal gives Avis a much-needed boost.

The announcement also heralds Avis’ entry into the complimentary car-sharing market – a move its competitors have already made with Hertz on Demand and Enterprise CarShare. Not only that, Avis will instantly vault ahead of its rivals, since Zipcar owns 70% of the car-sharing market.

And the price?

Avis will pay $491 million – a bargain compared to Zipcar’s IPO valuation of $1.2 billion.

Or is it?

Look behind the headlines at Avis’ so-called “bargain” and a very different picture emerges…

Show Me the Growth

When Zipcar was founded in 2000, it brought an innovative business model – one that reformed the car rental market with its car-sharing model instead. (More on that in a moment.)

And when the company hit the stock market in April 2011, it did so with great fanfare. When the stock debuted, it immediately rose to a peak of $30.

But in hindsight, Zipcar was a terrible IPO. Shares steadily fell to the $8 to $12 range, where they remained until the buyout announcement on January 2. In fact, my colleague, Louis Basenese, made a prescient case against the Zipcar IPO.

And when you consider that Zipcar’s projected annual revenue for 2012 is around $270 million, it means Avis is paying roughly $1.79 for each $1 of Zipcar revenue. So $491 million isn’t really the bargain it looks.

Also, Zipcar’s customer growth rate appears to be slowing. As Paul Coster, a research analyst at JP Morgan Chase & Co. (JPM), noted recently, Zipcar’s new customer numbers declined from 190,000 in 2010 to 130,000 in 2011 to an estimated 115,000 last year. “It doesn’t… reconcile with this notion that [you’ve] got a really large, untapped market that’s still in growth mode,” he said.

Still, Avis anticipates that the deal will lower the companies’ combined costs by $50 million to $70 million a year, as well as generating $20 million of profit-and-loss benefits in the first 12 months of ownership and $50 million in year two.

“It’s the substantial synergies that really enable this transaction,” says Avis CEO Ron Nelson. In other words, the savings on operating costs and the boost to revenue from the combined companies.

However, a recent McKinsey & Co. study found that 40% of mergers fell short of their cost-synergy targets, while 70% failed to meet their revenue-synergy goals. The study also found that buyers usually have skewed assumptions about market growth and competitive realities and tend to be overly optimistic about cross-selling opportunities.

And in this case, that’s particularly notable…

Zipcar is in for Culture Shock

Avis and Zipcar have very different approaches to the car rental market.

Avis is a traditional rental company, designed for travelers who need a car for several days at a time.

But Zipcar is a pay-as-you-go car-sharing outfit that offers a cheaper, more convenient service. It caters mainly to urbanites and college students who need a car for a shorter time (but generally more often) to run errands.

Zipcar reinvented the industry with its annual membership-based service. After the simple application is approved, members receive a personalized Zipcard. It’s the key to any car in the Zipcar fleet.

And here’s where the technology comes in: Once a member reserves a car, the vehicle and Zipcard are coded specifically to that person for that set time. The Zipcard connects with the card reader on the car and thanks to RFID (Radio Frequency Identification), the car recognizes the reservation, the doors unlock and the keys are inside the car in a pre-determined, hidden spot. No-one else can start the car without scanning the Zipcard first.

Zipcar reservations are quick, simple and cars are available by the hour or day, with 180 free miles per day in the United States. Gas and insurance are included in the price, too.

Each company’s distinct business model makes it nearly impossible to fulfill the other’s customer needs without a radical reworking.

For example, Zipcar’s problem is that much of its fleet stays idle during the week, but is overburdened on weekends. As a result, Avis would have to constantly reposition its fleet from airport parking lots during the week to costly city parking spots on weekends – a logistical and technological nightmare that would play out every Friday night and Monday morning in cities across America.

Now consider the Zipcar user’s point of view. Zipcar has built a brand identity that its customers – Zipsters – identify with strongly. They like the convenience of picking up vehicles in their neighborhood, the cool cars that Zipcar provides (such as Mini Coopers and Toyota Priuses), plus the idea of “sharing” cars with like-minded people.

Now along comes Avis, and instead of a Prius parked on the street, there’s a Ford Focus or a Chevy Cruze.

To me, the business models and customer bases don’t match up well. Not to mention the fact that both user interfaces and computer systems will need to be combined.

Washington Post columnist and Pulitzer Prize winner, Steven Pearlstein, predicts the future like this: “Avis executives will say how they respect Zipcar – its culture and its way of doing business – and promise to preserve it. But a year down the road when it comes to some decision in which they’ll have to forgo cost savings or some revenue increase in order to maintain those differences, the decision will be to do it the ‘Avis’ way. And that will be it: Zipcar as we know it will be history.”

My advice: Don’t get taken along on this ride.

I’ll discuss Zipcar’s place in the greater car-sharing market in my next post.

Ahead of the tape,

Elizabeth Carney

 

Editor’s Note: As we publish this article, one Zipcar investor has filed a formal complaint in Delaware Chancery Court, attempting to block Avis’ takeover bid. The suit states that the proposed $491-million sale price significantly undervalues the company. And several law firms are investigating the deal, on the basis that Avis’ $12.25 per share offer for Zipcar – a 50% premium over Zipcar’s December 31, 2012 closing price before the deal was announced on January 2 – is still much less than the company is actually worth and that Zipcar’s board didn’t fulfill their fiduciary duty in getting maximum value for shareholders.