Zipcar – Time to Step on the Brakes?

19 Apr

After being a loyal lessee for six years, I turned in the keys to one of my few luxuries after the lease of my second car expired. As a resident of Manhattan, I paid the “bargain” rate of $400 per month to park the vehicle which, after 39 months, had all of 21,000 miles. When you add up my lease payment, parking and insurance, I was paying $1,500 a month before I even put the key in the ignition. Why did I effectively “put” the car back to the company? One word: Zipcar Inc. (NASDAQ: ZIP).

So you weren’t part of “friends and family” and you didn’t get allocated shares in the Zipcar IPO. Is now th time to jump in? Continue reading for the answer.

For those of you interested in the hard numbers – please jump to the bottom, the bull and bear case are put in a numerical format. For those interested in the bigger picture, read on.

Value Proposition

The math was easy for me – I pay a monthly membership fee of $50, credited towards my rentals, and I have access to a great line of cars. Typically, I rent the BMW 3 Series (reluctantly) or the Audi A6 for approximately $14 per hour or $150 per day. Assuming I drive an average of 30 mph, the mileage on my previous car equates to 18 hours per month (21k miles/39 months/30mph). If I were to pay the hourly rate (keeping the car 24 hours results in a lower rate), my cost would be $252 a month (18hrs x $14). That’s right, cheaper than it costs to park my car. Not to mention the savings I get by not having to pay for gas or insurance. Sure, that does not include the length of time I stay at the destination, but even if I tripled the cost, it would still be cheaper. Further, the Zipcar garage was the same one I used for the car I was leasing. As you can see, I’m a strong proponent of the company’s value proposition to the Zipster (the name given to the company’s members). However, that doesn’t necessarily mean I’m ready to buy the stock – and it’s not just because the ticker symbol is “ZIP.”

You can read the “investment highlights” for all of the good things about the company, including first mover advantage, brand awareness, and the economical ones I noted above. Instead, this article is about a few issues that caught my attention when reviewing the prospectus – as they say, “the devil is in the details.”

Growth

The company notes that revenue has grown from $30.7 million in 2006 to $186.1 million in 2010. However, this growth was not entirely organic (internally generated). Zipcar merged with Flexcar, Inc. in 2007 and acquired Streetcar Limited in 2010. In 2009, Streetcar had revenue of $23.1 million. Year over year growth would look a lot different without that acquisition. Instead of growing 41.9%, 2010 revenue growth would have been 24.3%, approximately the same as 2008-2009. This means that the second derivative of growth, that is, the change in the rate of growth is slowing. How long can the company grow through acquisition before it begins diluting shareholders?

Zipster Base

Secondly, Zipcar has “over 560,000 members.” Based on their revenue numbers, they are making approximately $402 per member. Assuming an average hourly rental cost of $12 (lower end cars like the Mini Cooper range from $9 – $11 per hour), the average Zipster is renting a car for roughly 2.8 hours per month. The prospectus states that the company has “over 8,000 cars” in their network – this amounts to 65 members per car (year end 540,484 members; 8,250 cars). Stated differently, each car is used on average 181 hours per month (2.8 hours x 65 members). When you think about the “usable” hours per month – arguably 244 hours per month (5pm – 10 pm weekdays, 6am to midnight weekends) – Zipcar may face issues should the Zipster base grows in existing markets. Specifically, if cars are not “there when you want them,” the company may be forced to buy more (ie. increase CAPEX) or face alienating customers. Perhaps that is why they currently offer a flat rate of $39 for “overnight” rentals (from 6:00pm to 8:30am) – half of the daily rate – pulling demand to low use hours.

Market Size/Share

The company states that it is identified “more than 100 global major metropolitan areas.” It currently operates in only 14 of those markets. By 2020, the company estimates that the car sharing market will grow to $9.1BN ($3.3BN US, $1.8BN Europe, $4.0BN Asia/Pacific) based on a study by Frost & Sullivan. The current market for the US and Europe alone is estimated to be just over $400 million. That means the market (US/Europe) is expected to grow at a CAGR of 32.7% over the next 9 years. Further, it means that Zipcar, with $186.1 million in revenues, owns over 45% of the market. How long will it be before Hertz Connect, the flexcar business of Hertz Global Holdings Inc. (NYSE: HTZ), begins to fight back and take share? Avis Budget Group, Inc. (NASDAQ: CAR), United Car Rentals (NYSE: URI) and Enterprise Rent-A-Car Company (Private) have yet to announce any meaningful plans for a me-too service.

Adjusted EBITDA

The company focuses on Adjusted EBITDA – “earnings before non-vehicle depreciation, non-vehicle interest, interest income, amortization preferred stock warrant liability adjustment, stock compensation expenses, acquisition and integration costs, taxes and other income related to [Zero Emission Vehicle] credits.” Phew, that’s some adjustment – if only my chiropractor was that good! If you don’t mind all of the adjustments, the trend is positive. In fact, the past three quarters were positive – primarily due to non-vehicle interest expense ($5.4 million) and acquisition and integration costs ($5.6 million). For 2010, adjusted EBITDA was $4.2 million. It should be noted that compensation expense will ultimately need to be realized. In 2010, stock compensation was $2.8 million or 65.7% of adjusted EBITDA.

Valuation

I have said it before, and I will say it again: “markets can stay irrational longer than you (or I) can remain solvent.” The current valuation seems to be worthy of the halcyon days of the dot-com bonanza. To put this in perspective, look at the company’s last acquisition. Zipcar paid $62.8 million for Streetcar. As noted earlier, Streetcar had revenue of $23.1 million in 2009. Thus the purchase price was 2.7x revenue and a whopping 43.0x estimated EBITDA. Based on current trading levels, ZIP is trading at 5.4x revenue and 240.4x adjusted EBTIDA. Either they got a steal of a deal on Streetcar, or the company is trading at lofty levels.

When looking at the established competitors, the numbers look even less compelling. Given the amount of leverage employed by the larger players, it seems appropriate to look at enterprise value (“EV” – market capitalization plus net debt) metrics. For ZIP to get down to the average multiple of EV to Revenue, the company would need to increase revenue by almost 300%. Stated differently, if the company grew revenue by 30% a year, the stock would have a more normalized multiple in 4 years – if the price remained at current levels. On an EV to adjusted EBITDA basis, the metrics appear even more daunting. In the fourth quarter of 2010, ZIP had adjusted EBITDA of $3.5 million. Annualizing the quarterly number to achieve a best case “run-rate” would still result in a lofty multiple of 69.2x. In order to reach an EV to adjusted EBITDA level comparable to the peers, ZIP would need to grow adjusted EBITDA by almost 500% (again, that’s only if the price stays flat)! Recall, the US/Europe market is expected to grow at an annualized rate of 32.7%. Granted, ZIP is starting from a smaller base, so it is likely that it can grow faster than the norm. However, the numbers seems to be flashing a warning signal.

To like the valuation at these levels, you must buy into the long-term market view espoused in the prospectus. If, and it’s a big “IF”, you believe the market will reach $9.1 billion by 2020 – the current valuations can be validated on an EV to revenue basis. Even if Zipcar’s market share drops to 20% from its current 46.5%, the stock could be worth almost 2.5x more than the current level (assuming a discount rate of 15% and current market multiples).

However, on an EV to adjusted EBITDA basis, the valuation is suspect. There a several assumptions that need to made when determining year 2020 adjusted EBITDA. Given that I don’t believe anyone can accurately project out 3 years, I have no intention of modeling out 9. As Warren Buffett likes to say, I’d “rather be approximately right, than precisely wrong.” As such, I have taken the assumption that the market will reach $9.1 billion and built my analysis from there. With that as a starting point, the next step was to determine Zipcar’s market share and adjusted EBITDA margin. For the sake of argument, I used a range of market shares from 10% to 40%. As for margins, I also used a range. In 2010, the company’s margin was 2.3%. However, in the fourth quarter, the margin was 6.9%. Thus, I used a range of 2.5% to 7.0%. The final assumption was the discount rate. There too, I used a range of 10% – 20%. Feel free to use CAPM to get a more precise level, but it seems most equity investors are looking for returns north of 15% for relatively young companies.

As you can see from the charts above, even with multiple expansion and discounting at 15%, ZIP’s enterprise value seems rich. Having said that, animal spirits have a way of propping up stocks for extended periods of time. Long or short, tread carefully.

Full disclosure, I have no position in any of the stocks mentioned and have no plans to initiate positions within the next 72 hours.

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One Response to “Zipcar – Time to Step on the Brakes?”

Trackbacks/Pingbacks

  1. Wednesday links: an artificial construction Abnormal Returns - April 20, 2011

    […] Zipcar (ZIP) grow into its valuation?  (Stone Street Advisors also […]

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