Zipcar (ZIP) offers a unique investment opportunity for Avis Budget Group (CAR) as the company is experiencing a remarkable growth rate. Due to its relatively short history as a public company, its shares were significantly undervalued based on a number of metrics. It appears that the recent announcement for Avis to acquire Zipcar is a good deal, despite the seemingly large premium.
This article will discuss why Zipcar is an attractive acquisition as a growth opportunity and from a valuation view point. Finally, a discussion of the competition and the threats will analyze Zipcar's long-term opportunities that make it a good fit for a more traditional car rental company such as Avis.
Since going public in April of 2011, Zipcar's stock price is down about 70% (prior to the Avis deal). While the stock is down significantly, the company's sales have been growing from $106 million in 2008 to $241.7 million in 2011. For the first nine months of 2012, sales are $208.2 million or up 16.4% compared to the first nine months of 2011. These are impressive results by any means, especially when considering that two major competitors, Hertz (HTZ) and Avis, are experiencing declining sales. For example, Hertz 2011 revenues were $8.1 billion compared to $8.4 billion in 2008, a decline of 3.7%. Similarly, Avis revenues declined from $4.6 billion in 2008 to $4.3 in 2011, a 6.5% drop. However, both Hertz and Avis maybe reversing these trends. As of September 30, 2012, Hertz and Avis year-to-date sales were up 6.3% and 32.6%, respectively, when compared to the same period in 2011. When looking at the three companies' price to earnings to growth ratios (PEG), Zipcar has the second lowest ratio of 0.87 between that of Avis of 2.01 and Hertz of 0.4.
Under Avis' ownership, Zipcar should be able to continue its growth while improving its profitability as the company refines its business model and adds additional efficiencies, services and options. For example, Zipcar is focusing on offering Zipcar for businesses (Z4B) and governments (Z4G), Zipvan, limited no annual fee services (tested in Canada), and breaking into new geographic markets including U.S. and international markets (latest were acquisitions in Spain and Austria). Operationally, technology is at the core of Zipcar and should enable it for a continued and relatively uninterrupted growth. The company is focusing on digital, mobile, social, and grass root marketing that utilizes data the company has gathered for more than ten years of operational history. This together with Avis' own resources (financial and operational), could ensure long-term success.
Despite a nearly 50% premium to Zipcar's prior day closing share price, Avis' acquisition looks like a good deal. Zipcar is a relatively new company that is experiencing significant growth. Importantly, for an acquirer, it is able to maintain strong fundamentals. Zipcar has several valuation ratios (based on pre-deal stock price) that are comparable to the more established (with lower growth rates) car rental companies. For example, Zipcar has a better liquidity, as measured by the long-term debt to equity ratio of 0.5 compared to 5 and 13.6 for Hertz and Avis. In terms of price to book value ratio, Zipcar has the most attractive valuation with a ratio of 1.4 compared to price to book value ratios of 2.6 for both Hertz and Avis. Low debt levels and book value, make Zipcar an excellent acquisition target. Even at a 50% premium, Zipcar's book value is below that of Avis and Hertz.
While Zipcar has worse profit margins, as it is still entering new markets and acquiring customers, it has a positive free cash flow and does not have a significant reliance on outside financing for its growth. In terms of profitability, Zipcar lost $0.24 per share in 2011 and it should earn between $1 to $4 million this year or approximately between $0.01 to $0.10 per share. In 2013, estimates are for $0.20 of earnings per share and at current stock price, the price to earnings ratio for 2013 is about 40. This is a rich valuation but given that the company is expected to double its earnings in 2013 and 2014, the valuation could actually be cheap. Following the Avis combination, Zipcar operation margins will be much higher due to synergies.
Zipcar is the first company to introduce and refine the business model where the car is rented by the hour and the day and can be picked up and returned at different locations throughout cities and university campuses. Avis has a relatively small car sharing business and Zipcar will complement its current rental offerings.
The two major competitors are Enterprise (Car Share) and Hertz (On Demand). However, Zipcar has the advantage of the early entry into the car sharing business and it also does not have a regular car business that in fact competes with the car sharing service. Currently, Hertz' On Demand has 85,000 members and 700 vehicles compared to over 760,000 members and over 10,000 vehicles for Zipcar. There is no data available for Enterprise Car Share but based on the areas it operates in, it is safe to assume it is smaller than the car sharing service offered by Hertz.
It appears that the current competition does not threaten Zipcar and the major threat to its business model is costs. If insurance and fuel costs rise significantly, Zipcar business model could collapse as the company does not charge extra for insurance and gas. These risks are significantly reduced if a larger company, such as Avis, is backing Zipcar.
While there are risks, Zipcar is able to bring in new technology and efficiencies that have been outpacing the rise in inflation. Also, Zipcar competes with taxi cabs and public transportation and if labor costs continue to rise, Zipcar will become clearly a better choice from a cost perspective. In addition, as the company continues to grow and increases negotiation power, due also to the Avis acquisition, it should be able to obtain more favorable pricing from service providers, car manufacturers, and insurance companies.
Without a doubt, Zipcar is a leader in the car sharing rental market. Assuming the Avis deal for Zipcar closes, it will provide a significant beachhead for Avis in this business. The car sharing market should continue to grow as consumers, governments, and businesses learn to share transportation and become more cost conscious. Avis should be able to expand further and faster Zipcar's business model into new geographic areas, offer additional services, and develop newer technologies that improve the customer experience as well as efficiency and safety. As with any acquisition, there are risks and there is limited margin of safety. However, Zipcar has been able to balance well between growth and profitability and the Avis acquisition will allow Zipcar to gain economies of scale while increasing investment in its technology and fleet. Avis' offer for Zipcar looks like a well-planned acquisition as regardless of the economic environment (people will always need cars for pleasure or work) car sharing is here to stay. A bidding war between Hertz and Avis will not be a surprising follow up to Avis' current bid for Zipcar.