I submit this write-up knowing full well that the SumZero community quickly frowns upon unprofitable young businesses with seemingly expensive valuations. I am doing so because I believe that Zipcar (ZIP) is one of the cheapest stocks available and offers a 2x-3x return opportunity.
Over the last 12 months, Hertz, Avis Budget, and Dollar Thrifty had average fleet sizes of 630k, 430k, and 108k, and generated annual gross margin per vehicle of approximately $3,000, $3,700, and $3,500 respectively. Zipcar, by comparison, generated $7,400 in gross margin per vehicle with a fleet size of only 10k. Note that ZIP acquires cars at the about same price point, if not a little less, than the traditional rental car companies.
In spite of generating roughly double the gross margin dollars per vehicle and having a far superior growth profile, Zipcar trades at a TEV to gross margin multiple of only 3.7x, compared to an average of 8.6x for its traditional rental counterparts. I expect Zipcar's valuation over time to at least catch up to, if not surpass, its traditional rental competitors as the company continues to penetrate key cities in North America and Western Europe.
I use a gross margin multiple because ZIP has only recently broke even and is likely to experience significant operating margin expansion as its fleet expands from 10k to 20k and its membership base expands from 730k to 1mm+. EBITDA and earnings multiples are not useful for evaluating ZIP's valuation because the company has only recently achieved positive operating profitability.
How did Zipcar become cheap? The below two developments resulted in a significant deceleration in top line growth and a significant revaluation of ZIP's equity.
(1) ZIP's expansion into the UK has gotten off to a very rocky start. ZIP acquired StreetCar in April 2010. In the second half of 2011, they finally received the necessary approvals and were able to start rebranding the service and upgrading systems. The rebranded service grew only 6% in 1Q12 compared to the 20%+ secular growth that ZIP has enjoyed historically. Growth in the UK remains weak, but is showing very slight signs of improvement. Over a longer horizon, I expect growth in the UK to accelerate to ZIP's historical levels.
(2) Subscriber growth slowed significantly in 2Q12 following a failed marketing experiment with online radio advertising. ZIP has since fired its CMO and returned to tried and true marketing tactics. Management indicates that its most mature markets continue to grow at a rate similar to its younger markets, offering evidence that the company is not yet approaching its addressable market opportunity.
With a TEV of $251 million and 2012 revenue of ~$275 million which will generate ~$80 million of gross margin, I find ZIP to be trading at a very attractive valuation now that it has reached profitability. Competitors are years behind in building the network of cars and online/mobile rental system that ZIP has constructed. And, with only 730k renters, ZIP still has a significant penetration opportunity ahead of it.