An Up-and-Coming Company Poised for Dramatic Growth

I was intrigued recently when two of our top analysts independently recommended the same stock at our annual investing conference. I spent the next five days obsessing over every detail I could find about this stock and concluded that it's even better than our analysts thought. Indeed, at the end of this article, I'll show how Zipcar (Nasdaq: ZIP  ) could hypothetically turn $6,975 into $1 million.    

The light went on
I'll be the first to admit that I never took Zipcar seriously. Like skinny jeans, I associated it with urban hipsters who used it to symbolize their social progress and, by implication, my social decay.

I was therefore surprised to learn that the executive chairman of Ford (NYSE: F  ) called it "the future of transportation." What I had failed to appreciate was that Zipcar isn't simply another car-rental company like Hertz (NYSE: HTZ  ) or Avis (Nasdaq: CAR  ) , but that its service may in fact redefine our relationship with the automobile.

For much of the 20th century, owning a car went hand-in-hand with the American dream of owning a home. And like owning a home, an automobile's expenses don't cease with its purchase, as you have to pay for a license, registration, insurance, fuel, maintenance, and taxes. With everything figured in, AAA estimates that the average American spends $9,279 a year on each vehicle he or she owns.

Source: 2010 AAA study, "Your Driving Costs." (Numbers represent an average of small, medium, and large sedans, SUVs, and minivans.)

Given the recent economic troubles, in turn, I was intrigued by Zipcar's claim that its members save $500 a month by not owning a car. Like Berkshire Hathaway's (NYSE: BRK-B  ) NetJets, which provides fractional aircraft ownership, Zipcar gives its members access to a fleet of vehicles dispersed throughout American cities and college campuses. As opposed to incurring the expenses associated with owning an automobile, its members simply pay by the hour or day when they need one. Zipcar then takes care of the rest, including gas and insurance. Under this model, Zipcar members purportedly save $6,000 a year!

Source: 2010 AAA study, "Your Driving Costs," and Zipcar's website.

If there's one thing I've learned …

Companies that save their customers money tend to make shareholders rich. Two classic examples are Wal-Mart and McDonald's. Although neither company invented a product, per se, both enriched their shareholders by figuring out how to sell products at a discounted price.

Costco (Nasdaq: COST  ) and Netflix are more recent examples. Indeed, Costco is so dedicated to low prices that it doesn't make a profit at all from the things it sells. Its profit comes entirely from membership fees, much to the consternation of Wall Street. And despite its recent troubles, Netflix gives its members access to millions of movies for less than $10 a month.

Zipcar is catching on
So I wasn't surprised to discover that Zipcar is rapidly growing its membership base.

Its domestic growth strategy takes a page out of Facebook's original playbook, using college campuses to acquaint young drivers with its services and thereby indoctrinate future Zipsters. It then expands into the surrounding metropolitan areas by purchasing conveniently placed parking spaces or entering into agreements with companies like Equity Residential, a nationwide residential real estate trust.

Zipcar's strategy has increased its membership base to 605,000 Zipsters, and it now operates in 15 major metropolitan areas and on 230 college campuses throughout the United States. And lest you think its growth is nearing an end, in the past two quarters alone its membership base grew by an average of 30% year over year.

Source: Zipcar's Q2 quarterly financial results.

What's the hypothetical potential?
The magnitude of Zipcar's success ultimately depends on the future size of the car-sharing market both here and abroad, as Zipcar also has a presence in the United Kingdom and Spain. Although the present size of the domestic market appears to be somewhere in the neighborhood of $500 million, Zipcar believes it will grow to around $3 billion. But if it reaches its hypothetical potential, according to my calculations, it could turn $6,975 in 372 Zipcar shares into $1 million.

Here's how. At present, there are 113 million households in the United States and 211 million household vehicles. There are, accordingly, 98 million households with more than one vehicle. If you replace these redundant vehicles with car-sharing memberships and also consider that our population continues to increase, then you wind up with somewhere in the range of 100 million potential new car-sharing members, 50% of which will sign up with Zipcar if it maintains its present market share. After factoring in Zipcar's average quarterly revenue per member and its target net profit margin of 27%, in turn, you end up with earnings per share of $142, and $164 if you include projected earnings from abroad. At a multiple of 16.4, this equates to a share price of $2,690, a vast improvement over its present $18.75. At this price, the 372 Zipcar shares you purchased for $6,975 are now worth $1 million.

Sources: U.S. Department of Transportation, Federal Highway Administration, 2009 National Household Travel Survey; Zipcar's Q2 financial results; Yahoo! Finance.

Granted, this is an extremely aggressive assumption. For example, the company wouldn't be able to command as aggressive profit margins in lightly populated rural areas where its services wouldn't be convenient. However, as a thought exercise, it does show the massive growth potential for Zipcar if the company can successfully market the cost savings its services represent for consumers.

So what should you do?
Whether you should buy Zipcar shares depends on what you're looking for in an investment. If you're looking for income, you're better off with companies such as UPS (NYSE: UPS  ) or CSX (NYSE: CSX  ) , two stable dividend payers with an established presence in the transportation and logistics industry. On the other hand, if you're looking for the one stock that could potentially singlehandedly finance your retirement, then I recommend you look closely at Zipcar.

Beyond Zipcar, I found great investing ideas in a free report by our in-house equity analysts that profiles five companies they hand-selected for The Motley Fool's own portfolio. It not only reaches across high growth but also includes a high yielder spinning out a 14% dividend yield. Grab this report while it's still free and available.

Fool contributor John Maxfield currently has no financial stake in any of the companies mentioned in this article. The Motley Fool owns shares of Costco, Ford, UPS, Berkshire Hathaway, Wal-Mart, and Zipcar. Motley Fool newsletter services have recommended buying shares of Ford, Netflix, McDonald's, Costco, Zipcar, Berkshire Hathaway, and Wal-Mart, creating a bear put spread position in Netflix, and creating a diagonal call position in Wal-Mart Stores. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (17) | Recommend This Article (37)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 07, 2011, at 11:55 PM, Guitarpack wrote:

    I've looked at this company too. So what's to stop Hertz or Avis or any number of car rental companies from renting out their vehicles on an hourly (they already rent them on a daily basis) basis? What's to stop any of these other companies from duplicating the same service Zipcar has?

  • Report this Comment On October 08, 2011, at 12:32 AM, JohnMaxfield37 wrote:

    Guitarpack -

    Great question.

    Obviously, there are not any physical/capital or regulatory entry barriers that protect ZIP's market share. And at least Hertz is exploring the market by signing a deal with the San Francisco Marriott Waterfront hotel. (http://www.fool.com/investing/general/2011/08/24/will-hertz-...

    As a result, ZIP's moat revolves around its brand and strategy, both of which it's done a good job at cultivating. In the first instance, its members are a dedicated lot (I don't know if you know any or not, but they swear by the company). And ZIP's strategy is really smart. It develops a relationship with a new bunch of captive customers every year at colleges around the country.

    In both regards, it's not that far removed from Facebook, although the network effects obviously aren't as robust.

    Beyond that, I believe the potential market for car-sharing in the future is enormous; large enough to split among a few companies. ZIP only needs a plurality to do extremely well given its current size.

    While the short-term is anybody's guess in light of what's going on in Europe, this is definitely a stock I'd keep on my radar until you're comfortable that the entire market's not going to take a bath at any given moment.

    John

  • Report this Comment On October 08, 2011, at 12:42 AM, catoismymotor wrote:

    When you look into your crystal ball what do you say the time frame would be for ZIP to reach it's full potential? Fifteen years? Twenty?

  • Report this Comment On October 08, 2011, at 1:25 AM, JohnMaxfield37 wrote:

    catoismymotor -

    I wish I knew what the time frame would be but I don't. What I do know, however, is that demand for ZIP's services are growing 30% year-over-year. And their member retention rate is something like 97%.

    Beyond that, ZIP saves its customers a lot of money; the importance of which in terms of future growth cannot be overstated. As a very general rule, companies that save people time and/or money do well. Some very much so. Look at Amazon, Costco, etc.

    So, yeah, if you're looking to flip a stock. This probably isn't the one. I do, however, like it for myself as a long-term buy and hold.

    While I could be wrong, I think it'll be huge.

    John

  • Report this Comment On October 08, 2011, at 3:20 AM, dag154 wrote:

    Your assumption is shocking - to say it nicely.

    You assume that, because people have said they like a product it will become a 20 billion market for 1 company.

    I am sure that all the competitors, both old and new will simply sit by and watch Zipcar grow huge and profitable. All the while going 'hooooo that's nice!'

    Any comparison to Amazon is inane (and insane). This company has 1 centralized market place which serves the whole country. Car sharing schemes require localized presence by nature. You set up 50, 100 or 500 cars in a town and hey presto! You are in business.

    It is a great idea and may take off with those who don't regard their car as an extension of their manhood or an expression of their social status, but the efforts will be localized and will be copied by other companies

  • Report this Comment On October 08, 2011, at 11:50 AM, JohnMaxfield37 wrote:

    dag154 -

    You're exactly right about the assumption I make. It is shocking. But ZIP's model is viable and its membership base is growing aggressively.

    I see alternative and less expensive means of transportation as a potential mega-market. On the one hand, you have the growing consensus around the need for environmentally-friendly transportation. And on the other, I suspect people will have less disposable income to spend on transportation as we churn through the unrealized losses on public and private balance sheets. When you finally factor in the continuing migration to urban areas, I'm left with the startling conclusion that companies that fill this void, could explode.

    That said, there will be competitors entering the market. And as I noted, there already have been - Hertz is placing cars at Marriott's San Fran Airport location. (http://www.fool.com/investing/general/2011/08/24/will-hertz-...

    ZIP's biggest challenge going forward, consequently, will be to cultivate a durable competitive advantage built around its brand and the growing ubiquity of its presence.

    Will they succeed at this? I don't know. but I want a piece of it if they do.

    John

  • Report this Comment On October 09, 2011, at 12:15 AM, kbmajmudar wrote:

    John,

    Nice write up and interesting these - but from an investment point of view - there is a huge and gaping flaw in your analysis - big enough to fly a 747 through. More of an omission than anything wrong with what you actually said.

    Even if your market size and growth assumption(s) turn out to be correct - debatable (at best) because due to competition it is possible (even probable) that zipcar's future market share could decline to well below 50%. But lets ignore this point and assume that you are right.

    The real flaw in your calculations is that you ignore the enormous amounts of equity capital that would/will be required to serve the giant market demand that you envision. This growth will not be even close to being self financing.

    Instead, ZipCar - if it is successful will have to raise tons of equity capital all along the way. This will dilute existing shareholders time and again. You should study what happened to Avis, Hertz, etc. from their founding days till now.

    I think you will find that overall these companies earned modest long-term returns for shareholders - even if they turned out to serve very large markets in the end b/c all the money went into buying more and more cars, facilities, or marketing the service to keep up with competitors. Once open a time, the idea of "renting cars" was just as new and exciting and had even more growth potential than zip car does today.

    You same line of thinking the growth is going to be exciting could have been applied to air travel or rail roads in the the early days with similar results.

    The best you can hope for is that as car sharing catches on and leads to top line growth, the share price may rapidly increase as investors bid it up to bubble levels (and this is not out of the question for a "sizzle" and "story" stock like Zip Car). Long-term, however, more of the growth will be eaten up by dilution of existing and early shareholders.

  • Report this Comment On October 09, 2011, at 12:49 AM, kbmajmudar wrote:

    So just to add to my point above, lets add a few numbers. As of the last quarter, Zip Car had approx 9,400 vehicles as compared to its 604,000 members that you cited above. This works out to a ratio of one car for every 64 members. While this ratio can change over time, lets assume that it stays relatively stable,

    Going back to your numbers, I think you assumed that Zip Car would eventually have 50 million members. Dividing 50 million by the ratio of 64 to 1, Zip Car's vehicle fleet would have to grow from 9,400 vehicles to 781,000 vehicles. Assuming a cost of around 20K per vehicle, Zip Car would need to invest a total of $15.6 billion to purchase cars between now and then (this assumes no vehicles depreciate and need to be replaced - clearly an unrealistic assumption).

    Now lets assume that cars can be purchased by ZipCar with only 20% down payment and 80% financed by a leasing company or finance company. This ZipCar would need to raise $3.1 billion in additional equity capital and probably another $500M to $1B to fund cumulative capital losses (as it has lost money since inception and probably will continue to do so for some time as long as it is in growth mode).

    Lets assume $4.0 Billion of equity capital needs to be raised between now and then total. Currently approx 32 million shares outstanding. Lets assume all this equity can be raised at a premium to today's price. Assuming $20 per share, that leads to another 200 million shares being issued. Then add is options etc. So your ending share count should be closer to 240 million shares outstanding.

    Now you should redo your EPS calculations based on this much higher number of shares. You will still get growth potential on an EPS basis, but much lower than you mentioned in your article. Now try to adjust your EPS numbers of the possibility and likelihood of competition driving down your ARPU (Average revenue per user) and also driving down margins and market share from what you assumed and you start getting closer to a real world likely scenario.

    BTW, I am an investment manager - check out my firm's food for though section at www.ridgewoodgrp.com to find out about our value investing philosophy.

  • Report this Comment On October 09, 2011, at 6:24 AM, memoandstitch wrote:

    ^- and this is just one of the many flaws. This article is so funny I forgot I was reading TMF (make more charts!). Honestly, TMF should stop publishing "amusing" articles. It's not good for your reputation and this community.

  • Report this Comment On October 09, 2011, at 7:57 AM, tradda wrote:

    How could you write this article without knowing what is going on with the competition? Hertz is already operating a car share program in major cities nationwide. It's a separate Division called "Hertz On Demand" offering - Cars by the Hour. 24/7. Convenient. Hassle Free. More importantly they're going to negatively impact the Zip business model because they don't charge membership fees, and their damage deductible is only $250, compared to Zip's $750 deductible. Beyond this, it's impossible for Zip to offer the customer service on breakdowns that can be offered by Hertz. Leaving this information out sounds alot like the author is cheerleading for Zip. FYI, for a couple of decades, I owned and operated one of the largest independant car rental companies in NYC, so I have a basic knowledge of the business.

  • Report this Comment On October 09, 2011, at 9:10 AM, JohnMaxfield37 wrote:

    kbmajmudar -

    Thanks for the comments!

    Obviously, there's no arguing that ZIP's in a capital intensive business. And as such, there is the distinct possibility that it'll need to raise new capital. The question is when and how much, both of which depend upon a number of assumptions as you pointed out.

    The biggest assumption, of course, is member growth. Because I addressed this in the article and preceding comments, however, I won't waste your time with it here.

    The second assumption concerns the member-per-vehicle ratio. At present, there are 64 members per vehicle, as you noted. This ratio, however, is much better than it previously was when ZIP's model focused more on daily rentals. And it's continuing to improve as ZIP experiments with the most productive mix of hourly vs daily rental. Consequently, it's realistic to assume that this number will continue to improve, thus decreasing the capital cost per member.

    Beyond that, it's up to ZIP to build a strong brand and get some pricing power. They're doing a great job of this on the brand front. They have high member retention rates and overall customer satisfaction. Whether they can maintain this as they scale and then translate it into pricing power, however, is a legitimate question.

    Although I believe ZIP's leadership has demonstrated an ability to do so, that could change. And if it does, so will my opinion. Until then, however, I believe ZIP is a good long-term play. (BTW: nice plug at the end!).

  • Report this Comment On October 09, 2011, at 9:14 AM, JohnMaxfield37 wrote:

    tradda -

    I appreciate the comment, particularly from someone with experience in the industry!

    Your point is duly noted. Take a look at my previous comments. We've written about Hertz's entry into the car-sharing market in the past: http://www.fool.com/investing/general/2011/08/24/will-hertz-...

  • Report this Comment On October 09, 2011, at 9:38 PM, sliderw wrote:

    Around 100 million households with more than 1 car each: This doesn't mean that all or most of them are potential customers of car sharing. In many households, both spouses work and have to drive 2 cars in separate commutes.

  • Report this Comment On October 10, 2011, at 10:17 AM, JohnMaxfield37 wrote:

    sliderw -

    I couldn't agree with you more.

    That said, there are large numbers of urban households with one car that may go down to zero cars by adopting car-sharing. The U.S. population, moreover, continues to grow, adding drivers to the rode every day. These two effects, in turn, could partially offset households that will continue to own two vehicles because car-sharing isn't a viable alternative or whatever.

    Thanks for the comment!

  • Report this Comment On October 10, 2011, at 2:04 PM, doc200 wrote:

    You miss the HUGE risk to this model, that an established competitor will develop an APP that allows/tracks hourly rentals of cars using exisitng car inventory and can do so WITHOUT a membership fee. ZipCar loyalty goes out the door if the market creates a free application

  • Report this Comment On October 10, 2011, at 2:18 PM, JohnMaxfield37 wrote:

    doc200 -

    Apps are unquestionably important.

    However, they're only a small piece of a much larger, capital-intensive operation that's thinly distributed to facilitate user convenience. In other words, car-sharing only works if you have many cars parked in many convenient places. A free app only tells someone where the convenient places with available cars are.

    Not to mention, ZIP does have an app. And while I have not downloaded it to a smart phone, it's supposedly pretty cool; Time magazine picked it as one of the 50 best iPhone apps for 2011.

    - John

  • Report this Comment On October 12, 2011, at 3:37 PM, trecer wrote:

    I'd like to be enthusiastic about this great company's potential for investors, and I do believe it's going to continue to be a very successful operation. But as someone who just moved to a city from a suburb, I think you have to take access issues into account in any investment thesis on zip cars. Here in the city where I live, there's really no rational reason not to switch to zip car, at least if you are not a daily commuter. With a (very) used car and infrequent use, my cost of maintaining a vehicle is only $2,000 a year, including gas, taxes, maintenance and insurance (and exluding depreciation, i.e., the fact that I would have to buy another car sometime soon). So I'm already quite a bit below that $5,000 average yearly vehicle cost. If I switched to zip car with the same usage patterns I have now, I could save $1,000 a year based on current zip car rates. So Zip is highly attractive even for someone with extremely low car costs to begin with, as long as they don't do too frequent driving. I'm in fact planning to get rid of my car at the end of the year and just use the zip cars (located just around the corner) for the 2-3 hours a week that I need them. Even relying on occasional rentals for out-of-town weekends, I will save quite a bit over keeping my own car, and particularly if and when I would have to purchase another vehicle.

    However, when I was living in the suburbs, I would never have used zip car. In the first place, with a daily commute of 7 miles, zip would not have gotten me to my job, since zip cars are not reasonable in cost for round trips over several hours duration. They're best for 2-3 hour runs. But in the second place, I would not have used a zip car because the car locations were too far to walk and it was not feasible to use public transport to get there (infrequent bus lines, too much walking involved).

    So when you assess what zip car's chances are going to be, you should really limit your analysis to--or at least skew it very heavily toward--the university campus and urban markets, and even more precisely to areas where one can preferably walk to the zip car location (when you add a $4 round-trip bus ticket to every zip car run, that significantly alters the equation). Sure, there will be some market in the suburbs, but it won't be nearly as vital as the inner-city market is. As soon as you have to take a bus to the zip car, or have someone drive you there, the model no longer works in financial terms. Zip car is building up impressively in the cities it operates in; very soon, nearly everyone in downtown areas of key cities is going to be able to walk to the car location. The same cannot be said of suburbs. In fact, it would be absolutely unfeasible to put zip cars within walking distance of most suburbanites.

    So this investment thesis needs to have its math re-done by excluding most of the suburbanite population from the equations. (May I add that I'm rather surprised that the urban/suburban distinction was not taken into account in the first place?)

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