News Analysis date published New: 
Tuesday, May 22, 2012 - 08:30
New Date created: 
Tuesday, May 22, 2012 - 08:40
New Date last updated: 
Tuesday, May 22, 2012 - 08:30

Forget the Innovators, Buy This Well-Funded Copycat Instead

Tuesday, May 22, 2012 8:30 AM

The business world is full of examples of innovators being left in the dust by imitators. Think Apple (Nasdaq: AAPL) was the first company to think of the tablet PC? Microsoft (Nasdaq: MSFT) first developed the idea a decade prior to the advent of the iPad. Think Mark Zuckerberg came up with the idea for Facebook (Nasdaq: FB) all on his own? As anyone who's seen The Social Network (the movie loosely based on Facebook's early days) can tell you, that isn't quite the case.

The point is, many, many times, the person or company who is first to the market with a new concept doesn't even approach obtaining the full value of the idea. In fact, many creative innovative companies fail, whereas the companies that copy the idea go onto great success.

In other words, being first to market isn't a criterion to successfully implementing the service, idea or product. Often it is the second or third generation of the innovation that changes the industry forever. Steve Jobs understood this. So did Mark Zukerberg and countless others before him.

It appears that this phenomenon of a copy cat company beating the innovator may be starting to play out in the highly competitive automobile rental industry.

There is no question that the traditional car rental model is outdated, cumbersome and makes things way more difficult for the consumer than they need to be. If you have ever rented a car, you know what a serious pain in the butt it can be. Not only do you have to get to the rental agency to pick up the vehicle, you need to fill out the same contract every time, have a large hold placed on your credit card, basically get interrogated by the rental agent, and return the vehicle to the same location you rented it from or face extra fees and costs.

Sensing this disconnect from what the market demands and the traditional car rental model, an innovative upstart named ZipCar (NYSE: ZIP) launched an on-demand car rental service. This model does not rely on a central location, but rather has cars scattered about in garages, parking lots and basically anywhere one can be squeezed in urban areas. Users pay a one-time membership fee and then are provided access to any of the vehicles in the program, which are then rented by the hour.

This is absolute brilliance, in my book. No more multiple forms to fill out, no more traveling to the rental agency and dealing with snooty clerks, no more being forced to rent for an entire 24-hour period if you only need the vehicle for an hour or two. Basically, ZipCar met the needs of the car-renting public in a way not done by the major rental agencies.

The upstart company has more than 500,000 dues-paying members, and sales grew by 25% last year with analysts calling for a 21% sales increase this year. Sounds great, right? Well, truth be told, ZipCar disappointed the market, plummeting more than 10%, as first quarter metrics showed only modest growth and a revised profit outlook. In addition, the company seems to be losing control of its expansion. Long-time users of the service have told me, in confidence, that the vehicles have become dirtier and sometimes even run-down feeling. Combine this apparent growth struggle with the barrage of upstart competitors in the space, and it paints a not-so-rosy picture for this innovative, original company.

Now, the large, traditional rental chains are getting into the hourly car rental business. This is where ZipCar faces its greatest threat. Hertz (NYSE: HTZ), which dipped its toe into the hourly rental business in 2008, has plans for a massive ramp-up of this division. Named Hertz On Demand, this new service will not require customers to pay an annual membership fee, and has plans to equip its entire U.S. fleet of 375,000 cars with on-demand technology by the middle of 2013.

The size of Hertz's plan dwarfs ZipCar. This type of competition has attracted short sellers to ZipCar's shares, with the number of shares held short increasing by 15% since January. Adding to the questionable outlook for ZipCar, only two major institutions, Greylock XII LLC and Yale University endowment fund, have substantial holdings in the stock. To me, that's a warning flag. Hertz, on the other hand, has 28 institutional holders, with only six decreasing their position size during the last quarter. Obviously, this has something to do with the size and history of the companies, but it still tells a story.

Looking technically at Hertz, shares have sold off during the past 12 days. This is mainly due to profit takers and weaker than expected consumer economic numbers in the United States spooking investors. However, shares remain within my trademarked value buy zone, signalling that the odds favor a long position right now.

Risks to Consider: While Hertz has a proven core business model and is moving into the future with its On Demand service, it will still be affected by competitors and the economy as a whole. Although Hertz appears to have the competitive advantage over any upstart because of its sheer size, other entrenched rental agencies are eyeing the hourly rental market. When Hertz's new roll-out meets success, expect a rapid increase in competition.

Action to Take --> My pull-back system has clearly triggered a buy signal for Hertz. The buy signal stays valid as long as price remains above the 200-day moving average, in the value zone. Should the price drop below the 200-day moving average, my strategy will switch to buying break outs above that level.

David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC owns shares of MSFT in one or more of its “real money” portfolios.