Investing in any recent initial public offering (IPO) carries one obvious risk: You may be buying as insiders and underwriters are getting set to sell. By federal law, these folks are "locked up," prevented from selling stock for 180 days after the IPO. When they can finally turn their pre-IPO stock into cash, they rarely hesitate.
So as soon as Zipcar's (NYSE: ZIP) backers and founders could sell shares in mid-October, they didn't hesitate, unloading more than 3 million shares by year's end. As a result, an IPO that closed at $28 on its first day of trading last spring now trades below $15.
That's a fresh opportunity for the rest of us, as Zipcar still has the makings of a solid growth story. It's also why it will be the next addition to my $100,000 Real-Money Portfolio.
For the uninitiated, Zipcar rents cars and vans to its members by the hour or by the day. The service has quickly caught on with younger urban consumers in the United States and Europe as a youthful brand that is spoken of in the same context as JetBlue (Nasdaq: JBLU) and Apple (Nasdaq: AAPL). Members are known as "Zipsters" (which is painfully close to Hipsters). Sure, you could rent a car from Hertz (NYSE: HTZ), but a Zipcar membership is much cooler, more flexible -- and quite cost effective.
Zipcar got its start in 2000, right as the dot-com boom was ending. Attracting funding and getting the business off the ground took time: The company needed seven years to get to 180,000 members. Three years later, that figure exceeded 600,000 members.
To be successful, Zipcar needs to be sure that its 10,000 cars stay as busy as possible (known as utilization). When Zipcar penetrates a new market, utilization is typically below 50%. As a market matures, that figure moves up to around 65%. The difference is crucial: Zipcar likely loses money in new markets and only makes money once a market matures. (Utilization is about 15 percentage points higher on weekends, and is also much higher in the June and September quarters.) Notably, Zipcar's steady expansion into new immature markets explains why the company is still unprofitable. (Although the company says 10 of its 15 first markets are now profitable).
It's hard to speak of any of Zipcar's markets as truly mature. Even in places like Boston or New York, membership continues to rise at a double-digit pace as more consumers finally decide that owning a car in a parking-constrained city isn't worth the hassle.
At first blush, this may seem like a business with few barriers to entry. For example, Hertz began a similar service in 2010 (and now has 70,000 members), and a half-dozen similar firms in the United States are in operation. Still, Zipcar controls more than 70% of the U.S. market.
With a major presence in only a handful of major cities such as New York, Boston and Washington, Zipcar has only scratched the surface. Worldwide, there are more than 400 cities with at least 1 million people. That's likely the minimum size market for Zipcar to get the utilization it needs. Zipcar aims to enter two to three new cities each year. Although most of the efforts have focused on North America recently, a steady push into the U.K. and Spain highlights management's expectations for the next leg of growth.
Analysts had been expecting Zipcar to finally become profitable at some point during 2012, but a surprise profit in the third quarter of 2011 moved up that timeline, thanks to higher fleet utilization. The December and March quarters are seasonally a bit weaker, and investors may have to wait until the second quarter of 2012 to see Zipcar's profits in the black again. Analysts think Zipcar will make $0.10 to $0.15 a share this year, reversing a likely $0.35 to $0.40 loss in 2011.
Frankly, focusing on profits is a mistake. Indeed, this company will be generating negative cash flow for the next few years, regardless of the appearance of actual profits under GAAP rules. The company's rapid expansion plans will rely on every dollar coming in going right back out. Instead, investors need to focus on sales growth, fleet utilization, customer churn rates, EBITDA margins and other metrics. Luckily, the company delivers all that and more each quarter. The key to this investment: that those metrics keep moving in the right direction.
On a most basic level, the fact that sales are likely to grow around 25% in 2012 to around $300 million is the primary focus right now. (The current consensus forecast of 20% growth appears too conservative.) I base that assumption simply on expected further growth in existing cities along with the entry into a few new cities in 2012. Sales could keep growing at a 20% to 25% pace into the middle of the decade, which is why this stock appeals to me. By 2013, the higher sales base should really translate into clear operating leverage on a per-city basis and across the company's entire income statement.
The Downside Protection -->To be sure, this stock does not enjoy the downside support my other portfolio holdings possess. Shares could easily move toward the $10 mark (from a current $15) if growth materially slowed and 2012 top-line gains came in below that 25% target. Still, Zipcar's $600 million market value appears to discount all of the funds that have gone into this business model. If growth hit a speed bump, then other firms may look to offer at least $600 million for the existing platform of business.
Upside Triggers --> So how do you value a business that has fast-rising sales but a low level of current profitability? Enterprise value-to-sales is likely the best metric. You should use this metric when a company's sales base isn't quite large enough to show what peak margins will look like. That figure currently stands below 2, but should be closer to three or four, especially in light of the solid sales growth projections. In fact, that's how this stock was valued last spring, well before the prospect of selling insiders was digested by investors. As that selling winds down, I expect that multiple to rebuild, and shares to move back up above $25 -- at least 66% higher than current levels.
Action to Take --> 48 hours after you read this, I will buy 400 shares (or roughly $6,000 worth) of Zipcar. That position could grow in size if upcoming quarterly results are solid and shares remain in the mid-teens.
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