Even After Its IPO, Zipcar Faces a Bumpy Road Ahead

I'll say one thing for Zipcar's IPO: The Zipcar prospectus is the first I ever remember that started off with a full-page image of two young women, wearing bikinis and modishly super-sized sunglasses. The idea is that they are Zipcar customers -- young, hip and in need of a hybrid car for an afternoon trip to the beach.

Zipcar calls those customers "zipsters." There are 400,000 of them, and they brought in $131 million in revenue to the ten-year old company, which makes the company a pretty nice success story for a recession-plagued decade. So, bikinis or no, Zipcar is driving into the public markets under the aegis of some of Wall Street's biggest underwriters: Goldman Sachs (GS) and Morgan Stanley (MS).

Those underwriters alone will be enough to entice some investors into buying shares in the Zipcar IPO (it's listing on the Nasdaq Global Market under the ticker ZIP). But the IPO market is mired in a pretty bad slump, and Zipcar's launch may be an effort to jump-start its batteries again. The problem is that Zipcar is a money-losing operation that could face growing competition in the future.

Zipcar has established a strong lead in a market it pretty much created: car sharing. Not car rentals, with their daily or weekly rates, but sharing, just long enough for an errand or a day trip. In cities like San Francisco, Boston, Vancouver and Chicago – where car ownership is expensive, public transportation is functional and populations are dense – Zipcar will rent out popular models like Honda (HMC) Civics and Toyota (TM) Priuses for between $5 and $10 an hour.

Driving in Reverse, Cashflow-wise

I've never driven a Zipcar, so I can't speak to their IPO from the invest-in-what-you-know school of thought. But I have taken a drive through Zipcar's prospectus, and there are a few potholes hidden in it that might present its investors with problems if they're overlooked.

For starters, Zipcar has an accumulated deficit of $56 million, including a net loss of $34 million in the past three years. Most of the expenses behind those losses went toward building fleets of shared cars, and for marketing in the 13 metropolitan areas in which the company operates.

In 2009, losses decreased relative to previous years. Last year's net loss totaled $4.6 million, compared to $14.4 million in 2007 and $14.5 million in 2008. But in the first quarter of 2010, Zipcar posted a loss of $5.3 million, which was larger than the loss of $3 million it posted in the first quarter of 2009.

Zipcar said the bigger loss last quarter was driven by an increase in fleet and administrative expenses. As new markets mature, the company says, it benefits from economies of scale, and uses cash flows from its more successful markets to help finance its entry into newer markets.

But operating cash flow in the most recent quarter was a negative $3.7 million, compared with a negative $2 million in the same quarter a year earlier and positive cash flow of $6.4 million for all of 2009.

Carrying a Big Load of Debt in the Trunk

Zipcar also faces long-term debt of $26.9 million and has access to another $10 million from which it can borrow. These loans bear interest rates ranging from 11.4% to 16%. Last year alone, the company paid $2.5 million in interest expenses. The company will repay $4.1 million in loans this year, plus $7.5 million in 2011 and $8 million in 2012.

An undisclosed amount of the money raised in the IPO will go toward paying down this debt, as well as more debt it incurred from Goldman Sachs. In May, ZVF -- a Zipcar subsidiary that buys cars and leases them to Zipcar -- opened a $70 million debt facility through Goldman.

There's an interesting thing about this credit facility. A disclosure in the prospectus noted that Goldman could end up receiving more than 5% of the money raised in the IPO, on top of underwriting fees, which could qualify as a conflict of interest under NASD rules. So the Zipcar IPO could end up being another one of those fishy deals to help Goldman make money.

Zipcar's debt isn't onerous, but it does place it at a certain disadvantage to larger companies that can build out car-sharing operations more easily or that can borrow money at more attractive rates. Which companies? Hertz (HTZ), for example, which offers a membership-based car-sharing service called Connect in Manhattan and plans to expand it in Paris and London. Like Zipcar, Hertz Connect offers trendy models like the Prius and the Mini Cooper.

Zipcar has done a good job of building up a loyal membership in 13 metropolitan areas and sees opportunities in nearly 80 others around the world. Its purchase of London-based Streetcar shows it's serious about expanding. Zipcar may well arrive successfully at that distant destination, but investors who tag along for the ride should be ready for some bumpy terrain ahead.