Yesterday, we were in Beijing at the Great Hall of the People attending the kick-off party for UAA’s new rental car business called China Auto Rental (CAR) – it was a very impressive turnout and a fantastic event.

Attending the ceremony was a generous helping of government officials, VC types (e.g. Gobi, KPCB, Legend), strategic partners (e.g. Cross Country Group, PICC), and several CEO’s from NASDAQ listed Chinese companies (e.g. Baidu, Air Media, Focus Media, KongZhong). And in the end, when the last bottle of Dynasty wine was emptied, consensus was that the rental car business in China is the next investment tsunami and CAR looks poised to be at the forefront.

Mike and Howard (CCG); Charles (UAA); Adam (Ymer)

In less than 2 months, CAR has grown its rental car fleet from zero to 150 cars operating out of 11 cities/airports – Charles Lu, CEO of UAA, expects to increase the size of his fleet 6x to 1,000 and double the number of cities/airports to 22 by year-end 2008.

This may sound like a tall order given the fact UAA just sat down at the table however, in many ways, UAA has been working towards this day (whether Charles and his team knew it or not) since 2006 – for example, consider how close the following UAA services track to basic rental car offering:

(1) UAA is already the leader in emergency roadside assistance with over 95% nationwide coverage for it 2.2 million plus members;
(2) UAA operates a 1,400 person call center staffed by both customer service representatives and direct marketing professionals;
(3) UAA has a co-branded credit card/membership card with China Merchants Bank (i.e. allowing not only for credit card processing but also data collection/mining);
(4) UAA is a leading auto insurance brokerage (i.e. can offer customized insurance packages to renters); and
(5) UAA branding is one of the most widely recognized and trusted names in China’s automotive services industry.

By some estimates China’s domestic demand for rental cars will reach 300,000 units to 400,000 units by 2015 on the back of sales revenue of US$2.3 billion. Even if we slice market estimates by 30% you’re still talking about a US$1 billion plus rental car industry however the challenge (for an operator) is cost effectively scaling and sustaining a business long enough to reach critical mass – and this will require a war chest of capital.

Our read is – CAR is either going to be a massive success or an epic disaster as there really isn’t any middle ground with this one. Don’t get me wrong, I’m certainly not getting all aggro and negative on CAR but, yeah, this is an extremely capital intensive and asset heavy business which, unlike a Web 2.0 application feeding off Facebook’s community juices and API, CAR must build and operate a national service platform from scratch.

With that said, as noted above, CAR has the benefit of leveraging UAA’s existing network and platforms – and this certainly gives CAR the leg up over its competition, and thus dramatically improving the likelihood of success.

Still, investors can’t overlook the fact that we’re in uncharted waters with an unproven model (“…does anyone have a machete I can borrow, I need to blaze a trail…”) and it’s bound to get a little scary. So, a simple way to actually measure the degree of difficulty facing Chinese rental car operators is to consider the performance of incumbents.

Over the past 5 years, there have been, of course, several attempts to enter this market – most notably from the majors (e.g. Hertz and Avis). Crash and burn, anyone?! Indeed, Avis Europe’s joint venture with Shanghai Automotive Industrial Sales Co. (Anji Car Rental Corp) has had a bit more success than Hertz in keeping their management team out of trouble and on the path of truth as witnessed in Hertz’s February 2006 announcement that the company was terminating its partnership with China National Automobile Anhua International Trade Co. According to a Forbes article,

“…the decision to part company with the local firm was made because Anhua lacks capital to run the business and has failed to monitor the operations of its franchised branches...”

Obviously, part of the reason Western firms have found it difficult to profit from China’s rental car segment is poor execution but the bigger issue is that the operations are running off business models that are heavily influenced by their western linage in a not so western environment. (We’re getting flashbacks of the Groupe Danone and Wahaha spat.)

In spite of this rental carnage there is another domestic company that seems to be making some in-roads into the rental car universe – namely Shenzhen based Top One. Established in 2006, Top One received Series A funding from SIG and Hong Kong Maida Fund. According to sources, Top One’s rental fleet contains around 300 to 350 units operating out of about a dozen Chinese cities – mindful that the company has been at it for over two years – we’re scratching our heads wondering why they’re not bigger – indeed, is this an execution problem, a market acceptance issue, or a lack capital?

To wit, we’re guessing it starts with the fact that the barriers to entry are substantial – unlike in the US or Europe where there is already a deeply embedded car culture and credit card culture, pre-existing networks and services providing emergency roadside assistance, extensive credit histories on consumers are readily accessible, Lo-Jack, and a significant secondhand car market where rental agencies can hock their 9-month old fleet vehicles – in China, not much of this actually exists, and thus an operator must build from the ground up – all things being equal, in the end, it will simply come down to execution (which, given the local/homegrown nature of CAR and Top One, is slightly different from the hiccups Western operators have encountered).

In many ways, if Top One had made more progress (unquestionably validating the model) this opportunity would be flooded with “me-too” players – the fact that UAA and Top One seem to be the lone domestic gunmen makes this one of the most tastiest investment opportunities in China – indeed, we’ve got a drag race on our hands.

Better buckle up!