On Jan. 17, the management team for online used car retailer Carvana (CVNA 5.24%) adopted what it calls its "Tax Asset Preservation Plan." In the investing world, such an action is more commonly called a "poison pill," because the plan is structured to prevent anyone new from owning too much Carvana stock.
Let's look at how this asset preservation plan works, why Carvana is making the change, and what it could mean for shareholders or potential shareholders.
The point of the poison pill
Anyone who follows Carvana's business knows it has substantial operating losses. These losses are a big reason why the stock price is down 98% from its all-time high.
Through the first three quarters of 2022, Carvana has used $585 million in cash from operating activities. And its net loss is approaching $1.5 billion.
By being unprofitable, companies like Carvana don't have to pay taxes -- businesses are taxed on profits. However, in some cases, companies like Carvana are allowed to carry over losses into other tax years if they turn a profit. And Carvana's management would very much like to save money this way if given the option.
However, Carvana won't have this option if there's a change in ownership. And according to the company's filing with the Securities and Exchange Commission (SEC), a change in ownership would be triggered if someone stepped in now and acquired at least a 5% stake in the company.
To prevent this from happening, Carvana adopted the poison pill. Basically, if anyone tries to buy a 5% stake, all other shareholders will have the right to acquire new shares of Carvana at a 50% discount. If someone were to acquire a 5% stake, the new shares would bring their stake back below 5%.
In reality, the very presence of Carvana's poison pill will likely be enough to prevent anyone from even trying.
What this could mean for shareholders
In recent years, there have been activist investors who have stepped up to floundering companies, purchased large stakes, and pursued changes. This includes Ryan Cohen, who jumped on stocks like Gamestop and Bed Bath & Beyond. Cohen's presence caused large spikes in the prices of these stocks, at least for a time.
Carvana investors shouldn't expect something similar with Carvana -- the potential short-term boost to the stock from an activist investor appears to be off the table.
For long-term investors, the business fundamentals were always more important than whatever might influence shares in the short term. And I don't believe Carvana's newly adopted plan does anything to alter the long-term outlook either.
The Tax Asset Preservation Plan would only help Carvana preserve cash if it turned a profit. But the company is still quite a long way away from that. Even though its revenue in the first three quarters of 2022 was up 19% from the comparable period of 2021, its overall gross profit was down 25% year over year. And this drop in gross profit is contributing to its deteriorating operating income.
CVNA Operating Income (TTM) data by YCharts
Carvana's gross profit could fall further in coming quarters. As a used car retailer, it was acquiring inventory over the last couple of years at record-high prices. But now used car prices are coming down, making it harder to move inventory. According to the Manheim Used Vehicle Value Index, used car prices fell almost 15% year over year in December -- a record drop.
To be fair, manufacturers may be struggling to move new car inventory as well due to higher interest rates. Higher interest rates make monthly car payments higher, decreasing what consumers can afford.
For example, Tesla just lowered the prices for some of its vehicles by up to 20%. There's debate over whether Tesla is facing demand issues or passing on operational efficiencies to consumers in an effort to gain market share. But either way, Tesla lowering the price of new vehicles impacts the used car market.
According to a report from CarDealershipGuy on Twitter, used car retailer CarMax responded to Tesla's price cuts by cutting prices of its own inventory of Teslas. It's the only logical choice.
Herein lies a potential problem for Carvana that shareholders should be aware of: Used car prices are already coming down. And if more manufacturers cut prices like Tesla, then used car prices could fall even further. This potentially could leave Carvana and other dealers with inventory that it will be forced to sell for little to no profit because of the high prices at which it was acquired.
I find this an increasingly likely reality for Carvana in 2023. I believe operating losses will grow as it lowers prices to move vehicles, making its future uncertain.
Carvana's Tax Asset Preservation Plan doesn't do anything to immediately improve the fundamentals of the business. And unfortunately for shareholders, the fundamentals do need to improve soon.
