Carvana (CVNA -0.48%) is working to change its business after the losses from its growth-at-any-cost approach resulted in Wall Street losing confidence in the company. That shift in sentiment can be plainly seen in the massive 95% or so stock price decline over the past year.
Worse, because of a heavy debt load, a clock is ticking on the company's efforts to turn sustainably profitable. The most recent push, a debt-exchange offer, is an example of how much trouble the company is in even though investors cheered the move.
The big picture
At its core, Carvana is simply a used car dealer. Auto sales can be done quite profitably on a large scale, as competitor CarMax (KMX 0.60%) has proven. But this is a capital-intensive industry, given that buying cars to resell costs a lot of money.
At the outset, however, Carvana wasn't just looking to sell used cars; it wanted to bring the used car industry into the internet age. Although it's not exactly a new business model, the company decided to start in the digital instead of the physical world, as CarMax has done. (CarMax sells cars online, but the driving force is really the company's dealership network.)
Image source: Getty Images.
Carvana achieved a great deal in a very short period of time, including introducing its eye-catching "car vending machines." The company sold around 2,100 used cars in 2014 and more than 412,000 in 2022. Its reach during that time went from just three markets to 316.
That's impressive, but it came at a cost. The company's long-term debt went from close to nothing to more than $8 billion. Worse, the unprofitable business is not covering trailing-12-month interest costs. This is not a sustainable situation.
CVNA Total Long Term Debt (Quarterly) data by YCharts.
Trying to get some breathing room
Management has shifted from a growth focus to a profitability focus. That includes aggressively cutting costs and pulling back from geographic expansion so it can concentrate on its most profitable markets. These are good moves, and the company expects losses to narrow, year over year, in the first quarter of 2023.
That, however, doesn't help Carvana on the debt front. Lenders will eventually want to get repaid, and a sizable chunk of debt comes due in 2025.
To strengthen its balance sheet, the company is proposing a $1 billion debt exchange. Investors on Wall Street got pretty excited by the news, pushing the stock sharply higher. But this is not a solution. At best, it is kicking the can down the road, and it requires that the company's lenders agree to go along.
That might not happen. The Wall Street Journal explained that "people familiar with the matter" said institutional investors that own 70% of the outstanding bonds aren't supporting the deal. Worse, even if Carvana does manage to exchange the $1 billion in debt, it might only reduce the company's overall debt load by a few hundred million. That's a drop in the bucket compared to the total debt load it's carrying. So even the best outcome isn't exactly a huge win.
Meanwhile, some key issues show just how desperate a move this is. For example, the first goal is to exchange near-term maturity that carries a rate of 5.625%. The exchange will extend the maturity but would carry a much higher 9% interest rate (though, admittedly, on a slightly smaller amount of debt). And the new debt can be paid in kind (also called PIK) for up to three years at 12%, which would allow the company to avoid interest expenses at the cost of increasing the amount it would owe. That's not something that financially strong companies need to do.
In addition to this, the debt being exchanged is unsecured, meaning there's less recourse in the event of default. The new debt would be secured by company assets. This, too, is something that financially strong companies don't have to do.
While Carvana is probably making the right choice in its debt-exchange attempt, this effort looks like an admission that the company needs more time for a turnaround than it currently has under its existing debt structure.
Best to watch from the sidelines
Although Wall Street got excited about the debt exchange, it's not the silver bullet it might appear. And then there's the not-so-small issue of turning the business sustainably profitable. All but the most aggressive investors should avoid Carvana.
