Online used car retailer Carvana (CVNA 8.79%) is taking advantage of a soaring stock price to temporarily alleviate some pressure from its mountain of debt. Along with its second-quarter report on Wednesday, the company announced a complex debt restructuring deal it struck with most of its noteholders.
Carvana's press release only tells part of the story. The company plans to eliminate 83% of its debt that matures in 2025 and 2027, which largely eliminates the next two maturities, while reducing its overall debt by $1.2 billion. For the next two years, annual cash interest expense will be reduced by about $430 million. The company is on pace to pay around $600 million in interest this year, so that's a big deal.
That all sounds great, until you look at the company's filing with the Securities and Exchange Commission that lays out the full details.
Kicking the can down the road
The agreement with noteholders has multiple parts. Carvana will issue at least $350 million in new equity, and potentially more. Shares of Carvana have rocketed higher this year, giving the company an opportunity to cash in and improve its balance sheet. Carvana will also commence a cash tender offer for some of its notes that mature in 2025. The total face value of those notes is $500 million.
The meat of the agreement is the exchange offer with existing noteholders. Carvana will exchange up to $4.376 billion of its existing unsecured notes, which have maturities ranging from 2025 through 2030, with new senior secured notes. This is where it gets complicated.
These new notes will come with an option for Carvana to pay interest in the form of additional notes for the first two years. So when Carvana says that its cash interest expense will be reduced for the first two years, that's true, but the company must hand out additional debt to make it happen. And after that two-year period, cash interest payments resume.
There are three sets of new notes:
|
Note |
First year interest |
Second year interest |
Third year and beyond interest |
|---|---|---|---|
|
$1 billion, matures 2028 |
12% payment-in-kind |
12% payment-in-kind OR 9% cash |
9% cash |
|
$1.5 billion, matures 2030 |
13% payment-in-kind |
13% payment-in-kind |
9% cash |
|
$1.876 billion, matures 2031 |
14% payment-in-kind |
14% payment-in-kind |
9% cash |
Data source: Carvana SEC filing.
In the first two years after these new notes are issued, Carvana will be making interest payments in the form of additional notes at elevated rates. In year three and beyond, interest payments revert to cash at a 9% coupon rate.
A temporary debt reduction
Carvana will pay substantially less in cash interest in the two years following this deal, but it will pay a high price for this relief. The deal will reduce Carvana's total debt by $1.2 billion initially, but the interest payments in the form of additional notes will eat away at that reduction. After two years, the total face value of this new debt will rise from $4.376 billion to somewhere around $5.6 billion if the company makes all in-kind interest payments. In other words, the debt reduction is temporary.
In the third year and beyond, Carvana will be paying 9% cash interest on that $5.6 billion of debt. That's roughly $504 million in annual cash interest payments, plus the interest payments from any existing debt that is not exchanged in this transaction. Carvana's cash interest payments may be slightly less than what they are now, but it's not clear if that will be the case.
This deal is particularly bad for shareholders because these new notes are secured by Carvana's assets, while the old notes that will be exchanged are unsecured. This reduces the risk for lenders, and in the event of bankruptcy, shareholders will likely come out worse than they would have otherwise.
This agreement buys Carvana time. The company is still unprofitable, reporting a net loss of $105 million in the second quarter. The cash flow situation will improve in the next two years as cash interest payments are reduced, but after two years the company will be back to having the same problem it has now: Too much debt and too-high interest payments.
Carvana has sidestepped a liquidity crisis and largely eliminated the risk posed by debt maturities over the next few years. Now it needs to prove that its business model actually works. Given the company's track record, that's a tall order.
