Carvana's Bet on Debt Restructuring

In this podcast, Motley Fool senior analyst Bill Mann and hosts Dylan Lewis and Ricky Mulvey discuss:

• Why Goldman Sachs is struggling in the consumer space and what its write-downs mean for real estate.
• How debt restructuring sent shares of Carvana up 30%. 
• Why investors might want to adjust their expectations for the car seller that's up 10x so far this year.
• The landscape of the world's largest car market.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on July 19, 2023.

Dylan Lewis: What's behind Carvana's 30% spike? Motley Fool Money starts now. I'm Dylan Lewis and I'm joined over the airwaves by Motley Fool Analyst Bill Mann. Bill, thanks for joining me.

Bill Mann: Hey Dylan, how you doing?

Dylan Lewis: I'm doing all right and I'm doing all right because we're in earnings season, our jobs are easy this week. We just get to talk through all these results from all these companies. It's fantastic.

Bill Mann: You better talk quick, I got work to do pal.

Dylan Lewis: We've got the latest earnings from Goldman Sachs and a surprise earnings release from Carvana. We're going to start with Goldman. We know that all of the banks tend to kick off earning season, and so we've been able to process both recent results from Goldman that came out this morning and also some of the results from some of the other banking institutions out there. For Goldman, a slightly different story, Bill, than what we've been seeing in some of the other parts of the industry, quarterly profit was 1.2 billion, down 60% from a year ago, and that amounted to three dollars per share, which missed expected estimates. What's the story here with Goldman's earnings?

Bill Mann: You always have to be a little bit careful when you're talking about financial institutions and their earnings because a lot of times what you're basing on, I think when a lot of people think earnings, they think of a cash return, and in the case of Goldman, they had two things that impacted their earnings very badly. Now, I'm not saying that these are less important, but they aren't necessarily cash-driven. The first of which was a massive write-down of their consumer banking segment. Which means that they only bought this in the last year and are already writing it down and that's nearly a billion dollars in a write-down. The other thing that happened is in their asset book, their investment book, they have to go through and occasionally revalue the investments that they have. They have a $14 billion real estate portfolio that's owned by Goldman and they wrote it down by about 8%, well, more than a billion dollars, that's a rough write-off. It's commercial real estate so we don't really need to go into the reasons why it's happening, we know why it's happening, but it is a big write-off for Goldman.

Dylan Lewis: It's sizable and I think it's probably the beginning of a trend that a lot of people have been expecting to see, Bill. In some ways, it's almost reassuring that we're seeing some of these write-offs because we've been hearing for a while that there's going to be some write-downs, there's going to be some adjustments in our expectations for commercial real estate, and in a lot of ways it hasn't materialized quite yet.

Bill Mann: Yeah, and that's one of the things that's interesting is that Goldman has their own asset book, but they also have a loan book, and they have about $27 billion in commercial real estate loans. They only charged off 0.3% of those loans in revaluation. Now, loans don't move as quickly as assets do, obviously because that's how leverage works, but I would suggest that there may be more pain than it is really hard to contemplate why there would be such a disparity between the two. Probably much more to come throughout the banking segment in terms of pain due to either backing or owning commercial real estate.

Dylan Lewis: Bill, you mentioned the consumer segment before, and this is a segment for Goldman that has been the subject of some internal turmoil and I think some disagreements among leadership, but I think one of the things that's interesting to me is we look at results from a lot of the big banks and financial institutions this earnings season, and the theme generally has been, they've been able to benefit tremendously from interest rate spread, and a big difference between what they offer consumers and their deposits and what they're able to do with that money once they own it. How come this segment has struggled so much for Goldman?

Bill Mann: Well, they got into it late. I think that it's really easy to think of Goldman as being the smartest players in the room, but actually, we have to remember over the last 14 years that the game has been borrowing money at almost zero and then lending it out at something north of zero, and capturing that spread, that game has changed a lot. I think that they probably found that because that base game play they changed, they needed to be better than what is out there in terms of service, in terms of things. Goldman didn't necessarily know how to do or have the know-how to do, so rather than doubling down, they are getting out of the commercial banking segment.

Dylan Lewis: Is it fair to say they were in a similar position to some of the regional banks when it came to those deposits where they had to be a little bit more competitive than some of the legacy big banks?

Bill Mann: I think that it's not quite the same thing, although they're all swimming in the same waters, a lot of times with the regional and smaller banks. That spread has come in the form of loans that have been in place for a long time, and so for them, the yield on those loans was below their cost of funding. In the case of Goldman, they weren't necessarily ramped up in the same way yet, so I think for them, the discussion is similar and yet different in the form of do we want to keep getting into this highly competitive business given that all of the base case assumptions that we made in terms of interest rates are no longer true?

Dylan Lewis: One of the other themes that Goldman seems particularly subject to that we've seen so far in 2023 is a lack of IPO activity and a lack of new businesses coming out there. This is a business that is generally known for its investment banking activity, and it seems like we're continuing to see the lack of IPO activity affect Goldman's results.

Bill Mann: People seemed awfully excited two weeks ago when Cava came public and it had the big pop like, maybe this will be the thing that reopens the IPO market. It's been slow and it has hit Wall Street across the board, 21,000 jobs have been eliminated across Wall Street firms in the last year, which is quite a number, that is a big number. An activity driven business like investment banking, I think that it's really hard for any bank, even one that is generally as well-run as Goldman, to make magic when there's just nothing going on. I get a little bit cynical about the IPO market because I think that too often it is sellers finding an advantageous time for them rather than buyers to engage in some activity, so I'm not sure that the Cava was as big of a bellwether as they might have hoped.

Dylan Lewis: We need to see a couple more names before we say IPOs are pack.

Bill Mann: For sure. It's interesting to me that we haven't seen a bunch of Artificial Intelligence names because that is how it has generally been. Remember, all of the companies that were like, hey, we're a sports drink company, no, we're a block-chain company, oh, no, we're dog whistles as a service. Whatever it is that was hot, but I think that at this point in time, probably in a post SPAC world where a lot of those are still floating out there looking for dance partners, it's really tough to get a company across the line in public these days.

Dylan Lewis: Speaking of hot, Bill, we also got an update from Carvana. This is a company that is a 10-bagger year-to-date and shares up 30% after the business reported earnings, and I should note reported earnings ahead of when it was originally scheduled. This was a bit of a surprise coming this week, they were supposed to be coming, I believe in two weeks. There was a lot to digest here, Bill. The price movement obviously caught a lot of people's attention, but it seems like the story with this result was the company's debt and the restructuring of the debt.

Bill Mann: They had a form of unsecured notes that were paying about 8% that were due in 2025 and 2027. They got an agreement with 90% of those debt-holders to essentially kick the can down the road just a little bit and they were being replaced by what are called payment-in-kind debt instruments where they don't have to actually pay any cash out for the next two years, and then after that, it will be 13%. Now, I don't know about you, to me, 13% money is really expensive money.

Dylan Lewis: It's credit card rate money.

Bill Mann: It's almost credit card rate money. To me, looking at what Carvana has done, we can look at the fact that the stock is up 700% since the beginning of the year, and we can look at the fact that it's up 30% today, it's good for shareholders. I think people need to recognize the fact that Carvana literally mortgaged the family's silver in order to be able to change the tenor of their debt. The debt is more expensive. They just are giving themselves a two-year cash cushion. This is not something that a healthy company does.

Dylan Lewis: One of the ways that they may be trying to operate their way out of this, Bill, is in addition to the restructuring of the debt, we also saw the company announce that it was going to be selling up to a billion dollars in shares to raise capital, given the massive swell in share price and market cap for this business. Is that what gave them the window to be able to pull this off?

Bill Mann: Yes. I would think that sorting out the debt would absolutely help because the type of offering that they're doing is called an ATM offering, which we all think of this being an automatic teller machine, but it's not quite that, it's an at-the-market offering. That means that they are not committing to do it at any point in time, they just have authorization over a period of time to sell what amounts to 35 million Class A shares of stock. At their leisure, they could do it all at once, they could do it over the course of time. They really did need to get the first element, which was would this debt overhang be taken care of before an offering like this was going to be anything other than a disaster for the company. You can see as we're recording, the stock has visited a ton of places today. It's about 32% up right now, who knows what it's going to be by the time today is over, but let's just say it's about there. This is happening even though they have come out and said they are essentially functionally raising their interest rates that they're paying and also engaging in a substantial amount of dilution. Good for Carvana, it is a move that will in fact help them. But the fact that the company is in this position, I think investors need to keep in mind.

Dylan Lewis: One of the things I wanted to ask you Bill is, we talked about Carvana on Friday's radio show and our colleague Matt Argersinger was talking about the short interest that follows this business. I believe as of June 30th, it was around 20% short interest and that was perhaps one of the catalysts pushing this company forward. You don't get to a 10-bagger just on short interest and short squeezes, I feel like there has to be some other stuff going on there. What do you see when you look at this business?

Bill Mann: I see a business that has been loss-making since it has been founded. There are a lot of companies that are losing money in the market. I see a business that is engaging in the business of selling used cars and it's a tough market. I've never been all that excited about Carvana as the business nor would I really suggest that although I'm sure that short sellers getting rid of their positions have helped move the stock. It's only been about two days worth of overall volume for the business for the shorts. For the shorts to be able to theoretically clear out their entire position, I don't know that it is that big of a thing. This is happening in a time in which a lot of the darlings from 2021 are up 4, 5, 6, 7 times in value since the beginning of this year. I think we're just simply in a period of time in which we are seeing the substantial amount of risk on activity by shareholders.

Dylan Lewis: Are you saying growth is back Bill?

Bill Mann: I'm saying, well, can you show me where Carvana's growing and I'll give you. [laughs] I am saying that people are willing to take a lot more risk now that the market has gone up than they were say at the beginning of the year.

Dylan Lewis: You got to level ball market. We always appreciate seeing the interest.

Bill Mann: Bring it up man.

Dylan Lewis: You have a growth and what we do is [laughs] we like to see some of those stocks do well too. Bill Mann, thank you so much. Did I cut out there?

Bill Mann: You did.

Dylan Lewis: Oh, sorry. I was just wrapping this up.

Bill Mann: I know. You got to, hey thanks Bill. Yeah, that was all fine. I'm just not going to be saying thank you back. You froze again? Nope, you're good.

Dylan Lewis: Sorry. Do we need to do one more of me, just wrap it up? 

Bill Mann: Yeah, let's get you guys you said thanks Bill and thank you from Bill and then I think we're good about thank you. You're going to allow me to be polite but it's great. Here we go. [laughs]

Dylan Lewis: Bill Mann, thank you so much for joining me today.

Bill Mann: Thanks Dylan, that always be an honor.

Dylan Lewis: Just one American carmaker is a top electric vehicle seller in China and just one Motley Fool Analyst is bringing you all the insights today. Ricky Mulvey caught up with Bill Mann to talk about the landscape of the world's largest Cava.

Ricky Mulvey: The United States is not the largest car market in the world, it's China. American car makers may be losing their foothold in the East. Bill Mann, I saw a headline in the Wall Street Journal and I'm just going to let you react to it. The headline is the following, "in China, the era of Western carmakers is over" is that true?

Bill Mann: No, but what good headline that is?

Ricky Mulvey: It sure is.

Bill Mann: It's such a good headline. It's bombastic, it makes a point that's not wrong but it's a little overstated. For the first time in China, local brands captured more than half of the market for new car sales and this is overall in the market, 54% and a huge amount of that and now a quarter of the overall sales of new cars in China, are electric vehicles. One of the fastest adopting electric vehicle markets in the world, I think Norway is top of the list then China. If you wanted to know what Norway and China had common, today is your lucky day.

Ricky Mulvey: I didn't even know, I wanted to know that but now I do. Also, with some grain of salt, this number comes from the Secretary General of the China Passenger Car Association.

Bill Mann: So it's good? Okay, move on. 

Ricky Mulvey: BYD is the top electric car manufacturer in China and they've gained market dominance. The people public of China's relationship with private enterprises though, is a little different from ours. What's the playbook for developing that homegrown market leader?

Bill Mann: The split that you think of in the United States in particular between private industry and the government doesn't really exist in China. Now obviously, these are all independent companies, but they are still part of an overall policy that is set by the Communist Party of China. There are actually 500 electric car makers in China right now. It's a staggering number. Now, we have seen here in the United States with computers, with the auto industry itself, with railroads, what happens when you've got a nascent industry like this is that everybody goes at it and then it will winnowed down to a few. That's actually happening in China now and you mentioned BYD, there's Nio, there's Xpeng, there's Li Auto. I think that's pretty much the largest of them and this is really the interesting thing when you think about China, you think of them as being in a perpetual form of catch-up when it comes to technology. But there was a really unique opportunity when we moved from internal combustion engines to saying that the future was electric vehicles, China wasn't behind. They were starting at the same exact place as nearly everybody in the world, maybe with the exception of Tesla in terms of going after this marketplace. They are very credible car companies but there is a little bit of a different footing in how they interact with the government.

Ricky Mulvey: Well, in the nascency, there were a lot of Western car makers that we're trying to enter into China, including Volkswagen and General Motors.

Bill Mann: I like how you just said that Volkswagen is American but continue that's great.

Ricky Mulvey: Oh sorry, Western carmakers.

Bill Mann: You may have said Western. The Germans will not be pleased with you.

Ricky Mulvey: I have a list of three, Volkswagen General Motors I was going to get Tesla in a sec. Foreign carmakers outside of China, including Volkswagen and General Motors. They had to create these joint partnerships though and then eventually China seem to not adopt those cars that we're entering their market.

Bill Mann: We can look at that and say that it is something that's unique to China, but it isn't. India has done the same thing with a lot of car companies, a lot of different industries coming into these markets. This is not actually uncommon. But if you think about what they were getting from the Western car companies, it's manufacturing expertise. It was not so much the IP of the electric vehicles. Now that they have that manufacturing competence and for whatever else you want to say about China, I think that you can say pretty definitively that they're pretty good at manufacturing across the board. What they are not getting from Western companies now is specific technology having to do with manufacturing electric vehicles.

Ricky Mulvey: China's developing this manufacturing base, but one Western and I'm pretty sure American Bill Mann carmaker  that has figured out the market opportunity. There is Tesla, it's among the Top 10 most popular electric carmakers in China. What Tesla figured out that these other Western carmakers did not?

Bill Mann: I'm not sure that they figured anything out. Although Elon Musk went into China and interestingly enough, Tesla has not had to do joint ventures. They've given away plenty. Otherwise in terms of pricing of the vehicles and things of that nature. But on the one hand, they were the most credible electric vehicle manufacturer in the world. China wanted them. Whereas every other company is playing catch-up and again, if you were to whatever else you want to say about, about Tesla, their technology was way ahead of everybody else. Warren Buffett recently and I think rightfully so, gave credit to Elon Musk for having such big audacious plans and ideas that the things that he was doing, we're always going to be incredibly risky and if they worked, they were going to have a huge payoff and this is one of those areas they had credibility in electric vehicles. They created credibility's for electric vehicles before anybody else. I think that that's been the reason that they have been on a different trajectory with every other Western company in China.

Ricky Mulvey: There is this shotgun-style approach to electric vehicles in China between 2016 and today, more than 50 new car companies have sprouted up. Half of the industry there is less than 10 years old. It seems they have this shotguns style approach that exists for a lot of industries that they tried to enter. One industry that the People's Republic of China's government would very much like to enter is microchips. But why is this strategy working for one but not the other?

Bill Mann: I think it has to do with the fact that they weren't playing catch-up to anybody for manufacturing and also specifically for electric vehicles. There is a big program right now in China that the Communist Party put into place and it was called made in China 2025, where they have really encouraged Chinese consumers and Chinese manufacturers to both make and consider localized products. Now, with the semiconductor industry, you are talking about an industry in which they find themselves perennially behind. The Western companies that are participating, primarily in Taiwan and in South Korea. But there are plenty of competent semiconductor manufacturers and they are simply ahead of where China is now. They haven't been able to catch up. You could say at least partially due to industry realities. There also have been embargoes and limitations put into place. Particularly a large Dutch company called ASML, has been restricted in what they can sell in China and without these technologies and without the building blocks for these technologies, it'll be really hard for China to catch up.

Ricky Mulvey: See, I liked how you just referred to Taiwan Semiconductors, a Western company.

Bill Mann: Fare. Right, I got you.

Ricky Mulvey: What Bill Mann? [laughs] I do think Taiwan Semis, it's one of the most interesting companies to watch right now because the PRC government would very much like to replicate what it does. I think that proves what a moat that company has is a chip fab.

Bill Mann: Yeah, for sure. It's not just the government of the People's Republic of China. Intel would like to be able to recreate what Taiwan Semiconductor is doing. Yes, they have what is generally described as about a 24-month technological lead over every other participant and everyone else is playing catch-up. There's a huge amount of trade and a huge amount of technology sharing between Taiwan and the People's Republic of China. You don't think about this from here. Ricky, in the West, I think we're going to get the nomenclature right this time. Where you think, they're on the brink of war so they don't cooperate at all. Taiwan is maybe still, but it certainly has traditionally been over the last 15 years, the largest investor in China and the reverse is true as well. Yes, they have found ways to both cooperate and also to have certain components and mostly what you're getting out of Taiwan Semiconductor is being fairly well protected from China.

Ricky Mulvey: Well, the market might not think so because when you look at these chip companies Taiwan Semiconductor is a company that Nvidia can't live without. One of these companies trades at more than 200 times earnings and the other trades around a grocery stores multiple.

Bill Mann: Yeah. I think Taiwan Semiconductor should immediately change its graphic from TSM to T and then capitalize the AI. One semiconductor and then see what happens.

Ricky Mulvey: I think you figured it out.

Bill Mann: I did. I will charge my usual fee for this. I mean, without being too negative about Nvidia, what you see for Nvidia is the market right now pricing out something that is promising to be so massive that if they hit it, Nvidia is going to do very, very well and it's kind of an unbounded opportunity. Whereas Taiwan Semiconductor as the world's largest manufacturer. Their path is seemed to be by the market to be a little bit more predictable.

With the slight exception of the fact that people believe that there may be a hot conflict between Taiwan and China. I'm not sure that I agree, but I would suggest that that probably puts a damper there on their valuation somewhat.

Ricky Mulvey: Bill Mann. Appreciate your time and your insight.

Bill Mann: All right, Ricky take care. 

Dylan Lewis: As always, people on the program may own stocks mentioned. The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening. We'll be back tomorrow.