Does Carvana's Debt Deal Set Shareholders Up for Losses?

The stock of Carvana (CVNA 8.79%) has been on a tear this year. The auto seller began the year staring bankruptcy in the face. But a debt restructuring deal has offered some relief and could even put Carvana on a path to positive free cash flow.

Nonetheless, the deal, which eliminates most of its near-term debt obligations, appears to be financed mainly on the backs of shareholders. Hence, those who own this retail stock are likely being set up for losses for three reasons.

Reason No. 1: The stock price

Carvana stock, which began the year at $4.81 per share, has already made 2023 gains of approximately 900% as of this writing.

Admittedly, investors could persuade themselves that Carvana is beginning an uptrend. Even after the increases, the price-to-sales (P/S) ratio is at 0.4, and it sells at an 87% discount to its all-time high. Also, Carvana believes it is on its first steps toward achieving positive free cash flow.

But it is unlikely to benefit from additional catalysts anytime soon. In the first six months of 2023, its revenue of $5.6 billion fell by almost 25% compared with the same period last year.

Thanks to expense reductions, the loss of $218 million for the period was less than the $498 million lost over the same time frame last year. But with the outlook pointing to third-quarter sales comparable to the second quarter, investors have no obvious reasons to expect further improvement.

Reason No. 2: Stock issuance

Moreover, the company has implicitly told shareholders it will reduce the stock price by issuing up to $1 billion worth of additional shares. Even at its recent price of $45 per share, the company could increase the shares outstanding by up to 22 million, significantly diluting existing shareholders. The share count, which stood at just under 107 million before the debt deal, has already risen above 111 million.

With more shares available, it will take a higher level of shareholder interest to bid the stock price higher. It could also significantly depress the price if investor sentiment turns more negative. 

Reason No. 3: A weakened balance sheet

An investor must question whether the debt deal improves the balance sheet or merely offers some temporary relief. As of the second quarter, Carvana held just under $8 billion in long- and short-term debt, a concerning situation when the stockholders' deficit, or negative stockholders' equity, exceeds $1.4 billion.

Under the deal, bondholders are trading debt due in 2025 or 2027. This deal will postpone interest payments due over the next two years, saving Carvana around $430 million over that time frame.

Source: Carvana 10-Q, Q2 2023.

In exchange, bondholders will receive new notes due later but at higher interest rates, likely at a rate comparable to what it pays on its 2030 senior notes. If Carvana fails to service the existing debt at that time, bondholders could seize the company's assets.

This buys time for Carvana to turn its business profitable, and the bonds are callable, meaning the company could pay back the debt before the higher interest rate kicks in. But if its plan to save itself fails, the company faces a high probability of bankruptcy.

Avoid Carvana stock

The debt deal has undoubtedly delayed a potential financial reckoning. Unfortunately, the recent gains likely limit further upside in the stock, and by the company's implicit admission, it will devalue current shares by increasing the share count.

Also, while the debt deal offers some temporary relief from interest payments, the company appears on track to end up with more debt at significantly higher interest rates. This does not bode well for shareholders, who sometimes suffer under such deals.

Could the company save itself? Perhaps. But one way or the other, investors will pay a price, making Carvana a stock they should probably avoid if possible.