Carvana Co. (CVNA, Financial) has been struggling with debt for years, thanks to its aggressive growth strategy that relied heavily on loans to fuel expansion of its used car business. The company’s debt problems have only increased over time, with its long-term debt balance more than doubling in 2022 to $6.57 billion.
Failed attempts and a surprise deal
After multiple failed attempts to cut a deal with creditors, Carvana looked to be on the verge of collapse. Thus, the company’s announcement on June 19 that it had made a deal with its noteholders came as a surprise to many investors. Carvana’s shares surged on the news.
Yet, while Carvana’s latest debt deal has managed to buoy investors’ spirits, the actual content of the deal is far less exciting. Indeed, it appears the company has done little more than buy itself some time while leaving the core issue of its unsustainable debt load unresolved.
A surprise reprieve
After its attempt at a $1 billion credit swap fell apart in June due to lack of investor interest and opposition from its creditors, it seemed to many like the writing was on the wall for Carvana. The deal was dubious at best to begin with; S&P Global called it “tantamount to a default” in a scathing note in March.
Yet on June 19, Carvana announced that it had effectively resurrected the deal. The final terms of the proposal involve swapping outstanding notes for new notes secured by company assets. Through the deal, the company will eliminate more than 83% of its 2025 and 2027 unsecured note maturities, cut its mandatory cash interest expenses by more than $430 million per year for the next two years and reduce its total debt outstanding by more than $1.2 billion. The reduced cash outflows will be achieved through a payment-in-kind arrangement for the first two years.
Management's perspective
Unsurprisingly, Carvana's management team wasw eager to celebrate their apparent success. In the statement announcing the debt deal, Chief Financial Officer Mark Jenkins hailed it as a major achievement:
“The strong performance of our business in 2023 presented an opportunity for an impactful and win-win transaction for Carvana and its senior unsecured noteholders. This transaction significantly increases our financial flexibility by reducing our total debt, extending maturities, and lowering near-term cash interest expense as we continue to execute our plan of driving significant profitability and returning to growth.”
A temporary bandage
At first glance, one might conclude that Carvana has managed quite a financial coup. However, a closer look reveals the deal to be less a cure than a temporary bandage.
Carvana’s press release announcing the debt deal excluded many key details. The full terms, released separately, reveal a number of concerning elements. Most notably, the short-term cash flow benefits come at the price of a higher interest rate on all debt. In other words, Carvana has succeeded only in delaying cash outflows and stretching maturities. The deal will also see the company conduct a dilutive stock offering, selling 35 million shares at the market price.
Analysts' take
Analysts were less than enthused about Carvana’s revived prospects. S&P Global was particularly scathing in a note. It said:
“The proposed transaction will somewhat extend Carvana’s maturities and offer significant cash interest cost savings due to the PIK option. However, we view the offer as tantamount to default because we believe lenders will receive less than originally promised. The principal amount of the new securities offered is less than the original par amount, the new maturities extend beyond the original dates, and the timing of payments will be slower by adding a PIK feature.”
Unresolved business model issues
The PIK aspect of the deal will allow Carvana to preserve cash, but will do little to solve its underlying economic issues. Ultimately, the deal has done little to alleviate the company's extreme financial vulnerability, a fact noted by Bloomberg Intelligence’s Joel Levington on July 21:
“Carvana hasn’t proved its operations can consistently generate cash. The recapitalization gives them room to work on performance, as it heads possibly into an economic recession without the stability of after market sales that many of its peer auto retailers have.”
Financial statements reveal
While Carvana has claimed the deal will allow it to refocus on sustainable growth and achieving profitability, the issues with its business model have not been resolved. This is evident from the company’s own financial statements. In its second-quarter earnings report, which was released alongside the debt deal announcement, Carvana reported $2.97 billion in revenue, down 23.6% year over year. While its net loss of $58 million was a significant improvement, the company remains unprofitable.
My take
My takeaway from Carvana’s deal with its creditors is that it has bought the company a little time to figure out a long-term strategy for achieving sustainable profitability, while giving no indication as to how it might achieve that feat.
As things currently stand, Carvana has not won a reprieve, but merely a stay of execution. The company’s debt problems are not new. Its long-term debt increased by 83% in 2020, by 98% in 2021 and by 105% in 2022. Debt has fueled Carvana’s growth from the start, and I do not see that changing anytime soon.
Final thoughts
Carvana’s management team levered up the balance sheet in a desperate effort to grow at all costs. The price of that growth has started coming due. While it can kick the can down the road for a while, eventually it will have to pay the piper. Betting on that same management team to fix the mess they created seems unwise, in my assessment.
