Spruce Point Capital Releases A Strong Sell Forensic Research Opinion On Carvana Co. (NYSE: CVNA)
NEW YORK, Feb. 12, 2019 /PRNewswire/ -- Report entitled "A Countrywide Auto Stock Promotion" outlines how CVNA faces 50%-70% intermediate downside risk to approximately $9.60 to $16.00 per share due to the Company's expectations of unrealistic financial performance at scale, its use of aggressive and unsustainable tactics to boost earnings growth, its secretive reliance on closely-tied entities for financing and uneconomical subprime loan sales, and its premium, tech-like multiple compared to traditional auto dealers – its true comp set. The long-term future of Carvana, whose debt is currently junk-rated at CCC+, is heavily dependent on its ability to secure affordable financing for continued loans originations. If Carvana's access to capital begins to dry up, the stock could go to zero in a bear case scenario.
- Carvana Is An Auto Dealer, Not An Asset-Light Tech Company: Like any other large-scale used car dealer, Carvana buys used vehicles at auction and through trade-ins, reconditions them, maintains inventory, manages a logistics network, and arranges financing for customers. Carvana is targeting medium-term EBITDA margins >2x those of other auto dealers on below-average expected Gross Profit Per Unit (GPU). This suggests that management sees tremendous operating leverage in the business, and that it expects to achieve SG&A efficiency >50% that of CarMax (NYSE:KMX). Carvana's business model is simply not sufficiently different from those of other auto dealers to support such an advantage in scalability.
- Dubious Sources Of Gross Profit Per Unit (GPU): Carvana generates approximately 50% of GPU from 100% gross margin finance-related income – namely, auto loan sales and service contract commissions – versus <20% for CarMax. Underlying GPU on vehicle sales ex-finance income is >10% below the industry average ex-finance income GPU, and is less than half that of KMX. Meanwhile, Carvana engaged in questionable "riskless" refinancing maneuvers in Q3 FY 18 and Dec 18 which boosted Q3 GPU by another 7% by creating a new 100% gross margin finance revenue stream. We also find evidence that Carvana is failing to meet legal guidelines in its vehicle inspections, and is not transparent with customers about the terms of its warranties. Liability reassignment in the event of proven violations of consumer protection laws could, as a tail risk, wipe out the Company.
- Evidence of Closely-Tied Buyers Supporting Irrational Returns on Loan Sales: Based on our market intelligence, we believe management has made statements implying that it receives higher premiums on its sales of subprime auto loans than it receives on its sales of loans of superior quality to Ally Financial. We find evidence that the purchasers of its subprime auto loans are associated with Guggenheim Partners and its CEO, Mark Walter – a 9% shareholder in Carvana. Reports indicate that Walter and Guggenheim have been under SEC investigation for self-dealing, and that he and his associates may have financed their $2B+ purchase of the Los Angeles Dodgers in 2012 using captive insurance companies – entities to which they have since pledged personal assets, including Carvana shares, in response to allegations of improper management. Walter's strong incentive to keep Carvana afloat may be motivating him to purchase Carvana's subprime auto loans at a premium to market rates. Meanwhile, Ally recently reduced its bulk lending commitment to Carvana. We believe that, as Carvana grows and becomes increasingly dependent on third-party financing, it will be increasingly difficult for the company to identify counterparties willing to support its auto lending business at affordable rates, posing a serious threat to the business' continued operation.
- Multiple Valuation Approaches Point To 50%-70% Downside Risk At Best: Carvana is trading close to 1.5x 2019E EV/Sales on the belief that 83% YoY growth will shrink EBTIDA losses from -$189m to -$86m. Yet, not only are we skeptical of Carvana's ability to achieve its lofty sales expectations, but we also believe that losses will continue and be higher than expected. Carvana's multiple is greater than that of best-of-breed auto dealer CarMax. It is also richer than that of TrueCar, a profitable asset-light auto marketer that assumes neither car inventory risk nor subprime financing risk. Carvana should trade at discount to these peers to reflect its higher business risk and its lower quality management and governance. If valued at 0.5x to 0.75x NTM revenue, shares in Carvana would be fairly priced at approximately $9.60 to $16.00, implying 50%-70% downside risk. However, given its heavy reliance on financing to support its auto lending, together with the lack of unassociated third parties willing to provide affordable financing to the Company, shares in Carvana could easily be worthless in the event that credit markets tighten.
The research report can be found on our website at www.sprucepointcap.com and updates will be posted on twitter @sprucepointcap.
Spruce Point Capital has a short position in Carvana Co. (CVNA) and stands to benefit if its share price falls.
