Carvana Faces Cash Crunch From High Debt, Rising Interest Rates

Caravan Co.

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the used car dealer that was a winner of the pandemic, is rushing to conserve cash as once-abundant financing options dry up and business deteriorates.

On Friday, Carvana laid off about 1,500 people, its second round in six months. Its weak finances mean fundraising will be difficult and expensive, and it could run out of money within a year, analysts say.

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Few companies have been hit harder than Carvana by the rise in interest rates. The company’s interest expense nearly doubled earlier this year when it paid to get financing for an acquisition. Its cost to finance car purchases has risen by three-quarters this year, and some of its real estate has lost value. Meanwhile car buyers are holding off on purchases in the hope that rates will drop.

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In a memo to Carvana employees announcing the layoffs, CEO Ernie Garcia III blamed an uncertain economic environment that he said has been particularly tough on fast-growing companies that sell products affected by higher interest rates . “We failed to accurately predict how this would all play out and the impact it would have on our business,” he said.

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The company said it has millions of satisfied customers, and disrupting the automotive industry is not easy. “We have seen many e-commerce companies perish early in their journey only to become market leaders. We plan to follow suit,” said a spokesperson. Earlier this month, Carvana executives said cash flow and profitability are the strategic focus now.

The WSJ’s Ben Foldy explains the factors that helped drive Carvana’s growth and why investors are now questioning its future. Illustration: Preston Jessee

Carvana has become very popular among car buyers, with strong advertising and no-frills cars delivered to their doors. Investors bought in, sending the shares up more than sixfold. The stock is down more than 97% from its peak last year. Carvana’s bonds are trading at distressed levels.

“They built an infrastructure around the enterprise with the assumption that the growth would be there,” said Daniel Imbro, managing director of Stephens Inc.

Ratings firm S&P Global Ratings has warned that Carvana’s liquidity is likely to erode faster than expected, and changed the outlook on its CCC+ rating to negative earlier this month. He said the company’s position to raise more cash from equity and bond investors has worsened.

Less than a year ago, Carvana was still trying to keep up with demand. In February, it agreed to buy a car auction business that would help bolster inventory. Car sales declined, however.

On the day the deal was completed in May, Mr. Garcia said he outgrew growth and laid off 2,500 workers. Days earlier, it had issued a $3.275 billion bond with a 10.25% coupon to finance the purchase. The high coupon nearly doubled Carvana’s annual interest expense and reflected investor fears of a recession and rising inflation.

Carvana CEO Ernie Garcia III and his father, Ernest Garcia II, when the company went public in 2017.


Michael Nagle/Bloomberg News

Carvana succeeded when interest rates were low because it could borrow cheaply to buy cars and make loans to customers. Its line of credit from Ally Financial to buy cars had an average interest rate of 2.6% last year, compared with 4.5% at the end of September. Ally asked Carvana to set aside 12.5% ​​of the amount borrowed by the end of September, up from 7.5%, further tightening its cash situation. A spokesman for Allies declined to comment.

Carvana made huge profits by selling its auto loans to yield-hungry investors. Profits from the loan help Carvana offset the losses it makes by selling the cars. When investors turned more options on these securities in the spring, Carvana sold many of the loans to Ally instead, on less favorable terms. The proceeds it books from the sale of loans fell by about a third in the third quarter from the year-ago period.

Mr. Garcia told analysts on a Nov. 3 call that the company continues to cut costs and that it has access to about $4 billion in cash flow, in addition to its $316 million in cash and some other assets. . The amount includes what can be borrowed on lines of credit to buy cars and make loans. It also included about $2 billion of real estate, which is not normally considered a liquid asset.

The company’s chief financial officer said Carvana could borrow against the real estate, which includes sites it bought this year. He previously raised about $500 million from the sale of some car inspection sites and then leased them back for 20 or 25 years.

That move could work, analysts said, but it would also increase costs. They said any real estate deal would likely happen piecemeal over time, or involve high rent payments because of Carvana’s credit problems.

Scott Merkle, managing partner of SLB Capital Advisors, which specializes in sale-leaseback transactions, said long-term leases in the space generally depend on financially sound tenants who can be expected to make the payments. -leasing them for years. He said that the general conditions for sellers have softened in that market due to higher interest rates, but that the sale-leaseback still provides a better cost of capital for companies than other financing.

Carvana said it is testing ways to make more of its car sales, such as having customers pick up cars from its vending machines.



Some properties leased by Carvana have received a tepid response in the market. A 12-story “flagship” car dealership in Atlanta that Carvana sold and leased back in December was relisted this summer. It is still on the market, and the asking price has since been lowered.

Carvana said it is testing ways to make more of its car sales, such as taking payment before delivery and having customers pick up cars from its vending machines.

“We have a bunch of liquidity committed. We have a lot of real estate, and I think we feel like that puts us in a good position to ride out this storm,” Mr. Garcia told analysts on the Nov. 3 call.

—Ben Foldy, Will Feuer and Ben Eisen contributed to this article.

Write to Margot Patrick at [email protected] and Kristin Broughton at [email protected]

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