Last October we published a video titled Carvana's impending bankruptcy where we talked about the company's desperate Financial condition. Carvana is an online used car dealership where consumers can get an instant quote to buy or sell a used car. On the website, a Carvana truck will come to your house to pick up a car that you sell to them or deliver a car you bought from them. The idea was that Carvana could disrupt the traditional used car market by offering a more seamless customer experience and cut out the overhead cost of physical dealerships.

After the pandemic, Carvana's share price surged to a high of $360 giving it a market capitalization of about $30 billion. Low interest rates caused increased demand for cars as financing became cheaper. At the same time, the chip shortage hampered the supply of new cars. This combination of factors caused used car sales to Surge providing a huge boost for Carvana.

While its Revenue did grow impressively, Carvana failed to ever post an annual operating profit. So why is Carvana losing money? Despite its supposed advantages over traditional car dealerships, while their online model foros the cost of brick-and-mortar dealerships, they still incur substantial costs to inspect and in some cases, repair the cars that they purchase. The transportation costs are also significant due to the lack of any physical retail presence they have to spend massively on National advertising campaigns and digital marketing. Finally, the process of selling a used car is far more complicated than selling a toaster on.

Amazon You need to verify the car title of the seller and give a new car title to the buyer, both of which require substantial paperwork. Carvana has had problems in the past with failing to give car buyers their titles in a timely manner. Historically, Carvana has been able to fund its cash burn through the issuance of new shares in debt. Due to the company's fast growth and perception as a disruptive innovator, the share price grew, allowing Carvana to raise billions of dollars over the years.

In 2022, they acquired a used car auction company called Adessa for $2 billion. In addition to the purchase price, they plan to spend another $1 billion to upgrade Essa's facilities and integrate them into the rest of their operations. In total, they borrowed $3.2 billion in high yield debt to fund this. The Adessa acquisition would give them access to hundreds of thousands of new cars per year, which they can sell on their online platform.

The timing of this transaction was disastrous, beginning in late 2022. Rising Interest rates caused car demand to decrease, while the end of the chip shortage allowed New car Supply to recover. This resulted in a substantial decrease in Carvana sales despite the increased capacity from the Adessa acquisition. In an attempt to reach profitability, Carvana laid off 10% of its staff in two rounds of layoffs.

While this did help to decrease their operating loss, by this point, they had accumulated $6 billion of debt, which carried roughly $550 million of annual interest expense. Realistically, there is no way they could sustain their debt burden. That's how the situation looked when we published our video last October Speculating that Carvana would soon declare bankruptcy, Carvana's in pending bankruptcy was a widespread view amongst investors. By the end of 2022, the share price was trading at less than $4 per share, putting it within Striking Distance of penny stock territory.

It looked like they were approaching the end game. Yet shockingly, the stock has made a massive comeback in 2023, reaching $45 by the time of recording this video. In this video, we'll look at how Carvano is able to pull itself from the brink of bankruptcy and whether or not this turnaround is sustainable. From an operating perspective, Carvana rapidly shifted the business from focusing on growth to focusing on profitability.

In the past, they focused primarily on gaining market share. They priced their cars very aggressively and spent heavily on advertising. In 2023, they increased the markup between what they pay to Sellers and what they charge to buyers. This, along with higher margin wholesale revenue from the Adessa acquisition, allowed them to generate a record $5,900 of gross profit per retail unit sold in the third quarter of 2023.

Additionally, through layoffs and drastic Cuts their advertising budget, they cut their Sgna down to $5,300 per unit sold. so they are now making $600 of profit per vehicle that they sell. This is less than 2% of their revenue. So while they are profitable, their margins are still razor thin.

And importantly, this is before interest expense. The price hikes and lack of advertising caused Revenue growth to turn negative for the first time in Carvana's history. Based on the Run rate from the first 3/4 their unit sold is on track to decline by 23% versus 2022, and their revenue is on track to decline by 18% But the negative Revenue growth was the least of Carvana's concerns. The more pressing issue was their $6 billion of debt in $550 million of annual interest expense.

so they contacted their creditors to ask for restructuring. By this point, Carvana's Bonds were trading at distressed levels, with some of them marked below 50 cents on the Dollar bankruptcy was in nobody's best interests. Their creditors would probably get even less than 50 cents on the dollar from the Liquidation. In July of 2023, they came to an agreement under.

under the New Deal Carvana's total debt load was decreased by $1.2 billion, some of the maturities were extended, and the cash interest expense was reduced by $430 million for the next 2 years. In addition, Carvana agreed to raise $350 million through Equity offerings to further Shore up its balance sheet. Most investors viewed this deal as positive because it took bankruptcy risk off the table, at least in the short term. This catalyzed the Monster Rally in Carvana share price.

However, not everyone viewed this restructuring so favor. In September, The ratings Agency Standard and Pores downgraded Carvana's credit rating to D, which is tantamount to default. They said Carvana conducted the restructuring out of distress due to its high interest burden, minimal cash flow generation, and deteriorating liquidity position. Basically, the restructuring was an act of desperation on the part of both Carvana and its lenders.

The face value of the bonds decreased from $5.5 billion to $4.2 billion. The only reason the lenders agreed to such unfavorable terms was because if they didn't, Carvon would almost certainly go bankrupt. and even with the restructuring, Carvana still isn't Out. Of the Woods.

Prior to the restructuring, Carvana had about $1.2 billion of debt outstanding on two short-term revolving credit facilities which were secured against this vehicle inventory as well as auto loan receivables. These facilities had floating interest rates of 8% and 6% They also had $5.7 billion of bonds maturing between 2025 and 2030, with interest rates between 4.9 and 10.3% In total, they had $6.9 billion of debt with annual interest expense of $554 million. After the debt restructuring, the old Bonds were converted to new bonds with maturities between 2028 and 2031. More than 95% of Carvana's creditors agreed to the restructuring.

There were $200 million worth of holdouts who refused the holdouts maintain their original bonds at the original terms. While the new bonds have longer maturities and smaller face values. They also have much higher interest rates ranging from 12 to 14% Although, after 2 years, the interest rates will decrease to 9% using the proceeds from the recent Equity raise. Carvano was also able to pay down most of the outstanding balances on their revolving credit facilities.

In total, the debt restructuring plus the equity raise allowed Carvana to reduce the face value of its debt from $6.9 billion to $4.8 billion. However, because the new debt comes at much higher interest rates, their annual interest expense actually increases to $595 million. now that we look at it. from this perspective, the restructuring doesn't look so favorable anymore.

And how do we reconcile this with a company's press release which says the deal will decrease their cash interest expense by $430 million for the first two years? The key word is Cash Interest expense. For the first two years, the interest on their new bonds are paid in kind. This means that instead of paying the interest as cash, they'll be added to the principal. You can think of it kind of like a dividend reinvestment plan.

The bond holders are still acre interest, but they don't get paid cash until later. These char S compare Carvana's schedule of interest in principal payments through 2031. The cash payments are indeed substantially lesser for the first 2 years, but the interest expense balloon starting in 2025 once their 2 years of payment in kind. Runs Out In 2028, 2030, and 2031, they have to make massive principal payments.

While the face value of the bonds is lower after the restructuring, the amounts of money they'll have to pay in the long run actually increases. As a result of the restructuring, the undiscounted value of the principal and interest payments increased by almost 1li billion from $5.7 billion to 6.7 billion. While Carvana likes to tout the restructuring as having greatly reduced their cash interest expense, all they accomplished is kicking the can down the road for another 2 years. Starting from 2025, they're going to need to pay more than $600 million of cash interest per year.

Thus, they need to start generating significant operating profit. in past. As we discussed previously, Carvana's aggressive cost cutting has allowed them to make $600 of profit per vehicle sold. In the most recent quarter starting starting in 2025, they'll need to pay $155 million of cash interest expense per quarter.

Based on their current rate of quarterly unit sales, they will need to increase their per vehicle profit to $1,900 to cover their interest payments Is this possible? In addition to reporting Financial results, every quarter, Carvana publishes key operating metrics which give insights into the underlying strength of the business. These metrics include the average number of monthly visitors to the website, as well as the total website units. Total website units represents the total number of cars shown on their website which are available for a consumer to buy. One of the key value propositions of Carvana is that its selection is far greater than a traditional brick and mortar dealership.

The greater the selection The more likely a consumer will find a suitable car to buy. In an effort to increase profitability, Carvana has decreased the quotes given to people looking to sell their cars. This has led to a substantial decline in inventory and website units. Total website units peaked in the first quarter of 2022 at 89,000 Since then, it has decreased by 60% to just just 34,000 At the same time, they have drastically decreased their advertising budget.

The average: American buys a car once every 8 years, So, even if a customer was 100% satisfied with their Carvana experience, they won't return to the platform for a long time. The combination of less selection and less advertising has caused Carvana's unit sales to decrease dramatically. If Carvana Cuts costs even more aggressively, this deterioration will likely accelerate. Thus, it's very hard to see how they could generate enough profits to start making their interest payments in 2025.

With all that being said, the fact that Carvana is now generating a slight operating profit proves that the business is viable. They just got Reckless and took on an inordinate debt load based on the belief that their business would eventually become extremely profitable. While Carvana's online model has certain advantages over traditional brick and mortar dealerships, it also has some disadvantages. While maintaining a brick and mortar presence is expensive, Prospective customers can see the cars in the parking lot as they drive down the street, which serves as free marketing.

A traditional dealership only needs to store its inventory in one place and the customers drive the car off the lot themselves. This cuts down on Logistics and transportation expenses. The costs: Carvana: Saves By foregoing physical dealerships, they largely give up in higher advertising and Logistics expenses at the end of the day. It's a low margin commodity business, just like any used car dealership.

The recent debt restructuring is not a long-term solution. If Carvano wants to survive, it will likely need to do a multi-billion dollar Equity raise and pay off the majority of its debts. While Carvana May indeed be able to survive, it seems unlikely that they will ever reclaim their prior highs in terms of valuation and investor hype. All right guys, that wraps it up for this video.

What do you think about Carvana? Let us know in the comments section below. As always, thank you so much for watching and we'll see you in the next one. Wall Street Millennial Signing out.