Carvana is facing a cash crunch due to high debt and rising interest rates

Carvana Co.

CVNA -3.13%

the used-car dealership that was a pandemic winner is scrambling to save cash as once-abundant financing options dry up and business takes a turn for the worse.

On Friday, Carvana laid off about 1,500 people, the second round in six months. Weakening finances would make it difficult and costly to raise funds, and it could run out of money within a year, analysts say.

Few companies have been hit harder by rising interest rates than Carvana. The company’s interest expense nearly doubled early this year as it paid to get financing for an acquisition. The cost to finance car purchases has risen three-quarters this year and some real estate has lost value. Meanwhile, car buyers are postponing their purchases in the hope that prices will fall.

In a memo to Carvana employees announcing the layoffs, Chief Executive Ernie Garcia III blamed an uncertain economic environment that he said was particularly hard on high-growth companies selling products facing higher interest rates. “We haven’t been able to accurately predict how all this would play out and what impact it would have on our business,” he said.

The company said it has millions of happy customers and disrupting the auto industry is not easy. “We have seen many e-commerce companies write off early in their journey to become the market leader. We intend to follow suit,” said a spokesperson. Earlier this month, Carvana executives said cash flows and profitability are now the strategic focus.

WSJ’s Ben Foldy explains the factors that drove Carvana’s growth and why investors now have doubts about its future. Illustration: Preston Jessee

Carvana became wildly popular with car buyers, with heavy advertising and no haggling cars delivered to their door. Investors bought back, pushing shares 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 across the enterprise assuming the growth would be there,” said Daniel Imbro, a general manager at Stephens Inc.

The rating agency S&P Global Ratings warned that Carvana’s liquidity was likely to decline faster than expected and earlier this month changed its outlook for its CCC+ rating to negative. It said the company’s position to raise more money from investors in stocks and bonds has deteriorated.

Less than a year ago, Carvana was still trying to keep up with demand. In February, it agreed to buy a car auction company that would help increase inventory. However, car sales fell.

On the day the deal closed in May, Mr. Garcia that it had exceeded growth and laid off 2,500 employees. Days earlier, it had issued a $3.275 billion bond with a 10.25% coupon to fund the purchase. The high coupon nearly doubled Carvana’s annual interest expense, reflecting 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.


Photo:

Michael Nagle/Bloomberg News

Carvana thrived when interest rates were low because it could borrow cheaply to buy cars and make loans to customers. Ally Financial’s line of credit to buy cars had an average interest rate of 2.6% last year, compared to 4.5% at the end of September. Ally demanded that Carvana put aside 12.5% ​​of the loan amount at the end of September, compared to 7.5%, further worsening the liquidity situation. A spokesperson for Ally declined to comment.

Carvana made big profits by selling its auto loans to investors hungry for yield. Profits from the loans help Carvana offset the losses it incurs selling cars. When investors became pickier about these securities in the spring, Carvana instead sold many of the loans to Ally on less favorable terms. The profit it made from loan sales fell by about a third in the third quarter from the same period last year.

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

The company’s chief financial officer said Carvana could borrow against the property, including the sites it purchased this year. Previously, it raised about $500 million by selling some sites where it inspects cars and then leasing them back for 20 or 25 years.

That move could work, analysts said, but would also come at a cost. They said any real estate transactions over time would likely be piecemeal, or would involve high rent payments due to Carvana’s credit problems.

Scott Merkle, a managing partner at SLB Capital Advisors, which specializes in sale-leaseback transactions, said the space’s long-term leases generally depend on financially sound tenants who can be expected to make their rent payments for years to come. He said the terms and conditions for sellers in that market have been softened by higher interest rates, but sale-leasebacks still provide companies with a better cost of capital than other forms of financing.

Carvana said it is testing ways to get more out of car sales, such as letting customers pick up cars from the vending machines.


Photo:

USA TODAY NETWORK / Reuters

Some properties leased by Carvana have received a lukewarm response to the market. A 12-story “flagship” car vending machine in Atlanta that Carvana sold and leased in December was relisted this summer. It is still on the market and the asking price has since been reduced.

Carvana said it is testing ways to get more out of car sales, such as paying before delivery and letting customers pick up cars from vending machines.

“We have a lot of committed liquidity. We have a lot of real estate, and I think we feel that puts us in a good position to weather this storm,” said Mr. Garcia to 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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