How can Carvana afford to buy ADESA?
It was reported today that Carvana (NYSE: CVNA) will be buying the entire ADESA auction business from KAR Auction Services, one of the major legacy players in automotive wholesale, for over $2 billion USD in an all-cash deal. The press release states the sale “includes all auction sales, operations and staff at 56 ADESA U.S. vehicle logistics centers.”
According to its own 10K filing as of Feb 24th, 2022, Carvana has lost a cumulative $1.7 Billion dollars as an enterprise since its inception in 2012 and has never made an annual profit. This deal is a prime example of how massive debt and and a lot of hot air could turn a fundamentally bankrupt company into a profitable enterprise (on paper) and escape its day of reckoning in the courts. How is this market manipulation possible, and how will either company benefit? Who are the losers in this deal?
Even the salesman who sold you your last used car could be forgiven for wondering “Who is ADESA?” The company works in the mysterious and unfamiliar part of the auto industry, the wholesale business… you have probably heard it referred to by its more familiar term: “The Auction.” Carvana, on the other hand, is known as “that company with the giant glass car-vending machines that also made me an offer of more than I paid for my used car.” The general public has become quickly familiar with Carvana when selling or shopping for cars online, or spotting their branded flat bed trucks hauling cars around, and just to be sure they became a household name they even hit America with a very expensive superbowl commercial.
ADESA is owned by KAR Auction services (NYSE: KAR), a massive enterprise consisting of 17 individual brands covering services such as floorplan financing, dent repair, shipping, and more, but at the core of it all is the auction. In the pre-owned wholesale business, auction houses like ADESA (privately held Manheim Auto Auctions, a division of Cox Automotive, is their largest competitor) move millions of dollars of dealer and manufacturer owned inventory across a real or virtual aution block nearly every day of the week. The entire KAR Global corporation holds a $1.7B market share, yet CVNA is paying about 30% more than that for just a portion of it, though it is the largest portion to be fair.
Auctions effectively print money — see the hyper growth of specialty car auction Bring A Trailer for an example. The goal is to get as many customers consigning cars as possible, so they can charge a fee to the buyer and seller of every vehicle that crosses their auction block, averaging around $800 per vehicle in the dealership world. Auction sales typically last no more than a minute, hence the fast talking (yes that still happens). Over the last 5 years, KAR has invested hundreds of millions into acquiring digital auction platforms and technology companies, such as TradeRev and Backlot Cars, perceiving an existential threat to their physical properties. Running an on-site auction is expensive — staffing, shipping, and insurance are major costs but since 1989 it has largely worked for ADESA. Pre-COVID, ADESA showed $264 million in operating profits as a business unit (2019).
Meanwhile, since its inception in 2012 Carvana has been the subject of intense scruity and perplexed experts in the business who doubt their business plan’s viability. They have become known as a company that massively overpays for its inventory, spends disproportionately on marketing while cutting corners on reconditioning, and has had its dealer license revoked by multiple states for title problems. They have been accused of insider trading using its financing partner DriveTime, who conveniently stopped filing financial reports by using a securities loophole to delist the company from public markets. DriveTime is run by Ernie Garcia II, the convicted felon and father of Carvana CEO, Ernie Garcia III.
Its hard to believe that a company that has lost nearly two billion USD in a decade and was unable to turn a profit during a year when most dealerships are making record per-unit profits and benefitting from the highest margin sales ever seen in the industry has any other objective than enriching its executives. More formal financial analyses have been conducted, but Carvana has largely skirted interest from the SEC so far despite having been called on many occasions one of the largest ponzi schemes ever created. Carvana board members have cashed out billions of dollars of stock since 2020, much to the dismay of investors, and to escape more condemnation and litigation they have no other option than to show financial success for the company itself, not just themselves. That success simply isn’t possible or sustainable using the practices of the last ten years, so they are now are positioning themselves to completely change their business model. Buying an auction does exactly that. But where does the money come from?
According to the most recent filing, Carvana has $403 Million of cash as of Dec 31, 2021. Savvy readers will note that is substantially less than the “all cash 2.2 Billion” promised to buy the ADESA brands. Continuing along, the short-term revolving debt facilities had a total commitment of approximately $4.3 billion and $2.25 billion, as of the same date, and an unused commitment of $2.25 billion and $2.21 billion, respectively. The unused commitment from these senior notes is likely being committed here, unless it is brand new debt on top of the existing 7 billion already committed. The payment schedule does not begin in earnest for the new financing for five years. All of ADESA’s profit will be rolled into CVNA’s income statement before they have to make repayments on debt, likely leading to a more favorable P&L in 2022 and 2023, perhaps even a paper profit. To keep the investor money flowing into the stock, they must meet expectations of a profit this year and this is certainly a way to do it. How are they able to secure loans of this size? As long as the stock is valuable, the company itself is essentially a guarantee, stock pledged as collateral for all manners of debts. The bond issuances will be bought as long as investors believe the scent of profitability is still in the wind, and since the facade only falls apart if the stock falls apart, it is clear why Carvana’s biggest strength is marketing, not customer experience. It is critical to their continued growth.
Carvana has certainly been growing operations with their debt fuel, which is easy to do when you pay more than anyone else for your inventory. But owning a lot of cars also means a lot of space to store them. Carvana’s “Inspection Centers” have been operating out of small repair shops and hastily leased commercial property, which is a logisitcs nightmare. ADESA has auction houses that cover dozens of acres of land in every region of the US, with thousands of cars on each site representing consignments from local dealerships. With the ADESA properties, Carvana benefits from consolidated storage space for their inventory as well as on-site businesses like body shops for paint, dents, and wheel refinishing as well as mechanical repair services.
Much more substantially, they will have access to lower priced inventory compared to the vehicles they have been buying for outrageous sums direct from the public. With first dibs on all of the fresh trades that dealers typically sell at auction, Carvana expects to source cars cheaper and faster. Auction houses really don’t sell cars to the public, in fact this is almost a watershed moment in automotive wholesale. They usually focus on throughput — that’s why auctioneers talk so fast. Retail, consumer sales, financing, insurance… auctions leave that to the dealerships. But Carvana is trying to own both sides, both the wholesale and retail channels, which means they are in effect making the dealerships their most valuable clients while also turning them into their biggest competitor. I will be updating on this dynamic as it unfolds.
What’s in it for KAR? Their team says with this deal they will be able to pay off nearly all of their creditors — I hope so, receiving far more for ADESA alone than the entire global operation is reportedly worth in market cap, but one has to wonder what is really left of KAR after this deal? Were they in so much debt they couldn’t see a way out? Looking at KAR’s remaining brands, they will essentially just be left with their shipping and logistics company, CarsArrive, and AFC Floorplan financing, which acts like a bank to dealers who often don’t own their inventory outright. These may be strong companies in their own right, but KAR is essentially gutted of its cash cow business after this sale completes. I wonder if buried in this sale is a tacit admission that the hundreds of millions KAR has spent on unproven digital wholesale technology has been wasteful and premature. I believe these apps and services will continue to be unprofitable and impossible to scale without physical property and on-site inventory taking, making the tech worth a fraction of what was previously believed.
Who loses? Besides questioning whether KAR is actually a winner or a loser here, independent dealerships are the likeliest to pay the price with this sale. Dealers who buy trade-in vehicles will have to decide if they want to pay consignment fees to a company that is essentially their own competition. Whereas ADESA was just an auction house, Carvana will be an auction house AND a dealership, taking the best condition and highest margin cars for themselves and leaving slim pickings for the independent dealer buyers who are accustomed to a run list of hundreds or thousands of cars to select from every week. CVNA auctions may raise auction “buy” prices even further, prompting dealers to look elsewhere to competitors like Manheim, other digital wholesale apps, or smaller independent auctions. New-car franchise dealers lose too, because many of their new-car brands (think Jeep, Kia) partner with ADESA to run closed sales for Certified Pre-Owned cars to other dealers of the same brand, but they will be unlikely to allow Carvana to purchase these cars, and so these lanes will become dead weight for Carvana since they run at heavily discounted fees. These dealers will prefer to also seek other auction houses or rely more heavily on the brand manufacturers to build or run closed-sale platforms.
Ultimately the biggest loser will be the public. This is more fuel on the fire of already increasing car prices across the board, and yet another reason to feel skeptical about prices returning to average anytime soon. Retail investors are being misled by the smoke and mirrors financial environment that Carvana operates in, and by their splashy “digital revolution” marketing messages that play into consumer fears of being taken advantage of by traditional dealerships. Institutional investors should know better than to fall for the rampant cheerleading by sell-side analysts (who are still predicting $350/share) and do their due diligence. Carvana’s executive team has no functioning business model, customers and investors have been mistreated and mislead, and this recklessly expensive purchase of ADESA is a shell game to buy more time for the Garcias to siphon more funds out of both Carvana and DriveTime.
If you are interested in a more substantial financial analysis of CVNA as a whole, you can read a comprehensive report here. I share the sentiments of its author.
