'Dash for Trash' – The Carvana Edition

Carvana Vending Machine in Indianapolis demolished to make way for highway. (WRTV)

I have one question to ask...

Has everybody lost their minds?

I may have been a few weeks early with my "Welcome to Fantasyland" essay last month, but this is a market you could see coming.

We were clearly entering the "silly season," as a broker I met early in my career used to call these types of periods in the 1990s.

The signs were all there... but perhaps nothing signaled its arrival (to me, at least) more than online used-car retailer Carvana (CVNA).

Since I wrote that "Fantasyland" essay, Carvana's stock has more than doubled – spiking at one point this week by more than 50% in a single bound. But to give that some perspective, since its low point in April the stock is up more than 500%... and up more than 1,000% from its December lows.

Never mind that Carvana is down nearly 90% from its peak-memefied high back in August 2021...

Or that I once referred to it as the poster child of the "dash for trash"...

Or that it was a prime example of what my friend David Trainer of research firm New Constructs once referred to as a "zombie stock" – a tag he put on stocks that have a risk of going bankrupt...

Or that my pals at Kailash Concepts once put it on a list of "Enron lookalikes" – not because it looked like a fraud, but because it was part of a group of companies that by all quant accounts looked like it was manipulating its earnings (or lack thereof)...

Or even as my buddy John Gavin pointed out in his Disclosure Insight report yesterday, that there is "no reason to believe Carvana's SEC accounting investigation has ended." (He tracks these kinds of things.)

All that matters is that here we are... and suddenly it was like Carvana had risen from the dead.

Or has it?

I like to say there's the stock and there's the company, and the disconnect between the two can be enormous...

There is no better example of that, at least right now, than Carvana.

As I said on CNBC the other day, the only reason Carvana's shares rose the way they did earlier this week was because they were heavily shorted.

The Exchange/CNBC

By that, I mean that 49% of its shares had been borrowed and loaned out to short sellers... much of it by shorts thinking that with more than $5 billion in debt and a dubious business model, Carvana's stock was headed for the junk heap.

But to its credit, the company pulled the ultimate financially engineered rabbit out of its hat.

It was brilliant, really... stock market magic of masterful if not mythical proportions.

If you didn't catch the sleight of hand the first time around, here it is in slow motion in three steps...

First, Carvana maneuvered a complex restructuring of its debt involving the founding and controlling Garcia family and creditors, in an "arm's length" transaction. (I’m not getting into the details here, it’s too complicated.)

Then, in conjunction with the debt deal, Carvana announced an "at the market" offering of 34 million shares, roughly half of which will be bought by the Garcias. These kind of "ATM" offerings, as they're called, let the company issue shares at any time – a good way to raise quick cash... just like going to an ATM. That's not something usually done out of strength.

And for the fireworks-filled finale, Carvana rolled out its earnings a month early, to coincide with the other two deals. Not surprisingly, the results were better than analysts expected, or as the headline of the earnings release put it...

Back in the old days, plain old earnings before interest, taxes, depreciation, and amortization ("EBITDA") used to be the inside joke on Wall Street. I even wrote about it in July 2000 in Fortune magazine. Companies, under pressure to meet analyst expectations, favored EBITDA – making it their headline earnings number – because it diverted attention from the real GAAP earnings... which were usually worse.

In recent years, it became not just EBITDA, but adjusted EBITDA, which eliminates stock-based compensation and restructuring costs. The adjusted-out numbers at Carvana are tiny by comparison to interest, which at $155 million last quarter was equal to the company’s adjusted EBITDA.

The real earnings were a net loss of $105 million.

Here's the best part...

To hit that faux “adjusted EBITDA” profitability number, Carvana benefited from $70 million in nonrecurring items as well as reduced advertising spending and other costs.

Not that any of this matters... because the news based on headlines alone was enough to juice the stock and scare the shorts, many of whom likely covered. That in turn pushed the stock higher – giving Carvana the ability to issue more shares at higher prices.

The shorts covering, in the most convoluted way, helped (for now) save the company.

But the shorts weren't the only ones buying shares. So were – as one very smart friend put it – "idiot shareholders," who bought into the Carvana turnaround story.

That's where this gets even potentially more perilous...

Even with the perception of a turnaround, investors are buying into a money-losing company that's deeply in debt in a highly competitive industry.

To its credit, Carvana disrupted its competitors, who without question were caught sleeping. Since then, most have turned the way they buy and sell used cars upside down...

They’ve all become shrewder, and they're all considerably healthier financially than Carvana.

Yet Carvana trades at roughly the same enterprise-value-to-sales (EV/sales) ratio – which adds in debt – as CarMax (KMX), which has more than double the revenue as Carvana... and is profitable.

There's no question that with the debt restructuring and stock sale Carvana gave itself some breathing room, if not a lifeline…

Now it has to pull off a genuine turnaround.

If it doesn't, as Morgan Stanley wrote in a note, the onerous terms of its new debt deal "will likely put the company back in nearly the same position it was previously absent a meaningful improvement in the business or a redemption of some or all of the new notes."

All of this, it goes on to say, “with the clock ticking on the race to profitability...”

Yikes!

My bottom line: It's great that Carvana pulled off such a stock-goosing magic trick, but lost in all of the mania of the market is that the viability of company’s business remains a question mark... and until proven otherwise, investing in Carvana continues to be a dash for trash.

When there are so many other higher-quality companies to choose from, why so many people gravitate to those with the lowest quality continues to confound. Personally, I think casinos are more fun.

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DISCLAIMER: This is solely my opinion based on my observations and interpretations of events, based on published facts, and should not be construed as investment advice.

(I write two investment newsletters for Empire Financial Research, Empire Real Wealth and Herb Greenberg’s Quant-X System. For more information, click here and here.)

Feel free to contact me at herbgreenberg@substack.com. You can follow me on Twitter and Threads @herbgreenberg.