CVNA’s valuation vs competitors like CarMax (KMX), Autonation (AN) etc is completely irrational. I was a CEO of a subprime company in this space. CVNA’s valuation is a crime of capitalism.” – @beaconstagezero

Ernest Garcia II was convicted on felony charges in connection with his involvement in the Charles Keating S&L Ponzi scheme which stole billions from innocent bystanders.  Garcia is the founder and Chairman of Carvana (CVNA).   His son, a chip off the old block, is the CEO.

This morning CVNA released a terse “preview” of its expected Q3 results in which it said the Company will achieve record revenues, units sold and gross profit per vehicle plus it said its EBITDA would “approximately” breakeven.

In the same breath it announced another $500 million bond financing. YTD including this deal, CVNA will have had to tap the capital markets for $1.7 billion.  Why?  Because it’s operations burn cash like a home furnace in Weimar Germany in the early 1920’s and because the founder/Chairman and his CEO son use CVNA as their personal piggy-bank.

The press release tandem can be read like this:  “Hey suckers, our results in Q3 will be ‘great’ so give us another $500 million loan because we can’t seem to make any money.”

Carvana’s Q2 2020 showed 15.3% YoY revenue growth vs Q2 2019. But the gross margin dropped 100 basis points from 16% last year to 15% in this year’s Q2. No wonder CVNA is generating revenue growth – just like every other overvalued “unicorn” company hatched in Silicon Valley, CVNA charges a price for its product that does not cover the cost of its business model.

How do we know this? Its operating loss soared 66.4% to $106 million of red ink from $64 million in Q2/19. The cash burned (used) in operations fell to just $7 million from $168 million in Q1/20. But this was attributable to a $215 million run-off of inventory from Q1. As I’ve discussed previously, CVNA does not price the cars it sells at a price high enough to cover the full cost of the business model. This is why it issues debt and stock quite frequently.

A big red flag for me is the fact that has had to issue stock three times raising $1.3 billion subsequent to going public in 2017 plus another $700 million in two separate junk bond deals in 2018 and 2019. Two of the three stock financings occurred in Q2 2020, yet the cash balance between Q1 and Q2 increased by just $76 million dollars, part of which is restricted cash.

The Company used $781 million to pay down a short-term revolver used to finance inventory. This also explains the run-off in  inventory.  Including the inventory run-off in Q2, the Company has raised $2.7 billion in funding since going public, including the $500 million bond deal announced today. This is essentially the amount of cash burned by CVNA’s operations since its April 2017 IPO.

This Company does not make money and it never will unless it charges a much higher price for the vehicles it sells, in which case its sales volume will plummet. CVNA is 60% owned by Chairman/founder, Ernest Garcia (a convicted felon), and 40% owned by the public. Garcia sucks money out of Carvana via a series of “related party” arrangements with Garcia’s company, DriveTime, which include the leasing of office space and other facilities, used car reconditioning services and selling usage time on a corporate aircraft indirectly owned by Garcia. A Garcia-owned company also gets paid for servicing CVNA’s finance receivables. The conflict of interest and self-dealing between CVNA and Ernest Garcia II (Chairman) plus Ernest Garcia III (CEO) is mind-boggling.

The bottom line is that CVNA is functions as a vehicle (so to speak) that Ernest Garcia and his son use to raise money in the public capital markets and suck that money out of CVNA for personal gain.  It’s the epitome of fraud and corruption.

The short interest represents 30% of the share float, which explains the ridiculous run-up in the share price after the Company’s announcement today. Clearly I’m not the only one who has dissected the footnotes to the financials and determined that CVNA is to a large degree Ponzi scheme with an absurd market valuation.

Quite frankly I would bet that the asset value of the Company is not a lot greater than the amount of debt outstanding. The tangible assets – finance receivables (i.e. subprime loans extended to customers), inventory and unrestricted cash – are carried at $1.2 billion. The finance receivables ballooned in Q2 to $358 million from $199 million in Q1. This tells us that the Company lends aggressively to subprime borrowers.

There’s no way the market value of that crap is worth $358 million. PP&E is carried at $704 million. Thus, CVNA’s “hard” assets total $1.9 billion giving full value to receivables. Total debt plus payables was $1.4 billion at the end of Q2. Subtracting the debt from the tangible assets leaves $500 million of asset value. Beyond that, what is the value of a business that burns several hundred million in cash on an annual basis?

CVNA’s market cap at Friday’s close was $30 billion. If you laid out the numbers in the paragraph above and told me that the business described was valued this high, I would have thought you were hallucinating.

CVNA is an example of the type of business model, along with the operational and financial fraud crawling like cock-roaches beneath the surface, that has been enabled by 13 years of money printing by the Fed.  Thirty years ago when the financial regulator still maintained some independence from the big Wall Street banks, CVNA would not have survived very long.

The commentary above is from the August 9th issue of my Short Seller’s Journal. You can learn more about this newsletter here:  Short Seller’s Journal information.