Carvana Faces Cash Crunch From High Debt, Rising Interest Rates

Few companies have suffered more from rising interest rates than Carvana. The company’s interest expense nearly doubled earlier this year after it paid to obtain financing for the acquisition. Its cost of car purchases has risen by three-quarters this year, and some of its real estate has lost value. Meanwhile, car buyers are holding off buying in anticipation of a drop in rates.

In a memo announcing the layoffs to Caravana employees, chief executive Ernie Garcia III blamed an uncertain economic climate that he said was especially hard on fast-growing companies that sell products affected by high interest rates. . “We failed to accurately predict how this would all play out and what impact it would have on our business,” he said.

The company said it has millions of satisfied customers and disrupting the auto industry is not easy. “We have written to many e-commerce companies in the early days of their journey only to become market leaders. We plan to follow suit,” said a spokesperson. Earlier this month, Caravana executives said that cash flow and profitability are now a strategic focus.

Carvana became wildly popular among car buyers, with heavy advertising and haggle-free cars delivered to their doorsteps. Investors bought in and shares jumped more than sixfold. The stock has fallen more than 97% from its peak last year. Carvana’s bonds are trading at distressed levels.

“They built an infrastructure across the enterprise with the assumption that there would be growth,” said Daniel Imbro, a managing director at Stephens Inc.

Ratings firm S&P Global Ratings warned that Carvana’s liquidity outlook would decline faster than expected, and changed the outlook on its CCC+ rating to negative earlier this month. It said the company’s position to raise more cash from stock and bond investors has worsened.

Less than a year ago, Caravana was still trying to keep up with demand. In February, it agreed to buy a car-auction business that would help boost inventory. However, car sales remained slow.

On the day the deal was completed in May, Mr. Garcia said it had foregone growth and laid off 2,500 workers. A few days ago, it issued a $3.275 billion bond with a 10.25% coupon for purchase. The higher coupons nearly doubled Caravana’s annual interest expense and reflected investors’ fears of a recession and rising inflation.

Carvana flourished when interest rates were low because it could borrow cheaply to buy cars and loan them out to customers. Its line of credit to buy a car from Ally Financial had an average interest rate of 2.6% last year, compared with 4.5% at the end of September. Ally had to set aside 12.5% ​​of the amount borrowed to Carvana by the end of September, up from 7.5%, further tightening its cash position. An associate spokeswoman declined to comment.

Carvana made huge profits by selling car loans to investors who were hungry for yield. The profit from the loan helps Carvana offset the loss it incurs from selling the car. When investors became more selective on these securities in the spring, Carvana sold many of the loans to Ally on less-favorable terms. Gains from loan sales fell by nearly one-third in the third quarter compared to the year-ago period.

Mr. Garcia told analysts on a call on Nov. 3 that the company will continue to cut 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 he can borrow on the credit line to buy the car and the loan. It also includes about $2 billion in real estate, which is not generally considered a liquid asset.

The company’s chief financial officer said Carvana may borrow against real estate, including sites it bought this year. It raised about $500 million by selling the first few sites where it inspects cars and then leases them back for 20 or 25 years.

Analysts say the move may work, but it will also increase costs. Any real estate deal is likely to be piecemeal over time, or involve higher rent payments due to Carvana’s credit problems, he said.

Scott Merkle, a managing partner at SLB Capital Advisors who specializes in sale-leaseback transactions, said long-term leases in space typically depend on financially sound tenants who can be expected to They’ll pay off their lease for years. While higher interest rates have softened overall conditions for sellers in that market, sale-leasebacks still provide a better cost of capital for companies than other financing, he said.

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

Carvana said it is testing ways to make more from its car sales, such as taking payment before delivery and letting customers pick up cars from its vending machines.

“We have a bunch of liquidity committed. We have a bunch of real estate, and I think we feel like it puts us in a good position to ride out this storm,” Mr. Garcia said on Nov. 3. told analysts on the call.

—Ben Foldi, Will Feuer and Ben Essen contributed to this article.

Write to Margot Patrick at [email protected] and Kristin Broughton at [email protected]