Research | Hindenburg | Carvana: A Father-Son Accounting Grift For The Ages

Created

Jan 2, 2025 8:17 PM

Background: $44 Billion Online Used Car Dealer

Carvana (NYSE:CVNA) is a $44 billion online car dealer headquartered in Tempe, Arizona. The company was founded in 2012 and is led by co-founder, Chairman and CEO, Ernest Garcia III.

Carvana’s main business is an online platform that allows retail customers to buy and sell used cars, which accounts for ~70% of its total revenue, per the company’s latest quarterly report. [Pg. 2]

The company offers financing, insurance and other services like car protection plans.

(Source: Carvana website)

The company also runs a wholesale auction business, called ADESA, which it acquired in May 2022. [Pg. 7] ADESA has 56 locations where registered auto dealers can participate in auctions, either virtually or on-site. Carvana also acquires vehicles in these auctions.

Carvana originally spun out of a company called DriveTime – a used car-dealership chain run by Ernest Garcia II, a key Carvana shareholder and a felon convicted of bank fraud in 1990. Garcia pled guilty to charges alleging he helped a company report fake accounting income through sham transactions. SEC charges also alleged he “signed a falsified letter for [the company’s] auditors” as part of the scheme. His son, Ernest Garcia III has been the CEO of Carvana since its inception.

Carvana went public on the NYSE via a direct listing in April 28, 2017. It currently has a market capitalization of ~$44 billion.

Bull Case: A Disruptive Online Car Dealer Covering Nearly All Of The U.S., With Industry-Leading Unit Economics

The U.S. used car industry is projected to reach $600 billion in 2024, but remains fragmented, with many traditional dealerships serving a small sub-market.

Carvana now operates at scale, having expanded its presence to cover 81.1% of the U.S. population, per its Q3 2024 investor presentation. [Slide 13] Carvana had over 45,000 vehicles available for sale on its website as of September 30, 2024. [Slide 8]

(Source: Carvana Q3 2024 Investor Presentation [Slide 8])

Carvana prides itself on a “simple, seamless and differentiated used car buying experience”, where customers can purchase cars online rather than in dealership showrooms. The company’s platform has been described as “the Amazon of cars” by Forbes.

In September 2023, amid fears of bankruptcy, the company “aggressively restructured”, working with creditors to slash $1.3 billion of debt. Since then, the company has focused on a “three-step plan” that includes (1) driving the business to positive EBITDA, (2) achieving positive unit economics and (3) returning to profitable growth. [Pg. 2]

Pursuant to this “three-step plan”, Carvana has significantly improved its reported unit economics. Its retail vehicle gross profit per unit (“GPU”) has increased from $1,131 in September 2022 to $3,497 in September 2024, representing a 209% increase. This GPU is 54% higher than competitor CarMax’s equivalent metric in Q2 at $2,269.[1]

With Carvana’s share price rocketing up over 284% in 2024, investors believe the company’s worst days are behind it.

Fundamentals: Carvana Trades At An 845% Higher Sales Multiple Than Online Car Peers Like CarMax and AutoNation, And A 754% Premium On A Forward Earnings Basis

Even before considering the findings of our investigation, Carvana trades at exorbitant valuations relative to online car peers such as AutoNation and CarMax.

On a 1-year forward price to sales (P/S) basis, Carvana trades at a 845% premium to peers. On a 1-year forward P/E basis, it trades at an 754% premium to peers.

(Source: Bloomberg)

These extremely optimistic valuation multiples appear to factor in a high probability of continued growth that will result in vast, runaway profitability.

Carvana’s valuation also seems to take for granted that the company can overcome its current debt burden. Carvana has the lowest credit rating among its peers at B- (i.e., “junk”), per the Bloomberg data above. The company remains significantly indebted, with net debt currently at $4.8 billion as of the end of September 2024 —4.4x the company’s LTM adjusted EBITDA.[2]

As part of Carvana’s 2023 debt restructuring agreement, the company had foregone paying cash interest payments and chose to increase its principal balance. [Pg. 5] Now, starting in February 2025, the company is due to start paying cash interest of $215 million per year on $2.4 billion of outstanding long term debt.

Fundamentals: Carvana’s Business Is Highly Cyclical And Faces Major Headwinds – Subprime Auto Loan Delinquencies Are Higher Than During The 2007-2008 Global Financial Crisis, Per Fitch

Used Vehicle Prices Have Declined 20.3% In The Past 3 Years, According To The Manheim Price Index

The auto industry is highly cyclical, driven by broader macro-economic factors like interest rates and employment rates. Carvana acknowledges this in its own risk factors, stating that its financials may be impacted as a result.

Heading into 2025, signs of stress are increasingly evident in the U.S. auto loan market. Subprime auto loan delinquencies are currently higher than during the Global Financial Crisis of 2007-2008, per credit rating agency Fitch.

(Source: Fitch Ratings)

Approximately 44% of cars financed since 2022 are underwater, meaning they are in negative equity, per a report by CarEdge in December 2024. As detailed later, Carvana has heavily focused its operations on the riskiest ‘subprime’ and ‘deep subprime’ consumers most impacted by this problem.

Used car prices have fallen by 20.3% since their peak in January 2022, according to the widely-tracked Manheim Used Vehicle Value Index. The index is described as “a single measure that captures used vehicle pricing trends independent of underlying shifts in the characteristics of vehicles being sold”.[3] Since Carvana announced its February 2023 “three-step plan”, prices have fallen 12.4%.

(Source: Manheim)

Lower prices generally have a negative impact on gross profit due to a reduction in the price at which Carvana can sell its inventory. Yet despite these accelerating signs of stress, Carvana’s profitability metrics have all improved, almost as if by magic.

And, while Carvana’s claimed profitability has not reflected these pressures, other reported Carvana metrics are not immune to this cyclicality. Carvana’s quarterly sales still have not reached peak levels seen about two and a half to three years ago:

(Source: Carvana Q3 2024 Shareholder Letter)

Background: Carvana CEO Ernie Garcia III’s Father, Ernest Garcia II, Sold $3.6 Billion In Carvana Stock Between August 2020 and August 2021

In The Year After He Stopped Selling, Carvana’s Stock Plunged 99%. Within 16 Months, Carvana Was Facing Bankruptcy Concerns

“…The Garcias Knew It Was Short-Lived…The Garcias Knew The Music Would Eventually End” – Wharton Professor Dan Taylor

Despite volatility in Carvana’s share price, one key shareholder seems to have timed the market for selling shares with surgical precision: its largest holder, Ernest Garcia II, whose son happens to be the company’s CEO.

Between August 2020 and August 2021, Ernest Garcia II, father to Carvana CEO Ernie Garcia III, sold $3.6 billion in Carvana stock, per Bloomberg. On August 5th, 2021, as his sales were concluding, the company was touting a bright future:

“Our results relative to the industry leave us more optimistic than ever about our long-term model and path toward our goal of delivering more than 2 million retail units per year and becoming the largest and most profitable auto retailer.” (Q2 2021 earnings call)

Ernest Garcia II sold his last tranche of shares at $357.13 about 2 weeks later, on August 23rd, 2021.

Despite his son’s company touting the path to becoming “the most profitable auto retailer”, Carvana rapidly turned loss-making, swinging from net income of $45 million in Q2 2021 to a net loss of $68 million by Q3 2021. The company then reported 7 consecutive quarters of losses, totaling $3.5 billion. [1 2 3 4 5 6 7]

The stock plunged from $357 on Ernest Garcia Sr.’s last sale in August 2021 to a low of $3.55 in December 2022, representing a 99% decline.

Within 16 months of the CEO’s father ending his billions of dollars in share sales, the company was facing bankruptcy concerns.

(Source: KBB)

Commenting about the collapse of the company’s stock in 2022, Wharton Professor Daniel Taylor told Forbes:

“What I’m saying is the Garcias knew it was short-lived… The Garcias knew the music would eventually end.”

Since 2023, The Same Trend Has Restarted: Carvana Has Touted A Bright Future And Posted Three Consecutive Quarters Of Positive Net Income, An Aggregate Of $245 Million

For Every $1 In Net Income It Generated, The Company Added $139 In Market Cap, Representing A $34 Billion Market Cap Increase

With Carvana Shares Up ~42x, Ernest Garcia II Has Sold Another $1.4 Billion In Carvana Stock

The same pattern seems to be playing out again. Just like in 2021, CEO Ernie Garcia III is touting Carvana’s “incredible results” over the last two years and reiterated in a February 2024 statement:

“We plan to become the largest and most profitable automotive retailer and buy and sell millions of cars per year. So we need to keep marching. And we will.” [Pg. 10]

Over the last 2 years, since its restructuring, Carvana has seemingly flipped a profitability switch. Between Q3 2022 and Q3 2024, the company’s net income margin went from -15% to 4%.

(Source: Carvana Press Release)

By reporting just $245 million in net income in the past 3 quarters, Carvana’s stock added ~$34 billion in market cap, or $139 dollars in market cap for every $1 in net income.

Wall Street analysts have celebrated the turnaround, declaring that the worst is behind the company and touting further upside beyond the stock’s 284% gains in the past year.[4]

And once again, despite his son’s optimism and the company’s recent positive metrics, Ernest Garcia II has aggressively sold stock. He dumped $1.4 billion in Carvana stock over the last year, at times selling on a near-daily basis, making him by far the largest insider seller of the company’s shares.

(Source: Bloomberg)

During this time period, only 1 insider bought shares in the company: board member Neha Parikh, who bought 2,600 shares at around $77 for approximately $200,000. [1 2] This pales in comparison to $1.6 billion in total insider sales during the period, with Ernest Garcia II accounting for $1.4 billion.

Part I: Solvency Risk

Despite the market’s optimism, investors seem to under-appreciate that Carvana’s business is capital intensive and reliant on the willingness of third parties to purchase the loans it originates.

Carvana Relies On Third Party Financiers To Purchase The Auto Loans It Originates

Over The Last 9 Months, Carvana Sold $6.15 Billion In Loans For A Gain Of $541 Million, A Metric Representing 2.2x Net Income In The Period

“It’s Actually More Of A Subprime Finance Business Than It Is A Car Dealership”—Former Carvana Director

Financing is a key part of Carvana’s business model, with about 80% of customers financed by the company. Rather than keep these loans on its balance sheet, Carvana offloads the vast majority to third-party buyers.

Over the last 9 months, Carvana sold $6.15 billion in loans to third parties, reporting gain-on-loan sales of $541 million. [1, 2, 3] Those gains accounted for 26% of gross profit over the last 9 months. [1, 2] For further comparison, the metric represented ~2.2x Carvana’s net income in the period. [1, 2]

Any interruption or limitation in the third-party loan market would threaten Carvana’s entire business model.

Carvana Has Relied On A Purchase Commitment Agreement With Ally Financial, To Which It Sold $3.6 Billion Of Vehicle Loans In 2023, ~60% Of Its Total Originations

Carvana offloads a significant portion of its loans to third party bank Ally Financial in a forward flow agreement. (Most of the remainder are offloaded through securitization deals, which we detail later.)

Since FY 2021, Carvana’s loan sales to Ally have increased substantially relative to the amount of loans it originates, from 29% to 60% in 2023. [1, 2] In 2023, Carvana sold $3.6 billion of loans (“receivables”) to Ally Financial through its forward flow agreement.

(Source: Carvana 2023 10-K, 1, 2)

Carvana Has Told Investors For At Least 6 Years That It Is Seeking To Diversify Outside of Its Relationship With Ally, But Thus Far Has Not Announced New Banking Partners

In November 2018, a Bank of America analyst asked Carvana’s leadership about diversifying away from its relationship with Ally. Carvana CEO Ernie Garcia III answered:

“We’ll probably continue to develop more of those financial buyers over time. And those are some of the structural changes that we’re talking about that we believe we’ll have access to over the next several quarters. We continue to bring more people in. But Ally remains our biggest partner by a long way.”

Nearly 4 years later, in August 2022, a J.P. Morgan analyst again asked whether Carvana would be adding additional partners “outside of Ally” for whole loan sales. CFO Mark Jenkins responded:

“I think that’s an opportunity for us…I do think there could be opportunities to expand the set of partners over time.”

However, in the more than 6 years since that initial question, Carvana hasn’t announced additional banking partners, and has actually increased its concentration with Ally, as noted in the previous section.

After Calling Off An Earlier Agreement In Principle With Carvana Around 2019, A Wells Fargo Senior Manager Told Us: “As We Dug Into It, The More We Learned, The Less We Liked About It”

Former Carvana Exec: There Were “Lots Of Conversations [For New Banking Partners]… But, Always Roadblocks”

The growing concentration with Ally Financial has likely not been by Carvana’s choice, but because other partners have chosen to avoid Carvana’s risky loans.

Around 2019, Wells Fargo was considering becoming Carvana’s second financing partner, according to a Senior Manager at Wells Fargo we spoke with:

“As we dug into it, the more we learned, the less we liked about it.”

They outlined concerns with Carvana’s loan origination practices:

“Their underwriting practices were not something that we were particularly comfortable with.”

The manager recalled a particular example about document checks during origination:

“In one anecdotal example, when we had someone look at a proof of employment or a pay stub, it did not look to be legitimate. So we had significant concerns about some of those controls. To say you work for a large company, your pay stub shouldn’t look like someone built it in Microsoft Word. It should have a little bit more substance to it and look more official.”

Another “deal breaker” was Carvana’s insistence to service the loans via a third party run by CEO Ernie Garcia III’s father:

“We always stood pretty firm on the fact [that] we will never let another company service our auto customers. We want to make sure we’re in control of that experience. We want, based on the regulatory environment, we need to be able to understand if they’re a service member that has a complaint about their rate or repossession, or if they’re claiming any sort of concern that would run us afoul of the regulatory expectations. And so that was a deal breaker for us.”

A former Carvana executive confirmed that there had been many other unsuccessful conversations about additional banking partners:

“There’s been lots of conversations [for new banking partners] that kind of seemed like they could work. And maybe they will at some point. But, always roadblocks.”

As The Subprime Auto Loan Market Declines, Ally Has Amended Its Arrangement With Carvana 5 Times In The Last 2 Years

Each Time, Carvana Redacts Crucial Information From The Market That Would Help Investors Understand The Terms Of The Relationship

Carvana has chosen to redact 33 different metrics in its latest January 2024 amended loan sale agreement with Ally, filed with the SEC. Carvana states this information is both “not material” and deemed “private or confidential”.

The redacted information includes crucial risk metrics like the creditworthiness of borrowers (FICO scores), Loan To Value (LTV) ratios and the size of the loans that Ally is willing to finance.

The lack of information makes it largely a black box for investors trying to understand the sustainability of the Ally relationship.

In February 2023, Carvana’s CEO told investors they “couldn’t be happier” with the Ally relationship. However, after five amendments with Ally since 2022 alone and Ally’s deteriorating credit metrics across its portfolio suggest that while Carvana may be happy, Ally likely isn’t.

Over The Last 2 Years, Ally’s Loan Book Has Become Increasingly Concentrated, With Carvana Loans Rising From 5% Of Its Consumer Auto Portfolio to 8.4%In September 2024, Ally’s Stock Fell 20% After Warning Investors “On The Retail Auto Side, Our Credit Challenges Have Intensified”

Loans purchased from Carvana have become an increasingly concentrated portion of Ally’s loan book. Carvana-sourced loans in Ally’s consumer auto portfolio have risen from 5% in March 2022 to 8.4% in September 2024. [Pgs. 74, 87]

In September 2024, Ally reported an unexpected surge in delinquencies, with its CFO warning: “on the retail auto side, our credit challenges have intensified”. Shares fell almost 20% on the day of the announcement.

(Source: Retail Wire, Retail Industry News Site)

Sales To Ally Have Been Significantly Scaled Back Year To Date Through September 2024

Carvana Sold $2.15 Billion of Loans To Ally In The Period, Only ~35% Of Total Loan Originations (Compared To 60% In 2023)

The sales to Ally seem to have slowed down considerably, both in absolute value and as a percentage of total loan sales.

Carvana sold $2.15 billion of loan originations to Ally in the period (~$2.86 billion on an annualized basis), about 35% of its total. [Pgs. 14, 7] As a reminder, this compares to $3.6 billion in loan sales to Ally in 2023, representing ~60% of its total.

Ally Executive: “We’ve Pulled Back From Them [Carvana] Pretty Significantly In 2024”

Ally’s Commitment To Purchase From Carvana Extends Only To January 10th, 2025, Posing A Near-Term Risk To Carvana’s Business Model

As is reflected in the numbers, an Ally executive told us how the relationship with Carvana had scaled back in 2024:

“We’ve pulled back from them [Carvana] pretty significantly in 2024.”

They explained that this was also a function of the performance of Ally’s broader portfolio:

“A lot of it has to do with our own capital and, you know, liquidity, and performance of some of those older vintages that have been underperforming. There’s maybe an opportunity that we decide to go lean back in a little bit more at some point in time. But right now, we’re kind of, we’re buying a little bit to keep the relationship there, keep the relationship strong, but we have pulled back in a pretty significant way.”

The executive explained generally that they would not buy deep subprime originations from Carvana. When asked if they touch loans in the 567 to 584 FICO score range, they told us:

“We don’t go down there”.

As part of its latest amended agreement, Ally committed “to purchase up to $4.0 billion of principal balances of finance receivables between January 11, 2024 and January 10, 2025” from Carvana.

Given the almost doubling of concentration of Carvana in Ally’s loan book and the challenges caused by increasing auto loan delinquencies, further agreements could come at less favorable terms to Carvana, posing a near-term risk to its business model.

With Ally Quietly Pulling Back, In Q2 and Q3 2024, Carvana Sold $800 Million In Receivables To A New Unnamed Buyer, Which It Claims Is An “Unrelated Third Party”

The New Buyer Made Up 18.3% And 16.3% Of Total Loan Sales In Q2 And Q3 2024

Ally’s pullback has created an even more pressing need to find a new financing partner.

In May 2024, Carvana sold $400 million of fixed pool loans of “finance receivables” to an unnamed and “unrelated third party”, per its quarterly report. [Pg. 13] The following quarter, Carvana sold another $400 million of fixed pool loans to the same buyer. [Pg. 15]

The filings make clear that the sales to the unnamed buyer were “on terms substantially similar” to Carvana’s deal with Ally, indicating that Carvana found a savior precisely when it needed it.

The new purchases accounted for ~18.3% and 16.3% of Carvana’s total finance receivable sales in Q2 and Q3 2024, respectively.[5]

Given its historical dependence on Ally for financing, and management’s repeated assurances that it was looking to diversify, the introduction of a significant new buyer for Carvana’s loans would seemingly be a materially positive event, worthy of mention. However, Carvana chose not to say anything about the new relationship during its Q2 and Q3 2024 earnings calls.

We asked Carvana’s investor relations for more information on the mystery buyer. They said they don’t name counterparties aside from Ally, but insisted again that “this loan buyer is not a related party”, describing it as “a large, name-brand asset manager”.

Lien Filings Reveal The Buyer Is Likely A Trust Affiliated With Cerberus Capital

Carvana Director Dan Quayle Is Cerberus’ Chairman Of Global Investments, Indicating The New Buyer Is An Undisclosed Related Party, Contrary To Carvana’s Claims

Despite Carvana’s lack of disclosure, we believe we have identified the likely financier using Arizona lien filings. Contrary to the company’s claims, the financier appears to be an undisclosed related-party.

Arizona records show that two newly formed “Towd Point Auto” trusts filed liens on a series of Carvana’s loan receivables in May and August, respectively, matching the dates in Carvana’s filings for when it issued receivables to the mystery financier.[6]

(Source: Arizona UCC Search)

Exhibits to the records confirm the liens are for vehicle receivables, further evidencing that the “Towd Point” trusts were the mystery buyer:

(Source: Arizona UCC Filing, [Pg. 2])

Corporate records from the state of Maryland show that the principal offices of both “Towd Point Auto” trusts are located on the 10th floor of 875 Third Avenue in New York – the headquarters of Cerberus Capital Management, a “large name-brand asset manager”.[7] [8]

(Source: Maryland Entity Search)

Cerberus registered the “Towd Point Auto Trust 2024-A3” with ISDA using the email address cerberusswaps@cerberus.com, and using the contact name for Cerberus managing director Marc Toscano, confirming the link between the trusts and Cerberus.[9]

While Carvana explicitly claims in filings that the new buyer of its fixed pool loans is an “unrelated third party”, one of Carvana’s longstanding directors, Dan Quayle, is a member of Cerberus’ “senior leadership team” and the Chairman of Cerberus Global Investments.

(Source: Carvana Website)

Since the trusts appear to be controlled by or affiliated with Cerberus, we believe the company should provide more transparency around these deals, and explicitly mention whether these are the unnamed buyers referenced in filings.

Notably, despite not selling a single share since Carvana’s IPO, Dan Quayle sold almost half of his Carvana holdings in May 2024, the same month as the first transaction with the suspected Cerberus affiliate, a total of ~$3 million.

A third trust, “Towd Point Auto Trust 2024-A3,” was incorporated on October 29th, indicating that Carvana could be preparing for yet another opaque deal with a Cerberus affiliate.[10]

Part II: Carvana’s Lax Underwriting Has Resulted In A Uniquely Toxic Portfolio In An Industry Already Facing Stress, Threatening Its Entire Business Model

Straining its financing prospects, Carvana’s loan portfolio is showing signs of being highly troubled in an industry already facing major economic headwinds.

Carvana’s “Originate To Sell” Model Is Highly Skewed To Packaging Non-Prime And Sub-Prime Borrower Loans

“I Don’t Think The Model Is Much Different Than What We Saw With Kind Of The Early 2000 Mortgage-Backed Securities” – Former Carvana Director

Large Institutional Trader When Asked Who Is Buying Sub-Prime Auto Paper: “I Wouldn’t Even Call Them Flippers. They’re Just Morons.”

As we investigated Carvana, it became apparent that the company is skewed to non-prime and sub-prime borrowers, usually with low credit scores and few financing options available to them.

Carvana has very few restrictions on lending, merely requiring that a loan applicant have annual income of $5,100, be over 18 and have no active bankruptcies.

A former marketing head at Carvana told us that subprime was a focus behind the scenes, despite the company projecting a different image:

“When they would talk about the SEM [Search Engine Marketing] keywords that they were using. One of the most expensive but highest ROI areas was … ‘low credit’, ‘bad credit’ auto loan… if you look at their general marketing, nowhere in it does it say this is really great for people with subprime credit. But that is, I think, behind the scenes they are doing a lot to push that market.”

A former finance director went on to characterize the type of customers as:

“The sort of people that may get turned down from a different dealership or get quoted [an] unreasonable down payment.”

As an executive at closest competitor CarMax told us, Carvana’s business was becoming ever more like its CEO’s father’s sub-prime car dealership DriveTime. DriveTime specializes in providing finance to subprime and no-credit customers:

“Really what Carvana is evolving to is the online version of DriveTime with the son now. Ernie Garcia the third… This is going to be the online DriveTime called Carvana…

…Carvana is largely going to do the same thing: target the distressed consumer with a lower priced vehicle that’s not quite up to adequate standards of quality, and make it an easy process.”

Almost 44%, or ~$6.8 billion, of Carvana’s Receivables Trust (i.e. loans its sell in in ABS deals) are non-prime, with average weighted FICO scores ranging from 567 to 584, per Carvana’s filings and Morningstar.

(Source: Morningstar Pre-Sale Report, September 2024 [Pg. 14])

Given that 9 out of 11 of the above tranches have weighted-average FICO scores below 580, these loans are not just considered subprime, but “deep subprime”, according to the CFPB.

(Source: Consumer Financial Protection Bureau)

A former Carvana director even compared the subprime model to “early 2000 mortgage-backed securities”:

“I don’t think the model is much different than what we saw with kind of the early 2000s mortgage-backed securities.”

When we asked a large institutional credit trader and fund manager in the ABS market who was buying most of this sub-prime auto paper in the market, they told us, quite bluntly:

“The funny thing is the people buying this are… I wouldn’t even call them flippers. They’re just morons. Like, they don’t do any work. They just say, ‘Oh my god, the hot market. Let me buy.”

“We Actually Approved 100% Of The Applicants”: Interview With Former Carvana Director Describing Virtually Non-Existent Underwriting Standards

Generally, most loan originators have risk parameters dictating who they lend to, especially in cases where underlying assets depreciate quickly (like in autos) and where the cost and time to repossess is high.

Carvana’s website states that 99% of applications are approved within 2 minutes.

(Source: Carvana)

We spoke to a former director at Carvana who left towards the end of 2023 and told us they accepted all applicants fitting the minimal criteria:

“Like if people are under 18, you can’t give them a loan no matter what. Various other stuff like that. We actually approved 100% of applicants we didn’t decline for compliance reasons. And the way we managed risk was through down payment… Compared to banks, I think it’s probably substantially more risk tolerant.”

Increasing Underlying Credit Risk: As of September 2024, Carvana Has Issued Over $15.4 Billion Of Asset Backed Securities (ABS), Which It Retains Partial Interest In On Its Balance Sheet

60-Day Delinquencies Across Its Supposedly “Prime” Borrowers Are Over 4x Industry Averages

“Those Numbers… My Heart Might Have Skipped A Few Beats…. Those Loss Numbers Are High. The Delinquencies Across 30/60 Buckets Are High” – Former Ally Financial Executive

As noted earlier, in addition to its loan sales to Ally, Carvana uses the ABS market to package up loans and sell them to investors. This market cannot always be relied upon to find loan buyers, as was acknowledged by Carvana’s CEO on its Q3 2022 earnings call.[11]

Unlike its deal with Ally, when Carvana sells loans through its securitization deals, investors can assess certain details on loan composition and performance through Carvana’s disclosures and through credit rating agencies like Morningstar.

As of September 2024, Carvana had issued over $15.4 billion of ABS, which it keeps at least a 5% interest in via variable entities on its balance sheet, per Carvana’s trust report and 10-K.

Delinquency data found in the trust reports show that 31+ day delinquency rates have increased from 5.13% in December 2021 to 8.67% in September 2024 across both prime and non-prime borrowers. 61+ day delinquency rates have more than doubled, from 1.76% to 3.93% over the same period. [1 2]

(Source: Trust Report September 2024)

Specifically, for its prime borrowers, 61+ day delinquencies are over 4x the industry average of 0.3%, at 1.3% for Carvana’s ABS, per credit rating agency Fitch.

(Source: Trust Report September 2024)

When we asked a former executive at Ally Financial about similar delinquency data from the June report, he told us:

“Those numbers were like—my heart might have skipped a few beats if I was still working there [at Ally]… The loss numbers are high. The delinquencies across 30/60 buckets are high.”[12]

The comments and the stark data compared to industry averages hearkens back to when the company barely staved off bankruptcy two years ago, after its loan originations worsened and the ABS market became more difficult to access.[13]

Carvana’s Sub Prime Loans Had The Highest Increase In “Extensions” Of Any Sub Prime Auto Issuer, A Major Sign Of Stress, Per The Most Recent S&P Data

Over The Last Year, Carvana’s Sub Prime Loan Extensions More Than Doubled, While Most Peers Saw Declines

When auto loan borrowers run into financial stress or difficulty, lenders may offer loan extensions in the hope that the borrowers are able to figure out a way to eventually pay it back.

Loan extensions and modifications have often been part of more dubious “extend and pretend” schemes, where lenders inappropriately delay recognizing stress upfront and “extend the maturity of a loan to avoid recognizing a loss”.

Over the last year, Carvana’s extensions in its subprime loan securitization deals have increased from 1.97% of overall loans to 4.18%, more than doubling, per a report by credit rating agency S&P.

During the same period, the average of all other non-prime/subprime issuers went down, from 3.53% to 3.42%.

(Source: S&P Global Report, November 14th, 2024)

Carvana’s loan extension increase was the largest over the last year among the whole universe of 23 issuers tracked by S&P. The next largest loan extender by percentage in the S&P universe was DriveTime, the Carvana CEO’s father’s related-party dealership.

By contrast, most issuers (69%) saw their loan extensions go down over the year period.

(Source: S&P Global Report, November 14th, 2024)

As Carvana has targeted higher risk, lower credit score customers with minimal lending standards to fuel growth, it has now run into increasing signs of stress. In response, Carvana borrowers have been allowed to ‘kick the can’ further down the road through extensions.

Why Might Carvana’s Loan Servicer Be Granting Mass Extensions To Borrowers, Rather Than Recognizing More Delinquencies?

The Servicer Of Carvana’s Auto Loans Is An Affiliate Of “DriveTime”, The Private Car Dealership Run By Carvana’s CEO’s Father

Often, the function of loan servicer is separated from the loan originator so that the servicer can act in the best interest of lenders. Contrary to that practice, Carvana’s loans are serviced through an affiliate of the private car dealership owned by CEO Ernest Garcia’s father.[14]

This lack of separation is partly why, as noted earlier, prospective financing partners like Wells Fargo backed away from working with Carvana, per our interview.

As Carvana’s loans have faced increasing stress, its related-party servicer seems to have opted for granting mass-extensions rather than recognizing delinquencies.

As we found, Carvana’s servicing relationship is just one of many related-party accounting levers that the company seems to be using to prop up its numbers.

Part III: With Its Market Collapsing, Carvana Has Propped Up Its Numbers Through A Grab Bag Of Related-Party Accounting Games

In its proxy statement, Carvana’s policies state that it can engage in related-party transactions that are favorable or better than comparable options:

“The Board may approve transactions only if it determines that the transaction is on terms no less favorable in the aggregate than those generally available to an unaffiliated third party under similar circumstances”.[15]

While this statement seems innocuous at first read, our findings show that it has opened the door for vastly favorable related-party deals that can prop up Carvana’s recent financials and create the appearance of growth and profitability, while allowing key insiders to dump $1.6+ billion in overvalued stock.

In Fiscal Year 2023, $145 Million Of “Other Revenue” Or ~8.4% Of Gross Profit Came From Related Parties

This Includes $138 Million Of Commissions And Profit-Share From DriveTime

In FY 2023, Carvana generated $145 million of “other revenue” from related parties, per its 10-K. Given that these sales are “100% gross margin”, this is ~8.4% of Carvana’s total gross profit. The figures include $138 million of commissions on extended warranties, as we discuss below.

Carvana Appears To Be Dumping Unreported Costs Of Extended Warranties Onto Related-Party DriveTime, Resulting In Artificially Inflated Revenue And Profitability

A Former Carvana Leader Told Us That Warranty Reimbursements From Related-Party DriveTime Were “Pretty Generous… Back To Carvana” And Confirmed This Was Done To Show Better Revenue To Investors

As noted earlier, DriveTime is a car dealership run by the Carvana CEO’s father, Ernest Garcia II.

DriveTime administers Vehicle Service Contracts (“VSCs”, or extended warranties) that Carvana offers to its customers. As part of this financial arrangement, when a sale is made, Carvana takes a commission at the time of sale, recognizes revenue immediately and also has a profit sharing agreement based on performance of the warranties. It also pulls forward “excess reserves to which it expects to be entitled.” [Pg. 13]

Carvana’s investor relations head, Mike Mckeever, told us in a December 2024 email that “these are arm’s length transactions.” However, Carvana’s financial statements state that transactions with DriveTime are “not always negotiated at arm’s length”, per its most recent 10-K.

We followed up and asked, “beyond just declaring the related-party transactions to be arms-length, can you share more metrics on the deals themselves?”. The company responded:

“We have not shared publicly the breakdown of attach rates or counterparty economics for any of our ancillary products.”

Despite Carvana’s insistence without specific evidence of the “arm’s length” nature of the transactions, a former director at Carvana told us that the warranty reimbursements [profit share] back to Carvana were unusually generous:

“I mean, related party—it’s a pretty generous push back to Carvana to be completely honest… Both of them being primarily owned by the Garcia family — they’re going to get a higher multiple on that revenue back within Carvana versus as a standalone… The rates, I would say, are pretty generous in terms of the reimbursements back to Carvana post claims.”

They confirmed that this meant the terms were favorable to Carvana, which reports its financials publicly, and likely to the detriment of private company DriveTime, which has no obligation to report its financials publicly.

A current executive at CarMax suggested DriveTime may be taking substantial losses to prop up its stock so Ernest Garcia II can sell:

“So if you look at extended warranty and service. And you think about the fact that Ernie Garcia senior owns a major piece of Carvana. And DriveTime’s private so he could be taking substantial losses on the DriveTime side, providing service and logistics to Carvana. I mean, substantial losses because he’s going to benefit with his stock options and ownership structure on Carvana.

I’m not accusing them of anything, I’m just saying that we’ve looked at this… this is one where we’ve looked at it and we can’t explain some of it, and we know this industry better than anybody… There’s a high likelihood something is happening between the related parties.”

While DriveTime is opaque with its financials, in 2023 we found a glimpse into its operations through a report from Asset Securitization Report, a structured finance publication. DriveTime reported a net loss of $69.3 million at year end December 2023, per the report.

We Estimate Carvana Reports ~58% More Warranty Income Per Sale Due To An Overly Favorable Relationship With The Private Entity Controlled By Its CEO’s Father

The Result: Further Propping Up The Public Entity’s Financials While The Private Entity’s Financials Are Shielded From View

Carvana seems to intentionally obfuscate the economics of its warranty deal with DriveTime. While Carvana reports aggregate warranty sales, it does not break out details of the profit splits with related-party DriveTime or other key metrics which could be used to calculate the economics of the arrangement. On its Q3 2017 investor call, CFO Jenkins stated in response to a question:

“We don’t plan to break out the specific attachment rates (i.e. the portion of customers buying warranties) and metrics at the customer demographic level in general.”

By contrast, Carvana’s closest peer, CarMax, freely discloses these key metrics, like the attachment rate and the profitability of its extended warranties. With this information, we were able calculate that CarMax makes around $949 per unit sold on warranties.

In comparison, we estimate Carvana’s warranty income is ~58% higher than CarMax’s, at around $1,500 per unit sold on warranties.[16]

Given that Carvana refuses to disclose its attachment rates (i.e., the percentage of customers buying extended warranties), we derived a 30% attachment rate estimate based on interviews. A former Carmax executive told us based on their own business intelligence:

“Carvana is probably somewhere in the 30% [range]. CarMax tends to be around double that.”

We also asked a former Carvana director familiar with its warranty metrics about the attachment rate. They called the 30% estimate “directionally correct”, saying Carvana’s attachment rates are around “half of the industry average”, likely due to higher warranty prices and Carvana’s sales taking place mostly online versus in-person with a salesperson upselling warranty coverage.

When we asked Carvana’s investor relations for attach rates and profitability per VSC, they responded by suggesting we divide the total VSC revenue by the total number of vehicles sold, regardless of whether the vehicles were sold with a VSC or not. This approach makes little sense when trying to assess profitability per VSC sold and the economics of dealings with DriveTime.

We think the company should provide more transparency around its warranty sales and clarify its deals with DriveTime.

Carvana Says In Its Annual Report That It Is Entitled To Receive Profit-Sharing Revenues From Warranties It Sells “Once A Required Claims Period Has Passed”

A Former Director Told Us: “As A Related-Party, We’re [Carvana] Able To Kind Of Have An Agreement That Is Favorable To Pull As Much Of That Profit Forward”

In an extended warranty plan, the administrator of the plan sets aside reserves based on expected claims over the lifecycle of the contract.

Carvana has a profit sharing agreement which entitles it to receive revenue from DriveTime based on the performance of those warranty plans, i.e., if claims from customers are lower than expectations, they can share in the profitability.

Carvana notes that consideration is recognized as revenue “to the extent that it is probable that it will not result in a significant revenue reversal”. [Pg. 69]

A former director at Carvana told us:

“They’ll [DriveTime] give you a buffer and then everything else they can push up front because they know that there’s, in effect, minimal risk to them… And so, as a related party, we’re [Carvana] able to kind of have an agreement that is favorable to pull as much of that profit forward, which allows us to obviously have it up front… adds more value in present day versus 2, 3, 4 years down the road.”

Carvana does not disclose how much profit is booked upfront at the time of originating these extended warranties.[17]

Instead Of Marking Down Inventory, Carvana Can Offload Cars To Related-Party DriveTime At A Premium To Fair Market Value

“[Selling Cars To DriveTime Is] A Lever That’s Not Talked About… It’s Kind Of Like Fight Club…There’s Certain Things We Don’t Talk About, And We Don’t Talk About DriveTime” – Former Carvana Director Responsible For Wholesale Inventory

Over The Last 3 Fiscal Years, Carvana Has Generated $105 Million Revenue From Selling Cars Wholesale To DriveTime

In a low margin business like wholesale cars, a subset of highly profitable transactions can significantly “move the needle” on gross profitability.

In the last 3 fiscal years, Carvana has generated $105 million from selling cars to related-party DriveTime, per its 10-K.

A former director at Carvana, responsible for managing inventory and wholesale vehicle sales, told us that DriveTime could be used as a lever to elevate earnings by buying inventory at inflated prices when Carvana was faced with marking inventory losses:

“So here’s what happened… the market drops off. Oh wow—we’re 2,000 cars over inventory, right? Well what are we going to do? You got two options. You can mark the prices down on current retailable units and lose money there. Or let’s call up DriveTime and see if they can take, you know, 1,500 of these off of our hands at what we own [them] for. Now, we’re not over inventoried anymore.”

They went on to explain that this lever of selling vehicles to a related-party at higher valuations was kept quiet:

“It’s a lever that’s not talked about… when you’re in Carvana, it’s kind of like Fight Club…there’s certain things we don’t talk about, and we don’t talk about DriveTime. But it was there. It was an option. That’s Ernie’s dad’s company, right. And it’s not public. And at the end of the day, it’s like if my kids had a car lot and I had a car lot and they needed it, I’m going to go over and buy 1,500 of your cars, too.”

Carvana Engaged In “Sham” Deals With DriveTime, Along With Numerous Other Improprieties, Per A 2024, 332-Page Amended Class Action Lawsuit Brought By Two Pension Funds, Which Included Information From 12 Confidential Witnesses

Two pension funds brought a class action lawsuit against Carvana and its executives, alleging they carried out a fraudulent “pump and dump scheme”, per a 2024 amended complaint. [Pg. 41] The case remains ongoing.

(Source: Carvana Class Action Litigation Table of Contents)

The 332-page complaint covers a series of allegations (including some issues mentioned in this report) and contains information from 12 confidential witness.

One allegation is that Carvana entered into a “sham related-party deal” with DriveTime as early as 2021. [Pg. 43] As part of the alleged sham, Carvana paid DriveTime for vehicles it would sell and then remit the proceeds back to DriveTime for no economic benefit, as a means to artificially boost reported sales. [Pg. 43]

Quantifying the impact of these alleged sham transactions, the deals reportedly made up 19% of Carvana’s Q3 2021 unit sales growth and 169% of Carvana’s Q4 2021 unit sales growth, its number one growth metric. [Pg. 44 & Pg. 26]

(Source: Class Action Lawsuit, Complaint [Pg. 44])

Carvana’s “Independent” Audit Committee Has Two Individuals That Served On The Board Of Related-Party DriveTime

One “Independent” Member Of The Audit Committee, Greg Sullivan, Was Previously Suspended By The New York Stock Exchange After He Sent Money To Carvana’s CEO’s Father In Contravention Of A Prohibition Order, Per Legal Records

The board audit committee is critical for investor protection and is meant to be an independent function at all listed companies. It helps oversee financial reporting, risk control, ethics and compliance. Audit committee members must take an active role in asking “probing questions”, per BDO.

Obviously, companies wanting to demonstrate sound corporate governance try to avoid hiring old friends or long-time associates of related parties. This is especially true if independent directors are meant to oversee the very people they were previously accused of engaging in financial misconduct with.

Carvana even has an employee code of conduct which states “we will never be sneaky” and emphasizes “our customers trust us to be accurate, truthful and transparent.” [Pg. 10]

But Carvana fails to mention in any documents we could find that Greg Sullivan, a board member since Carvana’s IPO in 2017 and member of the audit committee, was involved with Carvana’s CEO’s father during the scandal that resulted his felony conviction, per litigation records.

(Source: Carvana Proxy Statement)

(Source: Shareholder litigation [Pg. 14])

Sullivan was later suspended by the New York Stock Exchange in 1992 for 6 months. The reason for the suspension was that Greg Sullivan ignored a prohibition imposed by the NYSE in repaying creditors of the brokerage where he was Managing Director. The creditor who he decided to repay, in violation of the rules, was Ernie Garcia II, father of Carvana’s CEO, per the litigation records. [Pg. 14]

(Source: Stockholder Litigation Complaint, 2021 [Pg. 14])

Sullivan was then employed by DriveTime, where he was president from 1995 to 2004, per his LinkedIn profile. He was then Vice Chairman from 2004 to 2007, per litigation records. [Pg. 15]

The Chairman of Carvana’s audit committee, Ira Platt, also has long-standing links to the Garcia family. Platt acted as a banker for DriveTime (then called Ugly Duckling) stretching as far back as 1998, per SEC records. He is named on stock pledge agreements, loan agreements, and bond placements, among others.

He was elected as a Director of DriveTime in February 2014, serving until 2017, per his LinkedIn. Like Sullivan, Platt also joined Carvana at the time of the IPO in 2017. A Delaware entity he manages, “GV AUTO I LLC”, has benefited from a tax structuring agreement with Carvana.[18]

Part IV: A Litany Of Additional Accounting Tricks And Issues

Beyond its questionable related-party deals, we found other aggressive accounting practices and red flags.

Carvana CEO: “We Don’t End Up Taking The Credit Risk Over An Extended Period Of Time”

Yet Carvana’s Loans Held On Its Books Have Increased 50% Since 2021, To $553 Million In Q3 2024

Carvana Records No Loss Reserves On These Loans At Booking, In What One Former Director Called A “Relatively Aggressive Accounting Practice” That Leads To Earnings “Volatility”

Carvana’s CEO told investors at an August 2024 conference:

“Part of our business is we provide financing to our customers. We then sell those loans off. We don’t end up taking the credit risk over an extended period of time.”

Despite this claim, nearly every quarter, Carvana carries hundreds of millions of dollars in loans on its balance sheet. Since 2021, loans held on its balance sheet have increased by 50%, from $368 million to $553 million despite retail unit sales decreasing during that time. [1 2]

(Source: Carvana Financial Statements [1,2,3,4])

Normally, companies use the current expected credit loss (“CECL”) model to record loss reserves at the time of origination. However, Carvana designates all its loans on balance sheet as “held for sale”, meaning it only must make allowances for impairments when they occur. A former director confirmed this:

“Carvana’s stance is we don’t hold loans, we just sell loans. Therefore, we’re not going to book any loss reserves at time of booking… it’s a relatively aggressive accounting practice but there are arguments that can be made on why it’s the right thing, because if you don’t do that, the volatility of the earnings just increases significantly.”

This accounting treatment helps Carvana avoid provisioning for loan losses upfront, improving current period profitability.

Carvana provides zero clarity around the nature or vintage of held for sale loans that sit on its balance sheet, making it impossible for investors to assess the risks of carrying over half a billion dollars in loans on its books.

A Former Executive Confirmed That By Holding Loan Sales Over The Quarterly Line, Carvana Could “Move Very Large Amounts Of Income Around Quarter To Quarter”

On May 4th 2023, Carvana Reported Q1 2023 Earnings, Showing A 41% Reduction In Year-Over-Year Loan Sales, Swinging Carvana’s Adjusted EBITDA Into The Negative Amidst Growing Bankruptcy Concerns

CEO Ernest Garcia III Blamed The Delayed Loan Sales On “Uncertainties” In The Securitization Market

Normally, a business that originates and sells high-risk loans will “de-risk” its own balance sheet as soon as it can after loan origination. As described above, Carvana records no loss provisions and books the “gain on loan sales” when they are sold.

A business like this looking to manipulate earnings could easily delay selling loans and warehouse them on its balance sheet at the end of a quarter if it wanted to pump up future quarterly earnings. This sort of behavior is commonly referred to as “cookie jar accounting”.

A former Carvana executive with knowledge of loan sales told us:

“The stance [of Carvana] is basically if you sell the loans quarterly and you expect to sell the loans quarterly, you shouldn’t have to book the CECL (Expected Credit Loss). It does mean that during the time periods where you hold loans over quarter to quarter, you can move very large amounts of income around quarter to quarter.”

According to the former executive, Carvana “undersold” loans starting in Q4 2022.

“So, like in Q4 of 2022. They undersold loans by a lot. So, they originated way more loans than they sold”.

The following quarter, sales remained heavily deflated. In Q1 2023, Carvana reported a 41% reduction in year-over-year loan sales. As a result, the revenue it booked from “gain on loan sales” plummeted by 39% and its total gross profit per unit fell by 51%.

(Source: Carvana Financial Statements [1,2,3,4,5,6,7,8])

During the Q1 earnings call, CEO Ernie Garcia III claimed that they sold “slightly less” than the normalized volume of loan sales due to “uncertainty in the securitization market.”

With The Stock Price Depressed From Poor Loan Sales, On July 17, 2023, The Garcias Signed An Agreement To Purchase $126 Million In Carvana Stock

2 Days Later, Carvana Announced The “Best Quarter In Company History,” Featuring A Massive Earnings Beat From Re-Accelerated Loan Sales, And A Successful Restructuring Of Its Debt

At Today’s Prices, The Garcias Are Up ~$427 Million On Those Precisely-Timed Purchases

While decelerated loan sales led to negative adjusted EBITDA for Q1 2023, the Garcias took the opportunity on July 17th to sign an agreement to purchase $126 million in stock, eventually paying ~$37 per share.

Two days later, Carvana announced the “best quarter in company history,” including the successful restructuring of its debt and positive adjusted EBITDA driven by re-accelerated loan sales, fueling its ‘comeback’ and sending the stock soaring to ~$57 intraday, per FactSet.

Gain on loan sales increased 134%, from $64 million in Q1 2023 to $150 million in Q2 2023, contributing ~30% to total gross profit during that quarter, resulting in what appears to be an engineered earnings beat just ~48 hours after the Garcias agreed to a large stock purchase.

At today’s prices, the trade has resulted in an estimated gain of over $427 million for the Garcias.[19]

In Q3 2024, Carvana Reported $3,497 In Retail Gross Profit Per Unit (Retail GPU), A Key Metric Tracked By Investors

Carvana Inflates This Key Metric By ~34.5% By Dumping An Estimated $390 Million Of Selling Costs Into SG&A Annually, In Stark Contrast To Accounting Practices At Competitors

One of Carvana’s most important metrics is Retail GPU (gross profit per unit), which is defined as the gross profit from vehicle sales minus the costs associated with those sales.

Given that nearly 70% of Carvana’s business comes from selling cars directly to the public (the “retail business”), Retail GPU is a metric investors use to try to understand how profitable Carvana’s vehicle sales are.[20]

In Q3 2024, Carvana reported Retail GPU (GAAP) of $3,497. However, this metric doesn’t include three of the most basic costs associated with selling a vehicle, which Carvana instead lumps into SG&A:

Limited Warranty – Carvana discloses that costs related to its limited warranty are expensed to “other SG&A”, despite its belief that “industry peers generally include these expenses in cost of sales”. In Q3 2024, Carvana expensed $31 million in warranty claims, or ~$285 per vehicle based on Q3 2024 sales of 108,651 retail units. Additionally, in Q3 2024, Carvana paid DriveTime $5 million to administer the warranties, ~$46 per vehicle based on Q3 2024 sales of 108,651 retail units.[21]
Outbound Logistics – Carvana also lumps the cost of “outbound logistics”, or vehicle delivery, to “other SG&A”, despite its belief that “industry peers may include these expenses in cost of sales”. In Q3 2024, Carvana expensed $29 million in logistics expenses to “other SG&A”, or ~$267 per vehicle based on Q3 2024 sales of 108,651 retail units.
Title & Registration – Finally, Carvana doesn’t include “transaction expenses” in cost of sales, such as title and registration fees, unlike competitors AutoNation and CarMax.[22] In a May 2022 presentation, Carvana stated that its “midterm” goal was $300 in transaction expenses. Assuming Carvana achieved this target, we estimate it expensed ~$32.6 million in transaction expenses to “other SG&A” in Q3 2024 based on 108,651 retail unit sales in the quarter, or approximately $300 per vehicle.

Taken together, we estimate that Carvana his shifted ~$97.6 million in selling expenses to “other SG&A” in Q3 2024 alone, or approximately ~$390 million annually. This has resulted in Carvana inflating its Retail GPU by approximately $898, or 34.5%.[23]

In August 2023, Carvana Told Investors Its Cost Reduction Measures Had Not Come At The Expense Of The Quality Of Cars It Sells

But A Former Carvana Reconditioning Leader Told Us The Company Adopted A Two-Tier Policy And Lowered Quality Standards For “Economy Line” Cars:

“They Did Make An Adjustment To The Standards, But Only For That Segment. They Call It Their Economy Line. I Don’t Think They Talk About That. They Don’t Advertise It That Way.”

When a company engages in a major cost cutting exercise to stave off bankruptcy concerns, the natural question would be whether this can be done without sacrificing product quality. Given that repairing cars (as opposed to manufacturing them) is broadly a function of the cost of parts and labor, at some point, there’s an obvious trade-off between quality and cost.

At a J.P. Morgan auto conference on August 9th, 2023, Carvana’s CFO assured investors that it succeeded at implementing major sustainable cost reduction measures without sacrificing quality—the used car market equivalent of discovering a unicorn:

“Our vehicle quality metrics have been stable, which means these fundamental improvements are not coming at the cost of reconditioning quality.”
(Source: J.P. Morgan August 2023 Presentation [Slide 7])

Carvana further tells investors that it applies “universal standards” in its investor presentation.

However, we spoke to a former leader responsible for overseeing reconditioning at Carvana, during the restructuring. They told us quite clearly that Carvana adjusted standards:

“They [Carvana] did make an adjustment to the standards, but only for that segment. They call it their economy line. I don’t think they talk about that. They don’t advertise it that way.”

We asked for specific examples:

“Brake pads. They would replace them at a certain point, and they lowered it to basically what the industry standard is.”“They made a lot of adjustments to the cosmetic standards. That allowed them to first get the cars through quicker, do less work and put less money into those units… the economy line, for instance, you may be allowed more dents on the low visibility [below the wheel arch] as opposed to the regular standard.”

Another former director confirmed the differing reconditioning standards for certain vehicles, noting it was part of many unwritten rules at Carvana:

“If you look at any document or any SOP [standard operating procedure] written on [Carvana’s] internal website, there’s never any note of an economy line or anything else… you would never notice that there was, that these cars get a different treatment… there were a lot of unwritten policies at Carvana.”

Part of the reason for this is because Carvana has begun to pursue lower quality cars. As one former reconditioning unit head explained:

“When I first got there, the vehicles that were coming in were immaculate. But once Covid hit, like I said, Covid came around…the cars we started getting were looking like they were out of a war zone. They were really, really bad… they [Carvana] would accept anything” – Carvana reconditioning site manager.

Not only is Carvana reconditioning less over time, Carvana’s process to buy from customers (called “sell to Carvana”) has limited checks to prevent it getting sold “lemons”.

It appears that instead of being transparent of the trade-off between cost and quality in reconditioning cars, Carvana chose a deliberate strategy to reduce quality and hide it, per the former leader.

Accounting Red Flag: Carvana Has Used Mid-Tier Auditor, Grant Thornton, For Over 10 Years, Since Its Pre-IPO Days. Grant Thornton Also Has/Had A Relationship With Related-Party DriveTime

“We Are Not Doing What The Market Thinks. We Are Not Looking For Fraud…We Are Not Set Up To Look For Fraud” – Former Grant Thornton CEO

Overseeing all this is Carvana’s mid-tier auditor, Grant Thornton, which has had a 10+ year relationship with the company, from even before going public. At a $44 billion market cap, one might reasonably expect Carvana to consider rotating to a larger, “Big-4” auditor. Carvana is now the third largest U.S.-listed client by market cap for Grant Thornton.[24]

Grant Thornton also appears to have a relationship with DriveTime, the private related-party owned by the father of Carvana’s CEO. Previous registration documents with the SEC show Grant Thornton audited DriveTime as far back as 2010.

In 2024, Grant Thornton’s website featured a glowing tribute to DriveTime under its “audit services” section, per internet archives. The section was removed from the site in the past several months.

(Source: Wayback Machine archive of Grant Thornton website)

For those that haven’t discovered ‘the hard way’ over the last few decades that auditors don’t always protect investors from fraud, the former CEO at Grant Thornton UK, David Dunckley, clearly disclaimed this in a 2019 British parliamentary enquiry:

“We are not doing what the market thinks. We are not looking for fraud and we are not looking at the future and we are not giving a statement that the accounts are correct…we are not set up to look for fraud.”

Carvana Is Subject To An Undisclosed SEC Investigation, Per Disclosure Insight, A Freedom Of Information Act (FOIA) Intelligence Firm

“We Know The Company Stayed Silent On Two Recent Investigations”, One Of Which Is Ongoing”—Disclosure Insight In August 2024

In March 2020, the company disclosed that it had received a “voluntary request from the SEC”, regarding “related party disclosure[s] and accounting policies and procedures for historical loan sales and refinancings”.

Over 4.5 years later, Carvana has remained silent on interaction with investigative agencies. Analysts haven’t questioned management about this on investor calls.[25]

Disclosure Insight, a FOIA intelligence firm, notes that it has “learned [that] there are two undisclosed SEC investigations here”, one of which remains ongoing, in an August 29, 2024 report.

(Source: Disclosure Insights)

We think the company should clarify any investigation it faces with regulatory agencies.

Conclusion: We Think The Garcias Will Leave Shareholders With Nothing

Many business leaders look for win/win situations where shareholders, partners and everyone that creates value can then derive value from those contributions.

Others treat business more parasitically, viewing every counterparty as an opportunity to extract as much as possible, leaving others with nothing.

At any point in Carvana’s first incredible run, the Garcias could have derisked the balance sheet by raising significant capital at its then-lofty valuations. Instead, facing an impending collapse, they hyped their prospects and raised modest capital while Garcia II sold $3.6 billion in stock.

As the numbers tanked, they seemingly pulled accounting levers to make them even worse. This enabled Carvana to extract a renegotiated debt package that wiped out principal and pushed off cash interest, essentially stiffing lenders, before pulling levers to kick off the next big rally.

With the numbers rocketing higher in this second incredible run, the company again could have derisked the balance sheet by raising significant capital at lofty valuations.[26] They could have made it sustainable. But instead, the priority again seemed to be raising only modest capital while enabling Ernie Garcia II to sell another $1.4 billion in stock.

In the end, the Garcias will bank billions. For customers, they face the prospect of inferior or potentially dangerous cars due to cost cutting measures favoring the bottom line over quality and safety. For shareholders and debtholders, we expect they are in for rough times ahead.

P.S. We want to thank the literally dozens of people who reached out to us, imploring us to look into Carvana, from the used car dealers and industry experts across the country to the average investors that sniffed out that something (or many things) weren’t quite right.

Disclosure: We are short shares of Carvana Co. (NYSE:CVNA)

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[1] Retail vehicle gross profit excludes gains from financing and wholesale sales. When including these categories, the company reports $7,427 in gross profit per vehicle, a virtually unheard-of metric in the used car industry. [Pg. 48]

[2] Includes short-term facilities ($76 million), current portion of long-term debt ($209 million) and long-term debt ($5,431 million) minus cash and equivalents ($871 million). LTM Adjusted EBITDA from September 2024 is $1,079 million. [1, 2]

[3] Description provided by Bloomberg “MUVINDEX”.

[4] For example, Wells Fargo in a note entitled “The Good Ole Days Are Back Again”, dated August 1st, 2024, wrote that they see considerable long-term opportunity in Carvana as a result of “sustainable/growing profitability”. JP Morgan’s investment thesis described a “more profitable and nimble operator” (see upgrade dated May 2nd, 2024.)

[5] In Q2 2024, Carvana generated $2,187 billion in total sales of finance receivables, of which $400 million or ~18.3% came from the unnamed new buyer of fixed pool loans. We calculated this by subtracting Q1 proceeds from the sale of receivables from the 6 month as of June 2024. In Q3, Carvana generated $2,452 billion in proceeds from sales of finance receivables, of which $400 million, or ~16.3% came from the new buyer of fixed pool loans. We calculate this by the subtracting the 6 month proceeds from the sale of receivables, from the 9 month as of September 2024.

[6] To replicate this search, navigate to Arizona’s UCC Lien Search and search for organizations “TOWD POINT AUTO TRUST 2024 A-1” and “TOWD POINT AUTO TRUST 2024 A-2” under “Secured Party”.

[7] To replicate this search, navigate to Maryland Business Entity Search and search for business names “TOWD POINT AUTO TRUST 2024 A-1” and “TOWD POINT AUTO TRUST 2024 A-2”.

[8] An “established alternative investment advisor” well known in the industry, Cerberus was founded more than 30 years ago in 1992 and has approximately $65 billion in assets,

[9] Beyond this, numerous other public articles, rating reports and industry publications link Cerberus and Towd Point. [1 2 3 4 5]

[10] Passing around risky loans like a hot potatoe.

[11] For example, an analyst had questioned the Carvana CEO in November, 2022, about it having to abandon the ABS market for a “couple of quarters”.

[12] Ally has a separate financing arrangement with Carvana that redacts key risk data. However, the granular securitization delinquency data likely offers insight into the Ally loans as well, particularly given the recent losses reported by Ally in its auto loan book.

[13] In 2022, an Exane analyst noted that Carvana had abandoned the ABS market for several quarters. Carvana’s CEO also acknowledged the difficulty in relying on the ABS market.

[14] As noted in the servicing agreement between Carvana and DriveTime affiliate BridgeCrest, the servicer is allowed “permitted modifications” which includes “extension, deferral, amendment, modification, alteration, temporary reduction in payment, or adjustment” to loans.

[15] The previous language found in the 2023 proxy statement was: “the Board may only approve those transactions that are in or are not inconsistent with our best interests and those of our stockholders, as the Board determines in good faith.”

[16] CarMax warranty income is calculated for the 9 months until the end of August (Q2 for CarMax).

[17] In addition to this, from 2018 onwards, Carvana had sold road hazard and maintenance contracts administered by an “unaffiliated third party”, per its 2023 10-K. The disclosure mentioned retrospectively that it had a profit-sharing agreement in place. Carvana’s 2018-2021 annual reports make no mention of this contract.

In 2022, the unnamed third party transferred the rights of these contracts to related-party DriveTime. Carvana booked $7 million and $3 million of profit on these arrangements in 2023 and 2022, respectively. [Pg. 95]

It is unusual that investors were informed of contract arrangements with an unnamed party years after the fact, and that Carvana was able to book profit sharing revenue immediately on transferring these contracts to DriveTime.

[18] This means Carvana passed tax benefits back to GV Auto when it exchanged “units” in the company for cash or common stocks.

[19] The Garcias paid $126 million to purchase Class A LLC Units, for which they received collectively 2,720,795 class B shares, per the company’s 8-K. Those Class B shares are now worth ~$553 million, a gain of more ~$427 million.

[20] This metric is without the benefit of gains from selling finance receivables or ancillary products, which are factored into a separate metric called Total GPU. It is widely tracked—Bloomberg Intelligence noted “record” gross profit per unit in retail vehicle sales in its June 2024 note. J.P. Morgan’s analyst spoke of “continued retail GPU”. Needham analysts spoke of a “rebound and acceleration in CVNA’s retail GPU” in an August 2024 note.

[21] On a Q1 2020 investor call, an analyst from Morgan Stanley noted that Carvana’s costs lumped in “Other” SG&A “has been a bit of a black box.”

[22] Closest peer CarMax includes title and registration in cost of sales, per our interaction with management, as does AutoNation, per a former executive.

[23] The addition of limited warranty, outbound logistics, and transaction expenses yields an estimated $897 in costs per vehicle that is shifted to “other SG&A” instead of “cost of sales,” indicating that a properly adjusted Retail GPU would be closer to $2,600. We estimated the total annualized impact of these accounting practices by multiplying $897 by Q3 retail unit sales of 108,651 units and multiplying again by 4 quarters.

[24] We downloaded components of the Russell 1000 from Bloomberg, sorted by market cap and auditor.

[25] We were unable to find any further updates on the SEC enquiry, using either BamSEC or Bloomberg company filing searches. Analysts have not asked for updates on investor calls, per a search of transcripts filed with BamSEC.

[26] The company has raised a modest amount under its at-the-market offering program, though the metrics pale in comparison to insider sales and Garcia II’s sales personally. [Pg. 22]