Chit Chat Stocks - Carvana (CVNA) | Not So Deep Dive

Episode Date: June 7, 2022

Carvana is an online car retailer based out of Tempe, Arizona. The company is known for its multi-story car vending machines. Listen closely as Brett and Ryan go through the history, financials, and future prospects of Carvana. Enjoy the show! This episode is sponsored by Potential Multibaggers. Multis are looking for stocks that have the potential to go up 10x in 10 years. Check-out the service here: https://seekingalpha.com/checkout?service_id=mp_1308 Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Subscribe to 7investing with the code "Money" and get $100 off: https://7investing.com/subscribe/aff/4/ Contact us: [e-mail] Timestamps Company Background | (3:43) Industry | (11:00) Management & Ownership | (13:11) Valuation | (17:02) Earnings | (19:27) Balance Sheet | (23:01) Our Analysis | (27:41) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not So Deep Dive episode on Chit Chat Money. Usually, we've been having another guest on the show for almost two years. Every other week,

it was Ian Gray, and we have Brad Freeman joining us once every month now, or once every four weeks, excuse me, which is almost every month. But since Ian has started his job at an investment bank, congratulations to him. We'll be going back to two for the time being, unless we can find someone else who lives up to our quote unquote high standards. Going back to our roots. Basically someone that's free. Yeah. We'll be looking for maybe some other people to hop on as a third guest because we do like having that. But for the time being, it is just going to be me and Ryan, Ryan and I on this show today, and we're going to be talking Carvana, which was a large homework assignment. Oh, yeah. Controversial. I didn't want to get stuff wrong for this one. I mean,

I guess we shouldn't get stuff wrong for any of them, but I didn't want my takes to be off because it is super polarizing stock. And some really smart investors are long Carvana, But then everyone else seems to think it's a zero. So on the half chance that you're listening to this and you're on either side of the spectrum, just know this is our first time really digging into Carvana. Yeah, but I think we're going to try to investigate why people are so bullish and why people are so bearish, why there is that dichotomy. And I'm going to let Ryan introduce their history, which is very interesting.

But first, we need to talk about our sponsor today, and that is Potential Multibaggers. The aim of the Potential Multibaggers service is to find stocks that can go up to 10x, over the next 10 years or compound at 26% per year. Potential multibagger service, if I'm looking at my inbox here, what's great about it is you get all the emails to your inbox if you're subscribed to it. I'm just looking over the past few weeks here, you have different reports about, say, well, I'm not going to spoil their picks, but say this software company, here's an overview of their earnings, here's an overall quality score for this specific company, comparing that to other companies. And it is focused on those high growth investments.

It also is, they also do a weekly overview, which they call overview of the week, going through different news reports from any sort of holdings that are not holdings, recommendations they've done. So you're really getting in-depth analysis and it's not, I think it's almost every day you're getting a report, but definitely multiple times per week. We got to have Chris back on the show soon. We will have Chris back on the show soon. Maybe when he does a pick or something a little while ago, we'll do a little teaser episode on something or maybe something he's looked at and passed on. Either way, anything. So if you want to check out and become a multi, go to Seeking Alpha and look for From Growth to Value. Google it or go to add From Value on Twitter. The link will be in the show notes as well. So that would probably be the easiest way. Ryan, introduce Carvana. Yeah. Carvana is the second largest used car retailer in the United States. And they were really the first ones to introduce an e-commerce only strategy to the auto space, meaning no dealership. So I'll try to walk through the life of a car in Carvana's system to kind of illustrate what they do. So Carvana purchases cars in one of two ways, either directly from consumers.

So a consumer goes on, they give the specs of their car, and then they get quoted a price from Carvana and they either choose, yes, I'll sell it to you or no, I won't. Or they buy from wholesale auctions, which is less, that's a more costly route because you have to pay auction fees. But Carvana then picks up the cars directly from the seller's home or location using a multi-car holding truck you've probably seen these kind of it's called like a hauler um you've probably seen these on the road where there's multiple cars on the back of a truck um and those cars are then taken to one of carvana's 17 inspection and reconditioning centers you're

going to hear people if you are into carvana you obviously hear the term r irc multiple times it's i think do they have 30 now that might be that's i believe that's the vending machines the ircs the inspection and reconditioning centers. These are scattered throughout the US. There's 17 of them and they're big. Think like a hundred acre centers. And at the IRCs, each car is given a thorough inspection. And then it's either, if it passes, it's listed as available inventory for purchase on the website, or if it doesn't pass, it's sent to their own wholesale channel and sold that way. So customers who are shopping on Carvana then get to shop a range of vehicles. The ones that past those inspections are presented with transparent pricing. So this is one of the

big benefits of Carvana's platform is that you don't have to haggle with a dealership person and negotiate the price. And then you can order the car directly from the website. It's kind of cool the way they have like this. I went on the website and kind of just looked around and each one has a uniform display in the background. It's kind of like this, you can get a 360 angle on it. It's pretty cool. Go look it up if you haven't. And so it's either once the car is purchased, it's either delivered directly to a customer's house, or it's sent to one of their 30 vending machines. I'm putting that in quotes. It's a car vending machine. And so you've probably seen pictures of these things. They're really tall glass windows.

And I'll talk about what they are, but if you choose that route, so if you choose a vending machine, you show up with a Carvana coin to that specific vending machine and the car drops down once you put it in. And so it's mostly a marketing tactic, but it also cuts out some of the last mile logistics of having to drive it to the customer's house. So you can drive it there. They go and pick it up and it looks cool. And people ask, what does Carvana do? Because I don't know, everyone likes those buildings. The other thing, once the customer has the car, there's a seven-day return policy. So one big concern about buying online was that there's no test drive. You know, you're not going to get that adoption, but if you have a seven day return policy, um, that is the test

drive. Yeah. It pretty much is the test drive. And it's a no, uh, no hat, no, no, if whatever it's a hundred percent, you know, guaranteed return. Now I did skip over one part during the customer's buying process, they're offered financing. So this is an important part for Carvana. It's not as high a percentage of revenue, but it is a high percentage of their gross profit. So Carvana extends them an auto loan, which they originate, but then Carvana tries to securitize these and sell the loans to other companies. A lot of these loans are purchased by Ally Financial. They have an agreement that kind of caps out how much of the loans they'll buy. And then this financing component makes up the bulk of what they call their other revenue segment.

And there is also service contracts and guaranteed asset protection coverage or DAP coverage that are included in there as well. but like I said, other revenue, think financing. And then the last thing I'll add, Carvana has three reporting segments. There's retail, which I talked about what that looks like. There's the other, which is the financing and service contracts and stuff like that. And then there's the wholesale. We haven't really touched on the wholesale. So if a car is not good enough to sell to customers, they will sell through the wholesale channel. And this is often done through a third-party auction provider. The reason I say this is because we're about to talk about one company that is that auction provider that Carfano recently purchased.

And so they're now bringing that in-house. Those are typically lower gross margin than selling to a customer. But we're going to talk about Odessa, which is the company they acquired during Brett's growth opportunity. So I'll leave it for that. The history, pretty interesting. So the history actually starts with the founder's dad in the early 1990s, Ernie Garcia II. So that's the dad, bought a rental car company out of bankruptcy, and he built a used car retailer that became one of the largest in the US. That company went public. He was already an entrepreneur on his own. The company was called DriveTime. His son, Ernie Garcia III, that's the CEO of Carvana, the founder and CEO, I believe, joined DriveTime in 2007 as the treasurer after graduating from

Stanford as an engineer and he served a few years in investment banking. And then he joined DriveTime. While he was at the company, I think five years into joining it, Ernie came up and Ernie, I'm saying the CEO, not the dad, came up with the idea for an e-commerce only retailer of cars and received funding from his dad or his dad's company to build the idea at the time. And there were only, so I guess at the two times, sorry, I'm talking for a while, but at this time, the two companies were basically intertwined. So Carvana was using a lot of DriveTime's resources like facilities, back office functions. There was, and we're going to talk about this, just a lot of sharing, I guess, of resources. And there's a lot of related party transactions.

When they did first launch the site, I heard the CEO say that they only had 40 cars available at the time. Last quarter, they sold 105,000 units. So it's obviously expanded since then. Carvana went public in 2017. They've raised several funding rounds since through stock issuances and debt. But hopefully that provides some color around the business and how they got to where they are. And I think we can probably see why this is controversial, because it really is debatable whether or not this is a model that can be profitable, like really profitable over the long term. Yep. The capital intensive, to say the least, and the related party transactions, the history of Garcia II, who actually has, I believe, it is either associated with or a direct felony charge. Do your research on that, though. I don't want to read up on that. Definitely read up on his history, because that is definitely something that people find controversial as well. We might talk about our opinion on that in the back half of the show. but let me hit industry and competition. Used car market is fairly simple, although recently, you know, we've seen prices with, since there was a semiconductor shortage since the pandemic, we've seen used car prices spike. So that has kind of thrown a wrench into the mix. And we'll probably talk about that and how that maybe has driven their earnings to basically explode and then kind of fall off a bit, or at least the used car market in general

has. But typically, it's been pretty stable at about 41 million unit sales in the US last year. If you multiply that by what a car costs, you get hundreds of billions of dollars in annual revenue potential. However, and Ryan will get into this in the earnings segment, the margins are quite slim. The competitors include CarMax, I think I spelled it with a C, but I spelled it with a K, AutoNation, small dealerships, and Vroom. And there's a few others. The market is really, really fragmented. Carvana is pitching themselves as the company can truly consolidate as the e-commerce retailer within this space and it hasn't really been done before i think one because people didn't think people people everyone didn't think buying cars online would really work

especially without an in-person test drive and two um it's so capital intensive ryan what do you got yeah and i think to to demonstrate how fragmented it is carmax who is the largest auto retailer or used car retailer has about they estimate they have about 4% market share and I think they're I want to say three times roughly as large maybe four times

as large as Carvana but Carvana is growing faster yeah the biggest competition here really is adoption and the small dealerships convincing people that they don't have to go to these dealerships and they can just use Carvana I think that's the true competitor here

I don't And I may be underestimating the competition from the other online players and CarMax, but I don't think that's really any sort of restriction on Carvana's growth. It's really going after that blue ocean opportunity, convincing people to switch to this online model. I'll move into management and ownership. I guess this is the first time I've been doing this one. So I'll have my own little mix on here.

I know either Brad and Ian have their own, they have their own style for doing it, but I'll have mine as well. Pretty similar though, not too difficult. Their founder, CEO, and chairman is Ernest Garcia III, like Ryan mentioned. He started the company as a part of DriveTime back in 2012. So the company is only 10 years old now, exactly 10 years old. And he has seven, according to the proxy, which I could be getting wrong because I don't know.

Well, I think the general takeaway is that the Garcia family has a controlling interest in this business. I could have been reading the tables wrong because the, wow, is it complicated to do the ownership structure here? It's not as bad as some businesses, but I would look at it yourself. It's hard to say everything in audio form. You kind of got to visualize it on a piece of paper or a whiteboard. Was there a flow chart?

There was. Well, that's what, yeah, I did tweet that the other day. There was a flow chart and I still couldn't get, I had to go to some outside source of some other investors to try to understand it fully or make sure I wasn't making any mistakes. but garcia the second apparently has 17 voting power and got paid five million dollars in total compensation last year so not too crazy but still you know hefty hefty payout however he had an interesting thing he recently gifted employees each 23 shares of stock and that was worth like

5 000 bucks when he decided to gift it now but the stock got like 90 it's like 600 bucks but it was it was 100 million dollars in total at the time 5 000 to each employee yeah sure yeah yeah like i said and uh this wasn't any dilution it was actually just taken from his what his ownership state was giving out to them so i thought that was nice um the rest of the executive team i believe there are five or six maybe seven members get paid about two million to four million a year nothing too notable there except on their board they had an ex-vice president of the united states don't know how meaningful that is to a car manufacturer but that was kind of cool to see um other important person is ernest garcia the second like ryan was talking about before he has

84 of the voting power according to the proxy statement but in reality i would just combine the two because they seem a bit joined at the hip but garcia the second is not an executive or on the board so it's quite interesting that someone with so much voting power um who also runs a giant customers, a company that has probably made besides Ally, the biggest relationship with Carvana has this much voting power at Carvana. That's a little bit sticky to me. And that drives into the related party transactions with Carvana. They include purchasing wholesale vehicles from the company. And if I was looking at investing in this company, I would definitely look at the proxy statement and kind of investigate all these transactions i didn't really know what's a

takeaway i think some of the claims might be overblown just because carvana was uh what would you call it they wouldn't exist without yeah they were incubated within drive time so i don't think the relationships are that nefarious but again there is that risk given the voting power of the Garcia family. And they also have these interesting things called LLC unit holders, which again, it's just, I don't know if it's for tax purposes or something, but it's just a strange way to have a class A and B stock where the LLC unit holders, which are the Garcia family, aren't publicly traded, but you can exchange them, these LLC units for class A common stock. and they have been doing that.

And you can do that. You can basically count them as shares outstanding, but they might not show up when looking at them. So again, you have to do some math there, add it up. I think I got it, but. Cox Panoramic Wi-Fi includes advanced security to help protect all your connected devices. You'll get real-time alerts.

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CVNA, enterprise value, which again, is for anyone that's not trying to learn finance, this is a very important metric to know and is taking, adding, starting with the market gap, adding back that and subtracting out cash. I calculate it to be about $11.67 billion, but that is subject to change, giving a ton of moving parts. With financing since quarter end, They're also burning a lot of money right now. And it also depends if you want to count short-term financing in the debt or add back inventory because they're using, part of the model is when they have to take some inventory on hand, they might finance that with some short-term debt or do the, take out short-term debt to finance those, the originate the loans, right? I don't know if you should count that in the debt to add back the EV to the EV, but I did. So again, it might be closer to $9 billion.

Hard to tell, though. I think I included it just to be conservative. Not a huge deal, given the valuation and the difference there. They're trailing enterprise value to sales. It's about 0.83. Trailing enterprise value to gross profit is about 6.1. They have a negative enterprise value to operating income and negative enterprise value to free cash flow. Total share count has gone from about 132 million in 2017 to 188.6 million today.

And that is if I'm doing that conversion between the A and B or the A and the LLC unit holders correctly. Now, I'll let Ryan hit earnings, but as you can see, this is low gross margin. They've had to dilute a lot, although revenue per share has grown a ton and gross profit per share has grown a ton. And they have some debt on the balance sheet. And I guess, Ryan, you're going to get into earnings and balance sheet to kind of clear up some of these numbers, their growth and what's the specifics on their debt. Yeah, I wish I would have provided some more longer term numbers, but I wanted to encapsulate what's going on now because they have grown rapidly.

They've expanded really quickly. Market share has grown. And now they've hit a very interesting point. So I'll try to focus more on Q1. So the first quarter revenue was $3.5 billion. That was up 56% year over year. They sold 105,000 cars during the quarter, which was up 14% year over year, but it was down quarter over quarter and it was less than their previous three quarters. So it's looking like they've, and part of that was their own problems, which we'll talk about. But then a huge chunk of that

was also external factors, macro. There was just less industry-wide sales overall. So there's the concern that this is turning around a little bit and that maybe it peaked last year. Their total gross profit was $298 million. That was down 12% year over year. One metric that I would say is the most important metric for them, aside from cashflow in the long run, is gross profit per unit. That has grown consistently over the course of their life. But this quarter, it was $2,833, which was- And that is per unit. So per car. So gross profit per car sold. And that's actually down 23% year over year. And the company had negative $813 million in cashflow, free cashflow for the quarter.

But they attributed two things or multiple things, but they attributed the weaker quarter to factors that were both internal and external. The internal ones, and I don't even know if you'd call this internal, but Omicron variant and winter storms hurt their reconditioning centers and their logistics. Apparently, they also had to move, they had new reconditioning centers that they had to move a bunch of inventory buildup to, which put them further away from the average customer that ended up in total increasing the cost per unit. But then the external part, affordability and consumer sentiment combined have drove fewer industry-wide sales. So that's really the big, I think, alarming concern for all investors.

Additionally- Yeah, wasn't units industry-wide down like 15%? That was their number? something like that. And Carbano was growing. So good market share gains. Yeah, they were growing year over year, but they were declining from their previous three quarters. So yes, they are, they're growing outpacing, they're outpacing the market, but that does not mean that they, they're still losing a lot of cash. So that doesn't mean it's sustainable for them. And then they also ramp up typically six to 12 months in advance for their sales. So that

means hiring as well as just getting, being able to service certain cars. So they overspent on their inventory, which they had to service. Inventories jumped a lot. And overspent on hiring for, because they thought they were going to go a little quicker. Which is costly and ultimately ends up hurting their gross profit per car sold. Yeah. And operating margin and free cashflow margin, which we're all trending in the right direction for a number of years. My big concern, or I guess just not even a concern. My thought is why not just grow a little slower?

Is that, is that crazy? I think you, I think it's hard to rein it back in. Maybe that's what they're, they realize that it seems like that's what they've talking about is not growing as aggressively. Yeah. I think it's harder to rein in expenses than it might sound. True. So I'm going to go through the balance sheet and this was a tough task because they raised a lot, right? They raised a lot after their most recent quarterly quarter, like share, they produce a good shareholder letter, which I think is worth to read for anyone that wants to read it. After that, they raised more money. So I'll go through

what they reported on the first quarter and then what they've done since. So assets on Q1, there's pretty much two things that I found most important. So there was about $247 million in cash. If that doesn't sound like a lot, it isn't. Keep in mind, they burned through, what was it? 800 million in cash last quarter. And then they have $3.3 billion in vehicle inventory. So they are hopefully going to be able to sell through some of that. And then they had another, I think it was like 250 million in restricted cash. I didn't put that in there just because it's tied up. And then the liabilities, I'm not including the asset backed debt here. So this is the part that you talked about where they have a lot of-

Yeah. Decide on your own whether you want to include that. It's to each his own, I guess. The current portion of their long-term debt is $178 million. So they have enough cash to service their current portion. But according to the 10Q, they also have roughly $2.4 billion in senior unsecured notes with an interest rate averaging just over 5%. Most of that debt is due after 2027. So obviously, they have to pay interest on that throughout, but it's not completely due until after 2027. But after the first quarter, here were the recent raises. So on April 26th, keep in mind, the first quarter ended March 31st. April 26th, Carvana issued 15.6 million shares,

which is roughly equal to $1.25 billion worth of stock to the public at an average price of $77. The stock today is, I think was at $26. So- Yeah. And that's lower than what I was doing the math on the market cap and stuff. So Again, I wasn't going to try to get exact on that, but it changes so much every day. Good. Yeah, it was good timing on that raise. Something that I found interesting, the Garcia parties, which I believe is the founder and his dad, bought 34.5% of that share issuance themselves. So it was raised by the CEO and his dad. Yeah, and I should have confirmed this before the show because I know people have been tracking how much they have been selling.

It is a bit either perplexing or if I was a shareholder, I would be a bit annoyed at this because I believe they've sold a ton of stock. They sold high. Yeah, they've sold high and bought back low, but if you're a shareholder, it seems… It's not necessarily the wrong thing, though. No, it's not. Because they're now using that stock price they sold at high as to fund or to provide financing for the company since they bought 35%. I still don't like it. It still seems a bit messy.

It does. On May 6th, so 10 days after they raised the stock issuance, Carvana issued $3.25 billion of 2030 unsecured notes at an interest rate of 10.25%. That is a high interest rate, no doubt about it, but that money gives them time. Well, a lot of it, also a lot of it was to finance the Adesa acquisition, which was an unfortunate timing. They announced that in February, which I'll get to, I guess, coming up shortly here. So, yeah. So, part of that was for the acquisition. They raised enough, I think, to buy themselves a fair amount of time.

I would say probably a year. Yeah. I, uh, I read from hard to tell. Yeah. I was reading, there's a lot of, you know, good long cases and short cases out there and, uh, from a lot of investors and funds. And I was reading that someone calculated that their interest expense will be about $600 million a year now, which is quite high. So there's 10%. That's it's hefty. And hopefully they can either pay that back or refinance it, but interest rates and their ability to raise funds. I guess what I'm saying is if the 10-year continues to go higher and the Fed continues to kind of do what they've been doing the last few quarters, it could be tougher for Carvana to raise some funds.

It could be a totally different operating environment than it was up until the end of 2021. Don't you wish you could just hit skip on the worst parts of your life? You know, the same way you can skip an ad? I get it. I'm Siyaya and I live in Ice Cove. I've made some questionable decisions that didn't end up the way I planned. And today I'm still figuring it out. Somehow things usually get worse before they get better.

Apparently, that's how I roll. So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem. All right. Anecdotal evidence. Let's get to the fun stuff here. What do you think? What do you use it? Yeah, definitely. Especially with the seven-day return policy. I think if I were shopping for a car, this is probably how I'd do it. I have no gripes about shopping online. I will say, and this has nothing to do with me as a customer, but I have seen some posts recently about Carvana buying people's cars and then the checks weren't clearing at the bank.

um so that is a potential concern but it's also i don't know it it could just be some someone shit posting like someone fake you know that could be a made-up story but um not not good stories to hear oh yeah that is that is not good i think yeah anecdotally i would check them out for sure seems very very convenient but the reason it seems very very convenient is and i don't think we have to go through some complicated model here it seems like an expensive model to run no matter how big they are even more expensive than say an amazon network which we don't have those biz million low margins and that's kind of their moat but on the flip side is the moat in the long term the low margins i think some of the bear cases people might have

could be part of the bull case yeah but i guess we'll get that into more or less interested future growth opportunities. Why don't you go first? Me? I'll go first. Okay. So let's talk about the, I think it's spelled A-D-E-S-A. I think it's pronounced Adesa. And that is a physical auction business that they acquired. This is for $2.2 billion in finance with the debt that Ryan talked about. This will add 56 locations and 6.5 million square feet for inventory management and better logistics. That's part of the case here for buying it. It seems like really bad timing because they did announce in February, closed in May, right when they went through a bit of a rough patch, but it seems like

a perfect fit for the company. This is a quote from the conference call on their pitch maybe to investors on why they're doing it. So here's the quote, a bit long, but I think it's important for someone to understand why they're making this acquisition at this time. Quote, this is the equivalent of approximately 30 Greenfield Carvana IRC locations in terms of the production volume that we expect to unlock over time. Adding the ADESA U.S. footprint will dramatically improve our logistics network over time. With the addition of these locations, we will eventually have reconditioned inventory within 50 miles of 58% of the U.S. population and within 200 miles of 94%. This will have the benefit of reducing shipping distances, time, and cost, accelerating us to a long-term financial model.

So I think the key here is that the more scale they have, the better leverage they can have with the logistics stuff, which is really tough as they're growing because the delivering to customers gets to do it across the country. It's not economical. Yeah, and the other thing is this is still an auction business. It's a business they're acquiring. It's not just land. Yeah. And there were some concerns on the conference call that a lot of the major OEMs or the major auto manufacturers are no longer going to use Odessa because they're essentially feeding their competitor by doing that. So sometimes the big manufacturers, if they have stuff they can't get rid of, certain cars, they'll go through these wholesale channels, wholesale auctions. But apparently there's quotes or rumors that they're going to stop using Odessa as a customer. Maybe it sounds like the auction business isn't necessarily what Carvano is after here, but hopefully they do get that auction system in-house.

And the reason I talk about that, so first of all, there's so many good write-ups on this company, but one that I came across was the 10th man blog. And he talks about a few different ways to grow the gross profit per unit. And so the first one he says is purchasing cars, more cars from consumers than wholesalers. They're generally the same price, but there's no auction fee. So they get a higher margin on those typically. And then greater utilization rates of their reconditioning centers. I think that one's pretty obvious. Using more in-house transportation than third parties. So not all of their transportation, moving cars from the IRCs to customers' houses or customers' houses to the IRCs is done by them. that's not always owned. Sometimes they use a third party that's more expensive. So bringing that in-house will increase the gross profit per unit sold. And then the last one, fewer days to sale. You don't want to hold the inventory for too long because it depreciates. You also have cashflow concerns there. Yeah, a hundred percent. And the other thing is the auction, as we talked about, the wholesale auction can be expensive. Actually, let me collect the thought because i i i'm losing my thought uh well there's a way that if you have your if you have the auction

in-house and you don't have to go through a third party i believe it's higher margin oh right right is yeah i don't know exactly how that business works i didn't want to for this show i don't think it was relevant to to learning that but if you're going to invest in carbonia you might want to i got it the so if you're wholesaling your cars you're selling it to the the wholesale auction provider, you have to pay the auction fee. If you own the auction in-house, you don't have to pay the auction fee or you're paying it to yourself essentially. So that is ultimately a higher margin for the wholesale channel. Yeah. And then I think that last point there, or your fourth point, not the one you just mentioned, the fewer days of sale is really,

really important for me. If that can improve over the next five years or continually improve over time that's just it would be so helpful for this business because part of the concern is they just have liquidity issues uh with if they get stuck with inventory we could see them having a peloton type situation even worse to be honest and the same concerns people have with open door about holding the homes on their balance sheet you could have a similar thing here although the velocity with used cars is better but still it's huge if they can keep that velocity of inventory going i think that's just that's just big for me all right highlights and low lights ryan what do you think well i do think it is a disruptive model um and i think it's a classic

example of the innovators dilemma where because they were able to start directly with online and this hub and spoke where there is no dealerships they're able to win or gain share faster than a company who would have had to cannibalize their own dealerships and so what's good thing is all the dealerships were tiny so it's not like they were even they could barely almost impossible to compete online yeah i i i buy the model in i think customers will shop online i think this is something that will go more and more online over time. That doesn't necessarily mean it can be super profitable. Obviously, you have to reach tremendous scale to eke out a profit, even if you can. And then my lowlights, well, I guess the other highlight is I like the CEO.

Hearing him, he did an interview with Patrick O'Shaughnessy. I think he's good for running a company. I don't necessarily know if he's good for investors. And that kind of leads into my low light. He said on that interview, his three priorities are number one, customers, number two, employees. And he thinks about investors last. Oh, clearly. Yeah. I know. Maybe that's a bit of promotionalism, I guess. I mean, the show is called Founders Field Guide. So it was kind of trying to like build a company but um i'm an investor not a founder so that that doesn't really encourage me um the other low light i have is i just don't see the consumer environment getting better anytime soon it feels and i guess this is just kind of gut economy feel that uh

rates are rising and spending is kind of getting reeled in and a lot of transportation prices here So the energy prices, they're influenced by that. Yeah. And one other thing that's a little frustrating for me is in reading through all these letters, people are, some of these big funds that are tracking this have much better information than I do. They have, they're tracking inventory on a weekly basis. They know more than I do on the quarterly report, which makes me feel like the stock price is reflecting that reality. and that maybe i don't know as much as the other people that just is something but there's also something here where you have the garcia family um who i believe who knows they sell a lot of shares so maybe that's even worse here but you you have a lot

of how do i describe it well i guess the cliche it's a hedge fund hotel a lot of big funds in this one a lot of the growth funds um and a lot of others have giant positions i think there was like five or six with greater than five percent positions so if someone gets margin called if someone gets uh redemptions that could cause a lot of force selling it and not only small positions yeah exactly these aren't small that's why i was saying on the proxy statement there was a lot there are five or six with more than i believe five percent positions in this at the time that could have happened over the last few weeks someone could get um forced to sell out uh but yeah i guess what are your highlights yeah i guess we'll talk more about this later in the

whole entire case when we talk about kind of right uh all right highlights seems like the best customer experience to me for buying used cars without experiencing it it probably seems like the best one is that because they're spending too much money per car they sold sell maybe but we'll see uh they have phenomenal top-line growth and they did have an extended expansion of both gross profit per unit, overall gross margins, overall EBIT margins, although EBIT margins haven't gotten to 0%. So the expansion has been from a negative to zero. And that was all trending in the right direction until I believe either the last few quarters or just this quarter. So that is great to see. And they have a phenomenal track record with that. Low-wise though,

currently hemorrhaging money, needing to manage inventory. With someone that needs to manage inventory like this. I think of automotive companies, Peloton is a recent example, but there's a lot of others. Opendoor, that just to me makes it seem like, not seem, to me, it's a worse business in my opinion than someone that doesn't have to manage inventory like that. The other low light that I didn't mention is this is an incredibly difficult challenge to solve. The business is really hard logistically, and it seems like they haven't mastered it judging by um some of the internal issues that they talked about last quarter and having to move inventory to and from sometimes it makes me feel like they're just like

winging it yeah um well they're inventing a whole new model so i think part of it is winging it it's just complex i mean it's it's definitely a difficult problem to solve here's another low light and that is the impact by wild swings and interest rates so first their debt is more expensive now, which is a negative, which we just talked about. But two, when they're in that financing stuff, okay, let me explain this, try to explain it simply over audio. When they originate a loan, they send out a rate to a customer. And then after that, they package it and sell it to their partners like Ally Financial, another bank. If interest rates change a lot in between the short period of time when they originate to financing or start to selling them back off to a

bank like they have in Q1 and recently, that can hurt their gross margins there. I know that's not a giant deal because it didn't impact it too much, but those factors are outside of their control. So that's just creates more uncertainty to me. And then also related party transactions and dilution. Garcia II makes me a bit nervous given his history of fraud. All right. The bull case, what do you have? All right. Mine, well, you can put a lot of different revenue growth numbers on here. So I just decided to use 30%, which is a slowdown. I think it's definitely doable over the next five years if they allow themselves to have the liquidity to pull this off. So if they grow revenue at 30% over the next five years, annual revenue would be $52 billion.

And if gross margin gets back to 15%, which I think is doable because it's not that far from there now, and they've expanded it every year over the last five years. So I don't think it would be surprising if it was even higher than this. and another caveat can they come they can achieve free cash flow margins of four percent i think four percent i wouldn't price in much higher than that given low gross margins and capital intensity which just is not a good combination if you have four percent free cash flow margins on 52 billion dollars in revenue that is about 2.1 billion dollars annual free cash flow compare that to the current EV, which depending on how you slice it, I had it at about 11 point something

billion. You might have it closer to 10 billion, I think. And obviously after these recent raises, it's a bit different, but it is highly likely, I think you make some money here if they can achieve that number. But the path to that, we got to build a big bridge to get there, I think. What do you think your bull case? Well, I mean, it is the bull case. So let's assume that the consumer environment turns around and that we don't enter some sort of like a recession that really hurts car spending. And they are able to continue doing what they've done

and climb in the market share. I think that 30% annual revenue over the next five years is doable in a bull case. Annual revenue growth, right? Yes. And then their long-term projection, management's long-term projections are for 8% to 13.5% EBITDA margin. So since this is the bull case, I'm going to go ahead and take the midpoint of that guidance. That would be about just under $6 billion in EBITDA on that revenue figure that you mentioned. If it trades at five times EV to EBITDA, which seems given

their interest expense, maybe. That's reasonable. That's reasonable. And capex requirements, yeah. That would be, I put a five bagger, but that was based on the market cap. You would. Well, no, that's based on, you know, market cap is what the stock does. True.

You would have a multi-bagger of those years, let's say. And that's not factoring in dilution, given their history, might be closer to three bagger. But that. That's still not. Like you said, that's a lot of – you have to make some pretty rosy assumptions. Yeah. I think high risk, high reward. Let me just say whoever was buying at a market cap – let's look at what did I pull up.

I'm going to get it up on Coifin. Whoever was buying at the peak market cap, which if I can see on Coifin, was over $60 billion. I want to know what your thoughts were. Well, I would almost say it was more likely to succeed at that point. The returns might not have been as good, but because their equity was worth something in raising money, it makes them more likely to reach scale, which is kind of the big question here. This is a Monday morning quarterback, but should they have done a big equity raise similar to someone like… Did they? uh they did it looks like well i don't have the press releases in front of you but i'm looking

at their share count chart looks like in april 2020 which is probably not where the stock was up very high they did a big share raise and then possibly in march 2021 but i don't know it's for sure but they did a giant the biggest one they've done in a dilution wise has been recently so i'm a bit maybe surprised given that they knew that they would need all this funding but they didn't do something like who did that shopify raised a good amount of money when they didn't need it i i mean clearly that's that's been a big mistake okay let's move on to bear case now i think this is where a lot of well who are there more bulls than bears i don't know i think there's more bears it's very much that you said it's like the black and blue dress or is it white and gold

it's white and gold or black yeah white gold black that you cannot sit on the fence with Carvana. You either have to be, it's either a multi-bagger or it's bankrupt. And I guess that's the bear case for me is bankruptcy. I will say that the recent financing round bought them a lot of time, but if we have- How much time though? A year is not that much. Yeah. If we have two years of a not so great economy and consumer sentiment dries up for new cars or even used cars, like, yeah, they're gaining share. Yeah, it's a superior model in my opinion, but they're just hemorrhaging too much money. It seems like this will belong to the creditors. if amazon didn't raise money in 2000 i believe they raised money in 2000 if amazon didn't raise money they it's possible they would have gone out of business in 2002 you can't say that's out of the question here and everyone compares over compares stuff to

amazon but in this case i believe the capital intent intensity and the hub and spoke model and the e-commerce nature of trying to bring a whole new industry online the similarities of another 2000 amazon are not i think it's actually relevant here the interesting thing is if consumer sentiment drives up and they have to wholesale a lot of their inventory at least now they have an auction for an auctioneer in-house to do it i guess so maybe it isn't quite as low margins yeah Yeah. All right. Mine is just like yours. They run out of money or they have to heavily dilute shareholders. I think they'll likely be able to raise money. Well, I would think so. I would think they would be able to raise money. But the question is how much from their founder. Well, yeah, maybe from their founders, which I don't know how to think about that still.

but yeah it depends how much solution you have from that i mean how much of this is tied to the stock price like if the stock price hit let's say five dollars a share could the company survive or do they have to raise money from the stock because i have a hard time believing that they're going to get any debt any more debt well it'd be pretty expensive yeah yeah They'd have to show, I mean, they haven't, the thing with, yeah, they haven't shown really strong history of profitability so that that's going to be expensive. If interest rates continue to rise, which the, who knows exactly,

but it seems like we're heading in that direction where interest rates are going to steadily rise. That's going to be more expensive. Stock's more expensive. Yeah. I mean the real, the bankruptcy or the getting close to bankruptcy or the need to dilute and double your share count or something like that could happen due to the macro factors it could happen due to the inability to turn over inventory which could happen because of the macro factors or just simply and i think this part i maybe the key bear case is a lot of people think they're selling dollars for uh am i saying this correctly selling dollars for 90 cents yeah exactly they

simply are unable to get operating leverage and they haven't proven they can get operating leverage for really sustainable. They've gotten close. They've gotten, the lines If they're at 4% market share if they're at 4% market share and with all those logistics centers they just added, if

those are operating as like at like 90% capacity, I have a hard time imagining there isn't some margin in that. Yeah, but it's a huge hurdle. Alright, I don't think we have anything else i'm more or less interested ryan i'm gonna go less um it just feels like a lot of uncertainty

to me and a lot of factors that are out of the company's control um for their success the other thing i will say is to the longs who have held through this if you're right and things turn around you get to take victory laps for the rest of your life because yeah there's definitely it'll be like the whole oh i bought it i bought amazon down 97 percent whatever there's definitely a world where carvana has a market uh well why don't we just say enterprise value of 100 billion dollars there's definitely a world the market opportunity is huge if they survive the next two years yeah well i guess the numbers look better than they did in 2015 but man they're a lot more scaled up yeah i'm less interested i don't like businesses like this

there's a lot of there's it seems like there's opportunity here but how much risk are you taking on uh for those potential 40 annualized returns or 10 beggar potential i think you're taking on a lot of risk i don't want to do that i don't like stuff that's impacted by uh energy prices i don't like the stuff that's impacted by interest rate interest rate hikes or interest rate movements i don't like stuff that is heavy capital intensity i don't like stuff that is uh a little can be impacted by the business cycle and i think and while used car prices have been fairly durable over the you know long history i think all four of those come into play with carvana and that i don't know if that could ever get me interested yeah all right that's gonna do

for this week i don't know when this next one you pick will come out because we have one coming up with brad freeman on lulu lemon and i picked farfetch so we have to determine the order but now it's your turn ryan for the next pick here so what's going to be one of the three here we're going with charter communications all right uh one of the big cable providers them in comcast in the united states part of the liberty well relationship to the liberty group i don't know it's so complicated with them uh so yeah the next three shows on the not so deep dabs are going to be in some order charter uh farfetch and lululemon all right that's going to do it for this episode if you like the show give us a review on apple or spotify preferably five stars and do not tell us

our analysis was bad if it was bad it'll be proven out in the stock price thank you very much all right that uh let's give the disclosures we are not financial advisors anything we say on this show is not formal advice or recommendation however we are general partners at arch capital arch capital clients may hold securities discussed in this podcast thank you all for listening we'll see you next time We'll see you next time.