With Carmax earnings approaching, I figured it would be worthwhile to throw something together for Carvana (CVNA) who should be reporting their Q4 2021 earnings sometime in Feb 2022. They have been spending money like crazy on inventory during 2021 to keep up with demand often paying ludicrous prices at auctions for cars much like Carmax which I would suspect lead to lower profit margins. Depending on the outcome of Carmax earnings, it could lead to a similar situation with Carvana. But there is something that sets the two apart greatly. Carvana is a very interesting company due to it’s intermingling of multiple streams of revenue through numerous family businesses.
Carvana Co., is worth nearly $40 billion and sold around 400,000 cars this year. It is still leaning on CEO Mr. Garcia III’s father heavily for support.
Mr. Garcia III spun Carvana out of DriveTime Automotive Group Inc., a 132-dealer chain started in the 1990s by his father, Ernie Garcia II. Mr. Garcia III grew up around the business, and went to work there shortly after graduating from Stanford University in 2005 with entrepreneurial ambitions.
The Garcias took Carvana public in 2017 with agreements to pay DriveTime for various business services. Last year, Mr. Garcia II’s companies took in around $85 million in revenue from providing extended warranties to Carvana buyers, collecting on their loans, and selling or leasing real estate, according to Carvana filings.
Carvana, known for its car vending-machine towers, has continued to strike new related-party deals with companies controlled by the elder Mr. Garcia which according to them “provide the most value in delivering exceptional customer experiences and growing into our opportunity as quickly as possible.”
When Carvana was having trouble meeting customer demand this year, it bought thousands of cars from DriveTime to help catch up. To add buildings for another 1,000 employees at its Phoenix-area corporate campus, Mr. Garcia II bought the land. To help pay for inspection centers getting cars to customers faster, Carvana purchased a building from Mr. Garcia II and sold it for more.
Mr. Garcia II isn’t a Carvana executive or board member but controls around 85% of its voting shares with his CEO son. He has also profited handsomely, selling $3.6 billion of Carvana stock since October 2020. Publicly traded companies often shun related-party transactions because they raise questions about whether shareholders, or the related parties, are getting the best deal in a transaction. They require additional disclosure under accounting rules and securities law.
A Carvana spokeswoman said: “At certain companies, there may be concerns with related-party agreements creating risks for investors,” but she said the roughly 20 times increase in Carvana’s stock since its initial public offering has “presumably resolved any potential concerns.”
Carvana’s share price has rocketed through the pandemic. Despite a recent pullback, it is by far the country’s most valuable publicly traded auto retailer. Investors betting on Carvana’s fast growth have sent the company’s market capitalization to nearly double that of rival CarMax, Inc.
Payments to Garcia family companies represent less than 1% of the company’s overall expenses. The younger Mr. Garcia stands to personally benefit from many of the deals. Public records in Arizona and Texas show Mr. Garcia III is the sole beneficiary of a trust that owns 11.31% of DriveTime and two other companies supplying services to Carvana, Bridgecrest Credit Co. and SilverRock Automotive Inc. With his children, Mr. Garcia III is the beneficiary of a second trust owning another 11.31% of the companies.
The father, Mr. Garcia II, had been in the used-car business since the early 1990s. It was a fresh start after pleading guilty in 1990 to a count of bank fraud for taking out a loan and facilitating a real estate transaction that benefited Charles Keating’s Lincoln Savings & Loan Association before it collapsed.
In a 2013 securities filing, Mr. Garcia II said he pleaded guilty after facing severe financial pressure and received a minimal $50 fine due to his cooperation with the investigation.
Carvana said it could grow quickly in new markets with limited investment compared with bricks-and-mortar dealers. It leased space at DriveTime sites to store and inspect cars, and outsourced resource-intensive collections on customer loans to another company Mr. Garcia II owns.
Some of the deals boosted Garcia family companies. SilverRock, which provides extended warranties that Carvana sells to customers, hit snags renewing an Arizona license in 2018 because it was in negative equity, according to a licensing renewal request to Arizona’s insurance department. It told the department that its financial position was improving from contracts with Carvana and DriveTime, and that it would soon be profitable.
Another Garcia family company, Bridgecrest, saw its loan servicing portfolio more than double to above $10 billion, driven by the Carvana business, according to filings from both companies. It earns between 0.54% and 1.41% in fees for managing loans packaged into public securitizations for Carvana, according to Mr. Scheitzach.
Bridgecrest changed its name from DT Credit Co. after the Consumer Financial Protection Bureau imposed an $8 million fine on its parent company and DriveTime in November 2014 for allegedly harassing borrowers. The companies didn’t admit or deny the findings.
The related-party agreements are important to Carvana’s earnings. Around 12% of Carvana’s gross profit last year, or $93.6 million, came from commissions for selling SilverRock extended warranties.
“They’re at the edge of the envelope,” said Amy Westbrook, a law professor at Washburn University who has studied large startups. “They have a convoluted tangle of interrelated companies and related party transactions, and it’s very difficult to understand or pull apart.” The problem with related-party transactions with large shareholders, she said, is “they don’t need to make money from this entity because they own the other entities.” Carvana “doesn’t have to make money for them to make money,” she said.
Carvana has grown at breakneck speed and has invested heavily, sacrificing profits to gain market share. It has yet to turn in a full-year profit. One big cost is building a national network of inspection centers to process cars. It has a goal to sell two million vehicles a year.
To make its money go further, Carvana has been buying inspection sites, selling them and leasing them back for 25 years, so-called sale and leasebacks that are a way for growing companies and retailers to raise cash from real estate. One such deal went through Mr. Garcia II’s real-estate company, Verde Investments Inc. Verde was leasing an inspection center to Carvana in Tolleson, Ariz. It sold the center to Carvana in September 2020 for $21.7 million net book value, according to Carvana company filings. Carvana immediately sold the center for $50 million to a Phoenix investment firm with an agreement to lease back the property for 25 years. The price included building improvements Carvana made.
In December 2019, Verde bought land around Carvana’s Tempe, Ariz., headquarters outside Phoenix and applied to develop a 14-acre campus. It described Carvana as the future land owner with plans to hire 1,000 employees. Verde got planning permission for the development in August.
Carvana is also potentially in the process of building a large vehicle reconditioning facility in AZ.
Carvana lost it’s dealer’s license in NC in Aug 2021 due to failure to deliver on titles for registration and ineligible to renew it until 2022. They are currently being threatened by the State of FL for the same issue of failing to deliver titles. Reports of this issue have also come out of numerous other States. They are also possibly facing a Federal lawsuit because of this.
This company overall just seems sleazy to me. I will be following the news on this over time and may play some puts on this when it comes time for earnings. Like I said, I’m really interested to see how Carmax does with their report for a comparison.
https://www.newsobserver.com/news/business/article253391658.html
