Key Takeaways:
- Commentary changes suggesting a materially lower value proposition as it relates to service and pricing for the customer.
- Disclosure suggesting GPUs is overstated by ~$1000 vs competitive set.
- Commentary that suggests difference vs competitors is less than previously thought.
- Disclosure suggesting business is abnormally benefitting from loan interest and selling off loan backlogs, while noting the risk of holding such loans.
- Detail on risk from both equity offering and cash interest payment requirements down the road, along with new insider programs for stock sales.
- Disclosure on odd organizational structure and business relationships that suggest applying a higher discount rate than comparable companies.
Operations
Changing of the Business Value Proposition. CVNA’s FY23 10-K removed the below statements, which promoted its intended value proposition vs the competition. The first statement highlighted how its “below industry average” sales prices passed on savings to its customers. While the second statement notes that it (formerly) maintained an in-house customer support specialist team that offered assistance “14-hours per day, 7 days a week”. While CVNA still has a customer support team, removing the language around Customer Advocate availability suggests it is clearly not nearly as robust a service operation as it was at the time of the 2022 10-K. We also noted poor service response in an anecdotal experience called out in our recent CVNA Black Book (CLICK HERE). It is also interesting to note that in the first statement, CVNA formerly mentioned that its “pooled inventory approach will at scale result in lower average days to sale than industry average” which would “help improve margins due to decreased vehicle depreciation,” but in the ’23 10K noted that they “have experienced, and may continue to experience, accelerated depreciation of [its] vehicle inventory due to changes in economic conditions, which could result in reduced retail and wholesale margins.” These are obviously conflicting, so makes sense that the original statement was removed, and it seems the opportunity to pass on savings to customers is not what was previously expected.
Customer Acquisition is Not Much Different (or Worse) Than Competitors. Another significant 10K removal, which formerly noted that “customer acquisition is expensive and inefficient for traditional automotive retailers,” attempting to highlight CVNA’s edge. This statement is no longer included in the updated 10K, as CVNA likely realized that its business model relating to customer acquisition is not that different. The company has gotten more regionalized and has ramped delivery charges when not near the vehicle's current location. In retail in aggregate, we consistently see how a physical store presence has a powerful impact on ecommerce engagement for consumers in a specific market. While the two business models are uniquely different, CVNA’s edge is apparently not what it once thought it was.
CVNA Notes Rising Competitive Risk With Amazon. While Amazon is not yet a material risk to CVNA’s business model, as it only offers new vehicles through local dealers, CVNA notes that AMZN *could* shift its focus to directly compete with CVNA’s offering. We tend to agree with this emerging threat given Amazon’s pilot of new car sales with Hyundai.
The Goal is to Maximize Units, Which Comes at a Price. CVNA Management’s long-term goal is to sell as many vehicles as possible. While management is focused on maximizing profitability in the short-term, it knows the planned return to growth will significantly increase costs across the business. This is a key point to our short thesis. Sure, when CVNA reduces units by -25%, cuts a ton of costs from the business, and strategically sells excess loans to optically boost adjusted EBITDA, the model looks more profitable. But in order to turn on growth costs come back in size, and the unit economics do not justify the stock price. Margins need to go down over the near term to attempt to prove the longer term equity bull case of high volumes and better margins from scale.
Retail GPU is Arguably Juiced by $1000. At first glance, CVNAs Used Retail GPU is impressive compared to other auto retailers. But CVNA added new disclosure in its investor letter that suggests the metric is misleading. First, CVNAs’ Non-GAAP GPU excludes non-cash expenses, increasing it by ~$150 per unit. Second, limited warranty expenses are put into SG&A, whereas competitors include it in COGS, lifting GPU by another $350 per unit. Lastly, and perhaps most importantly, CVNA books delivery charges in the price/rev per car, but includes outbound logistics expenses (delivering the vehicle to the customer) in SG&A, whereas this likely should be booked in COGS. CVNA notes that it does not know the exact competitive variance, because others don’t really do much shipping. The variance is almost certainly material given that delivery fees, when charged, can range from $200 to $1000+, and we don't have a good way to estimate the typical delivery cost. That means this delivery fee flows straight into the GPU without any offset in cost… We walk through this below.
Delivery Charge is Booked as Revenue with COGS Housing Inbound Transportation but SG&A Containing Outbound.
This Difference is Especially Important Given the Timing of CVNA Ramping of Delivery Charges. We don’t know the exact date, but scouring message boards it looks to be late 2022 to early 2023 that CVNA significantly increased delivery charges as opposed to more frequent free shipping. In the table below, non-cash expenses are including in CVNA’s GPU. Subtract $350 in limited warranty expenses and potentially an average ~$500 (rough estimate) in delivery fees (with no cost in COGS) and you get a sub-$2000 GPU. Keep in mind this is CVNA operating at “PEAK” efficiency with units down significantly and still burning cash. When trying to grow, this number likely gravitates closer to an industry median, and apples to apples is not better than the traditional model new/used dealers.
Financing - "Other revenues"
New Agreement to Sell Loans to Ally – Gearing Up for More “One-Time Benefits” In Q2 and Q3 ’23 CVNA benefited from selling excess loans to the tune of over $100 million in EBITDA, which is also reflected in their “Other Revenue.” We expected Q4 to be near the end of the tailwind, but CVNA actually originated ~$200 million more loan principal then it sold in 4Q, meaning “finance receivables held for sale” rose and remains well above the normalized rate. The company stated that its >$100mm Q1 EBITDA guide does not contain any assumption of one-time benefits. That may be the case, but we will watch this line item as it is likely to be a material one time help in upcoming quarters as it sells excess loans.
Holding Loans Longer Drove Interest Income. Optically CVNA got more profitable, but a significant portion of this total GPU growth was one time in nature (and on incomparable numbers) and deviating from its normal business process. Holding excess loans meant it was collecting elevated levels of interest, which is fine, but becoming a lender is NOT what CVNA wants to be. That would require a completely different return on capital outlook and much worse valuation framework than the bulls want to put on this. So we should ignore any excess near term profits from holding the loans longer, as it is should not be part of the ongoing business operations.
Added Risk of Loss of for Finance Receivables. While CVNA still notes that it “does not intend to hold the finance receivables it originates,” this newly added line around the risk of loss resulting from securitized receivables clearly shows that something has changed, and it felt the need to address the risk from holding these excess loans.
Shares
Still ~$700mm in Selling Pressure from ATM Offering. Not much else to be said here.
New 10b5-1 Plans from CFO and VP of Accounting/Finance. Both the CFO, Mark Jenkins, and VP of Accounting & Finance, Stephen Palmer, entered into new 10b5-1 plans allowing them to sell shares beginning in March. At the current price of ~$80, Jenkins could sell upwards of $25mm in stock, while Palmer could sell ~$1.2mm. Very interesting that a key executive like Jenkins is prepping to sell this much when management is outlining a huge longer term opportunity.
debt
Interest Burden is Heavy and Accruing into the Principal for Now. In Q4, CVNA’s cash went down, debt went up, and the business lacked underlying GAAP profitability. That is OK for now as PIK interest accrues to the principal debt balance, but cash payments of interest will start in relatively short order and the debt balance will be significant while having to pay a 9% interest rate.
Drivetime relationship
We Do Not Know the Full Details, But this Relationship At a Minimum Requires A Heavier Discount Rate. CVNA was spun out of DriveTime, which was founded by Ernie Garcia II, the father of CVNA CEO Ernie Garcia III… While the below slide is only a snippet of what CVNA chooses to disclose, it is hard to say to what extent CVNA can adjust profits based on service terms and business transactions with DriveTime.
Organizational structure
Odd Organizational Structure for a Public Company. Given the above relationship, the fact that the Garcia Party (Ernie Garcia II and Ernie Garcia III) controls 87% of the voting power and “can determine the outcome of all matters requiring stockholder approval” is unique to say the least. Again, potential shareholders should be aware of the structure that arguably means a higher discount rate vs companies with a more normal voting and organizational structure.
