Cars in Vending Machines, a Fading IPO and an Ex-Con OwnerBy and
Carvana’s shares controlled by character from S&L loan scandal
Online used-car vendor looks to stand out in troubled market
Who wants to buy a used car from a vending machine?
Enough customers to help a young company called Carvana Co. double its revenue in the first quarter of this year. Its first earnings report since going public in April, released after the market closed on Tuesday, showed its net loss doubling as well -- roughly in line with analysts’ estimates and in keeping with the company’s strategy of rapid expansion. Carvana’s share price closed at $9.53, up 6 percent.
The vending machines -- multistory glass structures that dispense certified used cars in four cities in Texas as well as Nashville, Tennessee -- aren’t all that’s noteworthy about the upstart that’s been called the “Amazon of used cars.” Carvana’s burning cash at a pace that recalls the dotcom boom and bust. It has agreed to pass along most of any tax benefit generated in its initial public offering, estimated at the time of the listing at $1 billion, to early investors, including Carvana’s largest shareholder, Ernest Garcia II.
And then there’s something investors didn’t learn from the prospectus for the New York Stock Exchange share offering: Garcia, who owns a controlling stake in Carvana and whose 34-year-old son Ernie III is its chief executive officer, has a criminal conviction tied to the savings-and-loan scandal that erupted in the early 1990s.
“A controlling shareholder having a fraud conviction is of interest to other shareholders,” said John Coffee, a professor of corporate law at Columbia University. While it may not be a legal requirement to do so, he added, “I think a company doing a public offering should disclose this factor.”
Ernie Garcia III declined to comment through Carvana in advance of the company’s earnings release. Ernest Garcia II declined to comment.
Carvana, whose shares have fallen 36 percent since its April 27 IPO, is pulling into the used-car business at a challenging time. An abundance of supply is pushing down car values. Loan delinquencies are rising. A Carvana rival, Beepi, wound down earlier this year after raising $150 million in venture funding.
Carvana, which operates in 27 cities, was spun off in 2014 from DriveTime Automotive Group Inc., a privately owned operator of brick-and-mortar used-car dealerships. The elder Garcia is DriveTime’s chairman and controls almost all of its shares. His longtime partner Raymond Fidel is DriveTime’s CEO. DriveTime and Fidel declined to comment.
Garcia pleaded guilty to bank fraud and Fidel to securities fraud in the early 1990s for their bit roles in the demise of California thrift Lincoln Savings and Loan Association, which sparked a national political scandal. Five U.S. senators came under a cloud for accepting campaign contributions from Lincoln’s boss, Charles Keating, and intervening on his behalf.
Testimony Against Keating
Garcia, a Lincoln borrower, and Fidel, a bank president, avoided prison time by testifying for federal prosecutors against Keating. Each received three years of probation and has since had his civil rights restored, according to DriveTime filings. Garcia was barred from the financial industry for at least three years.
The company’s recent IPO prospectus doesn’t mention Garcia’s past. He isn’t an officer or director of Carvana. But he and his son held 97 percent of Carvana’s voting shares through various entities at the time of the offering, and have control over matters requiring shareholder approval, like selecting directors. The prospectus also describes a spaghetti pile of ties between Carvana, DriveTime and other Garcia-controlled companies. Carvana leases dealership space and corporate aircraft from DriveTime, licenses some of its intellectual property and uses it for loan servicing and collections.
There’s no question that Carvana reaps significant benefits from piggybacking on DriveTime’s facilities -- so much so that some investors were spooked by the prospectus’s mention that DriveTime’s owners are considering selling it, says Ali Faghri, a senior analyst at Susquehanna Financial Group, who rates the stock a hold.
“We benefit a ton from the infrastructure that DriveTime brings to the table,” the younger Garcia told Bloomberg Television in July 2014. “It’s been a great partnership.”
To stand out from rivals including CarMax and eBay Motors, Carvana’s goal is to build a large distribution network and deliver used vehicles to customers around the country who buy, finance and obtain warranties on its website. By lowering interest rates and eliminating the cost of dealerships and add-on fees, the company says it can deliver used vehicles for hundreds or thousands of dollars below recommended Kelley Blue Book prices.
Customers who browse the 7,000-plus vehicle inventory can have cars delivered to their homes, with a seven-day money back guarantee. Or they can travel to a Carvana used-car vending machine, insert a giant coin and have their vehicles pop out a bay door. The vending machines help distinguish Carvana from Shift Technologies Inc. and Vroom Inc., two other venture capital-backed upstarts that boast web-based used-car shopping with lean distribution chains.
The elder Garcia laid the groundwork for DriveTime in 1990, when he bought a rental-car company called Ugly Duckling out of bankruptcy. Merging that operation with a financing company, he built a vendor and financier of used cars for subprime borrowers. Fidel, a fellow Phoenix-area businessman, came on in 2001. By this decade, according to Carvana, DriveTime became one of the five biggest used-car dealers in the U.S. Garcia bought a New York apartment in Trump Tower, the president’s permanent residence.
Like others in the used-car business, DriveTime has hit some legal potholes. In 2014, it agreed to pay $8 million to settle Consumer Financial Protection Bureau claims that its hundreds of collection agents used abusive tactics with the 46 percent of company loan customers who were delinquent. The company neither admitted or denied wrongdoing and agreed to make changes in its operations.
Garcia’s son, Ernie III, joined DriveTime in 2007 after earning an engineering degree from Stanford. He helped the company develop tools to assess consumer credit, set vehicle prices and structure deals, a Carvana biography says. Named CEO at Carvana’s founding in 2012, while he was still in his 20s, Ernie III brought a Silicon Valley swagger to the business, which boasts its customers can buy vehicles “in as little as 10 minutes.”
Carvana has burned through cash as part of its rapid expansion. It raised $460 million in funding prior to going public and was down to its last $39 million in cash earlier this year, company filings show. Its rapid revenue growth -- 180 percent in 2016 -- so far hasn’t been enough to make up for the burn, and Tuesday’s earnings will show whether it’s making progress in closing the gap.
Carvana’s public offering -- underwritten by banks including Wells Fargo & Co., Bank of America Corp.’s Merrill Lynch, Deutsche Bank AG and Citigroup Inc. -- brought in $211 million in much-needed funding and bolstered the company’s board with figures including former Vice President Dan Quayle. The IPO was something of a coup for the elder Garcia, turning his son into the boss of a NYSE-listed company. The $15 offering price also valued Garcia’s 71 percent stake at $1.5 billion, rendering him a certifiable billionaire.
The 10-figure status proved short-lived, however. The value of Garcia’s holdings in Carvana dropped more than 25 percent during its first day of trading and the shares have since drifted to below $10.
While investors have been cautious, analysts see room to grow. Merrill Lynch’s Nat Schindler set his initial target price at $25, saying Carvana’s package of vehicles, financing and warranties would bring “e-commerce disruption” to the used-car market.
Nine of 10 Wall Street analysts covering the company rate it a “buy.” Eight of those nine bulls work for banks that underwrote the offering, including the four largest -- Merrill Lynch, as well as Citigroup, Deutsche Bank and Wells Fargo. Representatives for those banks declined to comment on the offering or their analysts’ research.