No more roads: Apollo prepares for the Carvana showdown

No more roads: Apollo prepares for the Carvana showdown

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The last time Apollo made a big bet on the US auto industry, it walked away with hundreds of millions in profits thanks to Hertz.

This time it’s forced to join forces with Wall Street rivals as they prepare for a showdown with Carvana, the pandemic darling who promised to revolutionize the way Americans buy cars, but now before a fight is about survival.

The wealth management group bought just over $800 million in junk bonds issued by Carvana last April, betting it could recoup some of the $50 billion stock valuation it hit in 2021 before it plummeted when interest rates rose and consumers cut back on spending.

Apollo believed in Carvana’s plan to sell cars online and felt that the 10.25 percent annual coupon offered in the entire $3 billion bond offering offered plenty of protection. The company was also reassured by a study of Carvana’s business model it co-commissioned with other investors from Bain & Co in early 2022. Apollo, considered by many to be the world’s smartest debt investor, was a longtime investor in the online auto dealer’s debt.

“Apollo was drunk on the Manheim Index,” said a rival distressed debt investor, referring to the benchmark used-car prices that propelled Hertz and Carvana’s fortunes in 2021.

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But Carvana has gone from chasing breakneck growth to cutting operating costs and downsizing. And those bonds are now trading below 50 cents on the dollar. The paper losses imply a $400 million loss for Apollo, but that was mitigated by coupon payments and hedging activity, said a person familiar with the position.

Carvana’s collapse means Apollo and other bondholders are preparing for a possible clash with the company and the founding Garcia family, which holds shares that control 84 percent of the vote.

Born out of DriveTime, an Arizona used car store owned by Ernie Garcia II, Carvana positioned itself as the digital disruptor of anachronistic used car dealers. The company, which went public in 2017, sells hundreds of thousands of vehicles each year and is run by the founder’s son, Ernie Garcia III.

Apollo, Carvana and the Garcia family declined to comment.

In December, as economic conditions worsened, Apollo and at least six other companies, which collectively hold 80 percent of Carvana’s more than $5 billion in debt, struck a deal to prevent the company from expanding supports individual bondholders and plays them off against each other.

The “cooperation agreement” excludes side business and is valid for at least six months. The group of bondholders, as one member put it, includes Ares Management, Pimco, BlackRock, Knighthead Capital, Davidson Kempner and Oaktree.

All companies declined to comment.

The bondholders decided on an organization after learning that Carvana was working with law firm Kirkland & Ellis and investment banker Moelis and Company — advisers known for creative strategies in raising capital and allocating creditors.

One of the bondholders said the bondholders feared the Garcias and their advisors might try to force them into a “prisoner’s dilemma” in order to play them off against one another.

Knighthead was also part of Apollo’s foray into the U.S. auto sector when Knighthead co-led an equity investment to successfully buy Hertz out of bankruptcy in the summer of 2021.

Apollo, a longtime investor in the car rental company, had bought $1.5 billion worth of Hertz preferred stock and paid a 9 percent annual dividend. In late 2021, just months after filing for bankruptcy, the car rental company decided to redeem the expensive Apollo shares for a contract premium of 25 percent, or $1.875 billion.

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Like Hertz, Carvana had been fueled by American consumers inundated with stimulus funds and a shortage of vehicles, sending rental and used car prices soaring.

However, Carvana had never made a net profit. And in early 2022, it not only faced a slump in demand, but was also weighed down by the $2 billion acquisition of Adesa, a company with a network of physical auto auction sites. Carvana, which bought at the top of the market, struggled to raise the financing to close the deal.

As it sold bonds in the spring, in part to fund the Adesa deal, it also sold $1.3 billion worth of stock, a third of which went to the Garcia family.

Since then, the company’s stock price has fallen 94 percent from the $80 share offering, and Carvana’s market cap has shrunk to about $1 billion.

Despite the company’s ability to issue secured notes, it already suffers from hundreds of millions of dollars in annual interest payments.

In the third quarter of last year, Carvana announced its first year-over-year decline in vehicle sales. Despite the headwind, CEO Ernie Garcia III said the company has near-term liquidity ranging from $300 million in cash, $2 billion in revolving credit capacity and $2 billion in real estate to borrow against.

People involved in the organized debt group said bondholders have not yet developed any specific strategies or taken a serious look at Carvana. They said options include providing more capital in the form of debt or equity, but the company is unlikely to be able to pay more interest or issue new shares at its current valuation.

However, several Carvana creditors also told the FT that they believe fresh capital could allow the company to further reduce costs and turn cash flow positive.

John Colantuoni, an equity analyst at Jefferies, said Carvana’s survival would ultimately depend on “access to capital over the next five to 10 years and how cheap that capital is to fund growth.”

The Garcia family remains a wild card. The elder Garcia has no official role at the company, but has sold billions of dollars worth of Carvana stock in recent years.

An analyst had asked Ernie Garcia III at an earnings call in November if they would consider relinquishing control of Carvana to raise capital to keep the company afloat.

“We’re just going to continue our game and move forward,” he replied.

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