https://www.wsj.com/articles/apollo-to-purchase-1-6-billion-of-carvana-bonds-11651084271
Carvana’s financial troubles spilled over into debt markets this week when the online used-car dealer struggled to sell bonds and was forced to turn to Apollo Global Management Inc. for $1.6 billion to salvage the deal. The giant investment firm agreed to purchase about half of $3.275 billion of bonds Carvana is issuing to purchase car-auction network ADESA U.S., people familiar with the matter said. Carvana had a hard time attracting investors following a disappointing first-quarter earnings report and stock selloff. Apollo’s intervention highlights the growing clout of private debt and equity firms that are bankrolling swaths of the U.S. economy. Shares of Carvana surged during the pandemic but tumbled over the past eight months as secondhand car prices declined and investors grew concerned about the company’s continued losses. ADESA was meant to accelerate growth, and Carvana hired JPMorgan Chase to raise billions of dollars in debt and equity to pay for the purchase and subsequent integration.
The financing ran into headwinds last week when the company reported a more-than sixfold increase in net losses for the first quarter of 2022 compared with a year earlier. The company was one of the biggest losers in the tech stock selloff, which was driven by rising interest rates and worries about a recession. Carvana blamed a mix of tough economic conditions—rising interest rates, higher gas prices, inflation-weary consumers—for its first-ever decline in quarterly retail sales. It also acknowledged to investors that the constant pressure to continue its rapid expansion has played an outsize role in its priorities, and it pledged to reduce costs and improve its efficiency. The deal with Apollo is an acknowledgment that filling the hole in its balance sheet had taken precedence over growth. The onerous interest rate on the debt could make it difficult for the company to invest in growth. Carvana has burned cash since its founding 10 years ago.
Carvana shares dropped about 30% in recent weeks and bond prices also fell, pushing up the yield that bond investors demanded to lend the company more money. Bond yields rise when prices fall. Carvana disclosed plans Monday to issue $2.275 billion of bonds and $1 billion of preferred shares for the ADESA acquisition. Chief Executive Ernie Garcia III and his father, Ernie Garcia II, participated in a roughly $1.2 billion new common-stock issue to boost cash levels. Apollo privately committed to buy $600 million of the preferred shares, but JPMorgan struggled to find enough buyers for the bonds, fund managers who considered the deal said. By Tuesday, the clearing yield for the bond deal was above 10.5%, a level that might have forced JPMorgan to forgo some or all of its fees for the financing, the fund managers said. Apollo, which has invested in Carvana stock and debt for years, proposed an alternative: Carvana would scrap the preferred stock sale and issue $3.3 billion of 10.25% bonds backstopped by a $1.6 billion order from Apollo. That yield is well above the average for most junk bonds.
The revised deal came with a twist, in which Carvana would be barred from prepaying the new debt for about five years—roughly twice the normal period for junk bonds. Apollo stands to make about 1.6 times its money if the bonds are subsequently repaid. It would have made about 1.3 times its money on the preferred shares, one of the people familiar with the matter said. Such large checks have grown increasingly common as private fund managers raised unprecedented sums of money, prompting them to hunt for increasingly big trade ideas. The funds provided jumbo rescue loans to companies like Airbnb Inc. and Carnival Corp. during the depths of the coronavirus pandemic.
Apollo manages about half a trillion dollars and made a similar $1.5 billion preferred-stock investment in Hertz Global Holdings Inc. in 2021 to help lift the car-rental company out of bankruptcy. The Hertz deal paid out handsomely, but Carvana’s future is uncertain for now. Moody’s Investors Service cut its credit rating of Carvana this week to triple-C, one of the lowest rungs on the junk-debt ratings ladder, citing persistent lack of profitability, negative cash flow and corporate-governance risk. Credit ratings firm S&P Global said Wednesday that the replacement of the preferred equity with debt will result in higher interest costs that will put pressure on the company’s cash flow. S&P estimated that the additional capital would help the company cover about two years of cash burn. “Technology companies can offer excess yield, but investors need to pay attention to the quality and stability of cash flows,” said Scott Giardina, managing director at FS Investments. “Technology business models are generally asset light, and bankruptcy recoveries will tend to be lower than more traditional asset-based companies.” Carvana, which went public in 2017, has burned through cash and relied heavily on debt investors to fund its operations, similar to tech companies such as Netflix Inc. and Uber Technologies Inc.
