Too many weird things happening with this company and industry, so I might break this DD into parts.
*Not financial advice. Borderline fiction. Don't take what is written here for granted.*
TL;DR: Carvana has "*not at arm's length arrangements*" with DriveTime and this could be boosting their metrics. Meanwhile, Carvana's controlling shareholder and DriveTime's owner, Ernie Garcia II, has sold $1.4 billion in shares over the last few months.
# Numbers:
* Market cap of $53 Billion
* P/E ratio: 31,000x (yup, thousands)
* D/E ratio: 10x ($6.2B debt for just $600M equity)
* Founded: 2012 (as a spinoff of DriveTime)
* Employees: 13.700
* CEO: Ernie Garcia III (son of Ernie Garcia II, owner of DriveTime, and controlling shareholder of Carvana) ([TradingView](https://www.tradingview.com/symbols/NYSE-CVNA/financials-overview/))
* Insider Trading: +$1.6bi on stock sold in L12M, including:
* Ernie Garcia II: \~$1.4 billion since April
* Mark Jenkins (CFO): +$72 million and plans to sell more ([YahooFinance](https://finance.yahoo.com/news/carvana-ceo-father-sees-1-163234402.html), [SecForm](https://www.secform4.com/insider-trading/1690820.htm))
* \~9 million shares issued in Q2, bringing $347 million as cash and further diluting shareholder's equity. ([Q2 QR](https://investors.carvana.com/~/media/Files/C/Carvana-IR/documents/cvna-shareholder-letter-q2-2024.pdf))
* *"Record Adjusted EBITDA margin of 11.7%, a new all-time best for public automotive retailers"* is a highlight of their Q3 results. ([CVNA Q3 2024](https://investors.carvana.com/~/media/Files/C/Carvana-IR/documents/cvna-earning-release-q3-2024.pdf)).
# Hypothesis
Given that Ernie Garcia II owns DriveTime, Bridgecrest, and SilverRock and remains Carvana's controlling shareholder, Carvana could have been given beneficial contract terms that improved its metrics and, consequently, its market price.
Take a look at these paragraphs from their [2023 Annual Report (page 20)](https://www.sec.gov/Archives/edgar/data/1690820/000169082024000093/cvna-20231231.htm):
>"We were incubated by and may benefit from our relationship and a series of **arrangements with DriveTime not always negotiated at arm’s length**, as DriveTime is controlled by our controlling shareholder who is also the father of our chief executive officer. (...)
>DriveTime built certain of our inspection and reconditioning centers ("IRCs") in Georgia, New Jersey, and Texas and is now our landlord at some such sites. Verde Investments, Inc. ("Verde"), an affiliate of DriveTime, formerly leased to us our Arizona IRC and sold it to us in 2020. We have also historically leased certain of our hubs from DriveTime. (...)
>Consequently, certain of **our historical costs and expansion activities may not accurately reflect our future costs and expansion** to the extent that DriveTime no longer provides us with such services or refuses to continue doing so at currently contracted-for prices."
>"We continue to periodically engage DriveTime, its affiliates, and other entities controlled by our controlling shareholder to provide us with certain services, including the administration of certain VSCs and other related products sold to our customers. (...)
>Additionally, **DriveTime has in the past and may in the future purchase or sell certain vehicles or automotive finance receivables from or to us**. However, there can be no assurance that they will do so on the same or similar terms, or at all. As a result, our historical results may not be reflected in our future results.
>Before and after we sell automotive finance receivables originated by us, **DriveTime performs ongoing servicing and collections**. If DriveTime is unwilling to enter into servicing arrangements for our future automotive finance receivable transactions on terms or at prices consistent with their historical prices or at all, our revenues derived from the sale of those receivables may decline as a result. (...)"
By **"not always negotiated at arm’s length"**, it implies they might be receiving favorable benefits in terms of assets, revenue, and expenses. This raises the possibility that their reports may not fairly represent their future costs and expansion, as some aspects could be currently "hidden" under the financial and operational support from DriveTime.
According to their Q3 2024 reporting, \~15% of their L9M operating income comes from related parties. ([Q3 Report](https://investors.carvana.com/~/media/Files/C/Carvana-IR/documents/cvna-shareholder-letter-q3-2024.pdf))
# ELI5:
1. Carvana could be unintentionally overstating revenues and understating future expenses through its favorable agreements with DriveTime;
2. Carvana share price increases based on its *"all-time best"* metrics;
3. Ernie Garcia II - Carvana's controlling shareholder and DriveTime's owner - sells $1.4 billion in stock;
4. At some point, DriveTime and its affiliates may change or dismiss the arrangements, and Carvana's actual revenue, capex, and opex numbers would show up.
# "Other Gross Profit Per Unit - GPU"
Carvana mentioned their "Total gross profit per unit ("GPU") was $7,427." on their [Q3 2024 report](https://investors.carvana.com/~/media/Files/C/Carvana-IR/documents/cvna-shareholder-letter-q3-2024.pdf).
They arrive at this figure by adding together "Retail GPU", "Wholesale GPU", and "Other GPU". I find this calculation quite suspicious tbh but I want to focus on **"Other GPU"** instead, which was $3,000.
Going back to the [2023 Annual Report](https://www.sec.gov/Archives/edgar/data/1690820/000169082024000093/cvna-20231231.htm):
>"Other sales and revenues, which primarily includes gains on the sales of finance receivables we originate and sales commissions on ancillary products such as VSCs, GAP waiver coverage, and auto insurance, totaled $753 million and $741 million during the years ended December 31, 2023 and 2022, respectively. (...) **Other sales and revenues are 100% gross margin products for which gross profit equals revenue**." (...)
>"We generate other sales and revenues primarily through the sales of loans we originate and sell in securitization transactions or to financing partners, reported net of a reserve for expected repurchases, commissions we receive on VSCs, sales of GAP waiver coverage, and commissions and Root Warrants we receive on sales of auto insurance" (...)
>"In 2016, we entered into a master dealer agreement with DriveTime, pursuant to which **we receive a commission for selling VSCs that DriveTime administers**. The commission revenue we recognize on VSCs depends on the number of retail units we sell, the conversion rate of VSCs on these sales, commission rates we receive, VSC early cancellation frequency and product features. The GAP waiver coverage revenue we recognize depends on the number of retail units we sell, the number of customers that choose to finance their purchases with us, the frequency of GAP waiver coverage early cancellation, and the conversion rate of GAP waiver coverage on those sales." (...)
>"**DriveTime purchases wholesale vehicles from, and sells wholesale vehicles to, both the Company and unrelated third parties** through both competitive online auctions that are managed by unrelated third parties and the Company's wholesale marketplace platform. Additionally, beginning in September 2023, **the Company provided DriveTime with reconditioning services through its wholesale marketplace platform. The Company recognized $19 million, $32 million, and $54 million of wholesale sales and revenues from DriveTime** during the years ended December 31, 2023, 2022, and 2021, respectively."
Carvana engages in transactions with DriveTime **'not always at arm’s length,'** and DriveTime accounts for a relevant portion of Carvana's revenue and gross profit. This can be a problem.
Consider also a **hypothetical** scenario:
Imagine a vehicle with a market price of $10,000. Carvana buys it from a customer for $10,000 and then sells it to DriveTime for $11,000. DriveTime reconditions the vehicle and sells it back to Carvana at a wholesale price of $8,000. Carvana then sells it to a customer for $10,500.
* Carvana gross profit: $3,500
* DriveTime gross profit: -$3,000 (excl. costs)
This wouldn't be sustainable unless: 1. you own and control both companies, 2. one of them is publicly traded and sensitive to profitability metrics, and 3. you have the ability to sell shares whenever needed.
Please I'm not suggesting this happens at Carvana, but given their *not always at arm's length arrangements* and the lack of detailed data, this scenario remains a possibility. We rely on the work of their auditors to ensure that this is not the case.
# How to validate that hypothesis?
We would need to investigate the benefits Carvana receives, verify any discrepancies from reality, consider internal transactions, and calculate how these might affect the GPU and other metrics. Unfortunately, SEC reports don't offer enough info for that.
Based on their [2024 Proxy Meeting document](https://investors.carvana.com/~/media/Files/C/Carvana-IR/documents/proxy-statement-2024.pdf), these are the agreements between Carvana and DriveTeam entities and how Carvana has recognized revenue and expenses (summarized via GPT):
|Type|Description|Costs/Revenue|
|:-|:-|:-|
|Lease Agreement|Carvana leases inspection and reconditioning centers (IRCs) in Blue Mound, Texas, and Delanco, New Jersey from DriveTime.|Costs recognized: \~$2 million (2023)|
|Hub Lease Agreement|Carvana leased office and parking spaces at DriveTime facilities used as hubs. Expired in April 2023.|Costs recognized: \~$0.1 million (2023)|
|Houston, TX Vending Machine Lease Guarantee|DriveTime guaranteed Carvana's lease obligations for a vending machine in Houston, Texas.|Costs recognized: Unknown|
|Tempe, AZ Office Space|Carvana subleased office space from DriveTime and Verde in Tempe, Arizona.|Costs recognized: \~$0.8 million (2023)|
|Winder, GA Inspection and Reconditioning Center Lease|Carvana leases an IRC in Winder, Georgia, from DriveTime.|Costs recognized: \~$1.1 million (2023)|
|Servicing Agreements with DriveTime|DriveTime performs servicing and administrative functions for Carvana's automotive finance receivables.|Revenue for DriveTime: $3.7 million for owned receivables, $4.5 million for sold loans, $72.4 million under MPSA, $65.0 million under transfer agreements.|
|Credit Facilities|DriveTime services finance receivables under Carvana's credit facilities.|Revenue for DriveTime: $8.8 million|
|GAP Waiver Insurance Policy|Carvana purchased GAP waiver insurance policies from DriveTime.|Revenue: \~$18,000 from profit sharing|
|Master Dealer Agreement|Carvana sells and earns commissions on vehicle service contracts (VSCs), administered by DriveTime.|Revenue: \~$138 million in commissions, Costs: $17 million (2023)|
|Profit Sharing Agreement|Carvana sells Road Hazard and Pre-Paid Maintenance contracts, with profit sharing from DriveTime.|Revenue: \~$7 million (2023)|
|Insurance Services and Purchase Agreement|Carvana purchased technology assets from DriveTime and entered into an Insurance Services Agreement.|Revenue/Costs: None recognized in 2023|
|Wholesale Revenue|DriveTime purchases wholesale vehicles from Carvana.|Revenue: \~$9.8 million from DriveTime wholesale vehicle purchases, $8.0 million from DriveTime's purchases and sales through Carvana's wholesale marketplace platform (2023)|
|Retail Reconditioning Services|Carvana provides reconditioning services to DriveTime. Unknown how many vehicles were reconditioned.|Revenue: $0.8 million, Costs: $0.5 million (2023)|
|Retail Vehicle Acquisition Agreements|Carvana purchases reconditioned vehicles from DriveTime. Unclear how many vehicles were purchased and the difference between sold prices and Black Book values.|Costs: $0.1 million (2023). **Note that it was $168 million** in [2021](https://otp.tools.investis.com/clients/us/carvana/SEC/sec-show.aspx?Type=page&FilingId=15678819-125132-155068&CIK=0001690820&Index=17000) and $2.3 million in [2022](https://otp.tools.investis.com/clients/us/carvana/SEC/sec-show.aspx?Type=page&FilingId=16505487-154132-186087&CIK=0001690820&Index=19000).|
|Aircraft Time Sharing Agreement|Carvana shares usage of aircraft operated by DriveTime. Unknown how many flights were performed.|Costs: \~$0.5 million (2023)|
|Shared Services Agreement|DriveTime provides various administrative services to Carvana - such as accounting and tax, legal and compliance, information technology, telecommunications, benefits, insurance, real estate, equipment, corporate communications, software and production, and other services, additional administrative services including but not limited to certain account remediation services.|Costs: \~$35,000 (2023)|
# SG&A Expenses
On a side note, I found it impressive how they've managed to grow retail units sold and expand market hubs without increasing their SG&A expenses over the quarters.
https://preview.redd.it/tiyxx6fztw4e1.png?width=1507&format=png&auto=webp&s=bbb011b2e54031366e11afd3614f45dd19773ff6
https://preview.redd.it/ey0l1q60uw4e1.png?width=931&format=png&auto=webp&s=e8760c18263acd55275c4ead7c95139c9c31ce21
They expanded from \~120,000 retail and wholesale vehicles sold in Q3 2023 to +160,000 within 12 months, keeping their market occupancy and logistics costs flat. This should be featured as a case study by Harvard Business Review.
Quick Note: Under "definitional differences to consider" on [this document from Q4 2023](https://investors.carvana.com/~/media/Files/C/Carvana-IR/documents/cvna-shareholder-letter-q4-2023.pdf), "Limited Warranty Expenses" and "Outbound Logistics Expenses" are included in SG&A expense rather than COGS. Given that, I'd have expected SG&A to increase as a result of selling +35% more vehicles.
# What are other people saying?
1. **Grant Thornton** highlighted the financial receivables part as a "critical audit matter" ([2023 Annual Report](https://www.sec.gov/Archives/edgar/data/1690820/000169082024000093/cvna-20231231.htm)).
2. **Kellisdale Capital** sent a letter to the SEC in February requesting an investigation into these accounting practices ([Source](https://www.kerrisdalecap.com/wp-content/uploads/2024/02/CVNA-Auditor-Letter.pdf)).
3. Many people here on Reddit raised similar questions.
# Notes & Links
* Ernie Garcia II and Raymond Fidel (former CEO of DriveTime) have been previously convicted of fraud ([Source](https://www.latimes.com/archives/la-xpm-1990-10-31-fi-3371-story.html)).
>"Garcia II and Fidel are both convicted felons. They played small roles in the Charles Keating/Lincoln Savings and Loan debacle in the late ’80s and early ’90s, reportedly escaping jail time by ratting out their co-conspirators. Interestingly, there was no mention of any federal crimes in Carvana’s 2017 IPO." ([Source](https://www.autodealertodaymagazine.com/357662/never-argue-with-stupid-people))
* Seeking Alpha - Carvana: A Ponzi Collapsing
* S&P recently improved Carvana's rating from CCC+ to B- based on its revenue and earnings improvements ([Source](https://disclosure.spglobal.com/ratings/en/regulatory/article/-/view/sourceId/13215870)).
* Vroom, a Carvana competitor, failed to secure capital and went bankrupt recently. ([YahooFinance](https://finance.yahoo.com/quote/VRM/), [PressRelease](https://ir.vroom.com/news-releases/news-release-details/vroom-announces-equity-debt-recapitalization))
Let me know if I've missed any relevant details or made mistakes. I might post the second part soon, which will cover how their main gross profit depends on low interest rates, along with an overview of their cash flow.
Disclosure: I own puts expiring between March 2025 and early 2026. I was struck by the fact that the company depends heavily on DriveTime to operate, has less-than-ideal corporate governance, extreme high debt, and the market still values it at $53 billion.