Running out of road: Apollo gears up for Carvana showdown

The last time Apollo made a big bet on the US car industry, it walked away with hundreds of million in profits courtesy of Hertz.

This time it is being forced to band together with Wall Street rivals as they brace for a showdown with Carvana, the pandemic darling that promised to revolutionise how Americans buy cars but now faces a fight for survival.

The asset management group last April bought just over $800mn of junk bonds issued by Carvana, betting that it could regain some of the $50bn equity valuation it reached in 2021 before crashing as interest rates rose and consumers cut spending.

Apollo believed in Carvana’s plan to sell cars online and thought that the 10.25 per cent annual coupon on offer in the overall $3bn bond issuance offered plenty of protection. The firm was also reassured by a study into Carvana’s business model it, along with other investors, had commissioned from Bain & Co in early 2022. Apollo, considered by many to be the canniest credit investor in the world, had been a longtime investor in the online car retailer’s debt.

“Apollo was drunk on the Manheim index,” said one rival distressed debt investor, referring to the benchmark of used car prices that had driven the fortunes of both Hertz and Carvana in 2021.

But Carvana has gone from chasing breakneck growth to slashing operating costs and cutting staff. And those bonds now trade below 50 cents on the dollar. The paper losses imply a $400mn loss for Apollo but that has been mitigated by coupon payments and hedging activities, said a person familiar with the position.

The collapse in Carvana’s fortunes means Apollo and other bondholders are gearing up for a potential clash with the company and the founding Garcia family, which holds shares controlling 84 per cent of votes.

Carvana was built out of DriveTime, an Arizona used-car business owned by Ernie Garcia II, and pitched itself as the digital disrupter of anachronistic used-vehicle dealerships. 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 firms that together hold 80 per cent of Carvana’s more than $5bn in debt formed a pact to pre-empt the company from leaning on individual bondholders and pitting them against each other.

The “co-operation agreement” rules out side deals and stands for at least six months. The group of bondholders “locking arms”, as one member put it, includes Ares Management, Pimco, BlackRock, Knighthead Capital, Davidson Kempner and Oaktree.

All of the firms declined to comment.

The bondholders had chosen to organise after they learned that Carvana was working with the law firm Kirkland & Ellis and investment banker Moelis and Company — advisers known for creative strategies in raising capital and dividing creditors.

One of the bondholders said the creditors feared the Garcias and their advisers could attempt to force them into a “prisoner’s dilemma’ to pit them against each other.

Knighthead was also part of Apollo’s foray into the US vehicle 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 agency, had purchased $1.5bn of Hertz preferred stock, paying a 9 per cent annual dividend. Late in 2021, just months after emerging from bankruptcy, the car rental company decided to repay the pricey Apollo stock for a contractually agreed 25 per cent premium, or $1.875bn.

Like Hertz, Carvana had found itself propelled by American consumers flush with stimulus cash and a dearth of vehicles, which sent rental car rates and used car prices soaring.

Carvana, however, had never turned a net profit. And by early 2022 it was not only facing plummeting demand but was also weighed down by the $2bn acquisition of Adesa, a company with a network of physical car auction sites. Carvana, which bought at the top of the market, had struggled to raise financing to close the deal.

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

Since then, the company’s stock price has fallen 94 per cent from the $80 stock price offering and Carvana’s market capitalisation has dwindled to about $1bn.

The company, even while having the capacity to issue secured bonds, is already labouring under 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 unit sales. Despite the headwinds, chief executive Ernie Garcia III said the company had enough near-term liquidity between $300mn in cash, $2bn of revolving credit capacity, as well as $2bn worth of real estate it could borrow against.

People involved in the organised debt group said the bondholders had not yet formed any specific strategies nor had seriously engaged with Carvana. They said options include committing more capital in the form of debt or equity but that the company has little ability to pay more interest or issue new shares at its current valuation.

However, multiple Carvana creditors also told the FT that they believe the company, with fresh capital, could successfully further slash costs and turn cash flow positive.

John Colantuoni, a stock analyst at Jefferies, said that ultimately Carvana’s survival would come down to “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 in Carvana stock in recent years.

An analyst had asked Ernie Garcia III on a November earnings call if they would consider giving up control of Carvana to raise capital to keep the company alive.

“We’re just going to keep running our play and moving forward,” he replied.