Carvana, once a market darling, is forced to turn to Apollo for money

Carvana company

CVNA -9.96%

Financial troubles spilled into the debt markets this week when an online used car dealer struggled to sell bonds and was forced to turn to Apollo Global Management. company

APO -4.87%

for $1.6 billion to salvage the deal.

The investment giant has agreed to buy about half of the $3.275 billion in bonds issued by Carvana to buy US auto auction network ADESA, people familiar with the matter said. Carvana had a hard time attracting investors after a disappointing first-quarter earnings report and a share sale.

Apollo’s intervention highlights the growing influence of private debt and equity firms that finance sectors of the US economy.

Carvana’s shares have surged during the pandemic but have fallen over the past eight months as used-car prices have fallen and investors are increasingly concerned about the company’s continuing losses. ADESA was intended to accelerate growth, and Carvana JPMorgan Chase has hired JPM -3.23%

& Co. To raise billions of dollars in debt and equity to pay for the purchase and subsequent integration.

The number of semiconductors in a modern car, from the ignition to the braking system, can exceed a thousand. As the global chip shortage continues, automakers from General Motors to Tesla are finding themselves forced to adjust production and rethink the entire supply chain. Illustration/Video: Sharon Shea

Funding faced headwinds last week when the company reported a more than sixfold increase in net losses for the first quarter of 2022 compared to the previous year. The company was one of the biggest losers in the sell-off of technology stocks, which was driven by higher interest rates and worries about a recession.

Carvana blamed a combination of tough economic conditions — rising interest rates, rising gas prices, and inflation-weary consumers — for its first-ever drop in quarterly retail sales. It also acknowledged to investors that constant pressure to continue its rapid expansion played a large role in its priorities, and pledged to reduce costs and improve its efficiency.

The deal with Apollo is an acknowledgment that filling the void in its balance sheet took precedence over growth. A burdensome interest rate on debt may make it difficult for a company to invest in growth. Carvana has been burning money since its founding 10 years ago.

Carvana’s shares have fallen about 30% in recent weeks, and bond prices have also fallen, driving up yields that bond investors have demanded to lend the company more money. Bond yields rise when prices fall. Carvana on Monday revealed plans to issue $2.275 billion in bonds and $1 billion in preferred stock to acquire ADESA.

CEO Ernie Garcia III and his father, Ernie Garcia II, participated in a nearly $1.2 billion new common stock issue to boost cash levels. Apollo privately pledged to buy $600 million of preferred stock, but JPMorgan has struggled to find enough buyers for the bonds, said fund managers who studied the deal.

By Tuesday, the bond deal’s clearing yield was above 10.5%, a level that may force JPMorgan to give up some or all of its fees for funding, fund managers said.

Apollo, which has invested in Carvana stock and debt for years, has proposed an alternative: Carvana will cancel the sale of preferred stock and issue $3.3 billion in 10.25% bonds backed by a $1.6 billion order from Apollo. This yield is well above the average for most junk bonds.

The amended deal came with a twist, as Carvana was prevented from prepaying new debt for five years — roughly twice the normal period for junk bonds. Apollo is expected to make about 1.6 times more of its money if the bonds are paid off later. One person familiar with the matter said the company would have earned 1.3 times its dividend from preferred stock.

Such large checks grew increasingly large as private fund managers raised unprecedented amounts of money, prompting them to search for increasingly large business ideas. The money provided huge bailout loans to companies like Airbnb company

and the carnival corp.

In the depths of the coronavirus pandemic.

Apollo manages nearly half a trillion dollars and made a similar investment in preferred stock of $1.5 billion in Hertz Global Holdings. company

in 2021 to help lift the car rental company out of bankruptcy. The Hertz deal has paid off well, but Carvana’s future is uncertain at the moment.

Moody’s Investors Service this week lowered Carvana’s credit rating to triple C, one of the lowest notches in its junk debt rating scale, citing an ongoing lack of profitability, negative cash flow and corporate governance risks.

Credit rating company S&P Global said on Wednesday that replacing preferred capital with debt will lead to 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.

“Tech companies can offer a surplus return, but investors need to pay attention to the quality and stability of cash flows,” said Scott Giardina, managing director at FS Investments. “Technological business models are generally considered asset-light, and bankruptcy recoveries tend to be lower than traditional asset-based businesses.”

Carvana, which went public in 2017, has exhausted cash and relied heavily on debt investors to fund its operations, similar to tech companies like Netflix. company

and Uber Technologies company

write to Matt Wirz at matthieu.wirz@wsj.com and Kristin Broughton at Kristin.Broughton@wsj.com

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