In a surprising twist within the automotive industry, Hindenburg Research, the short-selling firm infamous for bringing down Indian billionaire Gautam Adani, has released a damning report targeting the used car dealer Carvana. According to Hindenburg, Carvana is embroiled in what they label a "century of accounting fraud" orchestrated by a father-son duo. Nathan Anderson, the founder of Hindenburg Research, claimed that a thorough investigation involving extensive document review and interviews with 49 industry experts, former Carvana employees, and stakeholders led to their confident assertion that the company's much-touted transformation is nothing more than a façade.

The Hindenburg report alleges that Carvana sold $800 million in loans to an undisclosed related party while simultaneously masking its financial issues through accounting maneuvers and lax loan approvals, which led to temporary revenue boosts. This financial juggling allowed insiders to cash out billions in stock options. Hindenburg argues that Carvana’s valuation is outlandish, stating that its sales multiples are 845% higher than those of online competitors like CarMax and AutoNation, and future earnings premiums are elevated by 754%. With approximately $4.8 billion in junk-rated debt, Carvana’s business faces significant headwinds. A clear indication of these challenges is highlighted by the Manheim Index, which reports a 20.3% decrease in used car prices over the past two years. Notably, the default rates on subprime auto loans now exceed those seen during the global financial crisis, raising alarms for Carvana's financial stability.

Despite the severity of the report, Carvana's stock response was muted. The stock witnessed a sharp decline of 8% in early trading, only to recover slightly by midday, settling at $203.39, a marginal increase of 0.015%. This resilience, however, contrasts with the serious implications of the financial practices being called into question by Hindenburg.

The scrutiny from Hindenburg extends beyond Carvana's operational practices to its critical funding relationships. Carvana relies heavily on Ally Financial, a key player in its loan purchasing agreements, having sold approximately $3.6 billion in automobile loans in 2023, representing around 60% of its total loan volume. Despite claims by Carvana that it is seeking to reduce its dependency on Ally, no new financial partners have been announced in the last six years.

Moreover, Hindenburg notes that Ally’s loan portfolio has become increasingly concentrated. Carvana’s loans now account for 8.4% of Ally’s consumer vehicle portfolio, up from just 5%. In September 2024, Ally warned investors of "growing credit challenges in retail auto loans," and the company saw its stock slide by 20%. As Ally curtailed its loan purchases from Carvana, questions arose about who was stepping in to fill the financial void.

New, unidentified buyers have emerged, acquiring loans from Carvana during a time of heightened need for capital. The report reveals that in the last two quarters, Carvana sold $800 million in loans to an unrecognizable third party, which made up 18.3% and 16.3% of total loan sales in the second and third quarters of 2024, respectively. Suspicion abounds regarding this mysterious buyer; Hindenburg suggests that the buyer may be a trust associated with Cerberus Capital, further alleging that Dan Quayle, a Carvana board member, is the chairman of global investments at Cerberus. This potentially indicates opaque dealings between Carvana and trusted entities that contradict the company’s public assertions.

The internal dynamics at Carvana suggest a troubling trend, especially among its leadership. Hindenburg points out that CEO Ernie Garcia III's father, Ernest Garcia II, sold $3.6 billion in stock between August 2020 and August 2021. Following the cessation of those sales, Carvana's stock plummeted 99%, putting the company on the brink of bankruptcy. This past pattern raises alarm as Garcia II has recently liquidated an additional $1.4 billion in Carvana stock, coinciding with a significant surge in the company's stock price—around 42 times its value—despite the gloomy prospect painted by Hindenburg's report.

Amidst the backdrop of liquidity issues, Carvana's operational viability comes into question as approximately 26% of its gross profit derives from selling customer auto loans to external parties, many of which are financially risky subprime loans. In the last nine months, the revenue from loan sales has been more than double Carvana’s net profit, elucidating an unsustainable financial model.

Interestingly, Carvana's third-quarter earnings last year exceeded expectations, achieving a record profit despite its prior struggle with bankruptcy risk. The adjusted EBITDA reached $429 million, surpassing analysts' expectations of $326.8 million and $148 million the previous year. The company opined that “as long as the environment remains stable,” profits for 2024 would be “significantly above” previous top estimates. This optimism, however, is more complicated when placed against the backdrop of looming high-interest payments and maturing debt obligations.

CEO Ernie Garcia has been seen negotiating with creditors, persuading them to accept a $1.3 billion reduction in debt come mid-2023. Additional extensions for paying cash interest have also been secured, providing Carvana with the necessary financial breathing room. In a bid to weather the economic storm, Garcia has begun acquiring more shares in Carvana, suggesting a somewhat optimistic outlook despite the troubling indicators. The company has actively worked to reduce costs, streamlining operations, downsizing, and focusing on increasing its used vehicle sales.

Carvana’s operational strategy has seen costs per vehicle sold decrease from $6,300 to below $3,800 in less than three years. Yet, despite these positive narratives, Carvana remains at high risk; its financial and operational leverage remains precarious, and a small internal bank dedicated to extending and selling auto loans adds to the financial complexities that characterize Carvana's structure.

As the fallout from Hindenburg’s report continues to unfold in the financial markets, the questions surrounding Carvana's legitimacy, sustainability, and future will remain pertinent. Stakeholders, both internal and external, are left to ponder the integrity of the company’s reported figures and the long-term implications of its aggressive business strategies amidst an increasingly volatile economic landscape.