Carvana’s car vending machines helped make the company famous, but now the retailer faces potential bankruptcy.
ILLUSTRATION BY STEPHANIE JONES FOR FORBES; PHOTO BY MARK RALSTON/AFP VIA GETTY
Ernest Garcia II made billions of dollars by timing his Carvana stock sales to perfection. As the used car retailer careens towards bankruptcy, his controversial cashout looks smarter than ever.
Shares of used car retailer Carvana plunged 43% Wednesday following reports that the company’s two largest creditors, private equity firm Apollo and investment manager PIMCO, entered an agreement to work together in any negotiations with Carvana, which many investors interpreted as a sign of the used car dealer’s impending declaration of bankruptcy. Carvana has not commented on that possibility.
No one has lost more than Ernest Garcia III, the 40-year-old founder and CEO of Carvana. His fortune soared to over $11 billion at Carvana’s peak in August 2021. Carvana’s shares, following the company’s pandemic-fueled boom and subsequent crash, are down 99% from that time. Garcia III sold a little stock in late 2020, but has also bought back shares at various times, offsetting any investment gains. His stake is now worth less than $200 million today.
His father, Ernest Garcia II, has fared much, much better. The elder Garcia (at 65 years old) sold $2.5 billion of Carvana stock in a nine month period, between October 30, 2020 and August 23, 2021, during which the stock was trading north of $180 a share. His last stock sale came on August 23, 2021, for between $350 to $360 per share, close to its intra-day peak of $376. Carvana’s stock closed Wednesday at $3.83. Needless to say, Garcia II, who is worth an estimated $2.8 billion, is far wealthier than he’d be if he’d never dumped shares.
Dad Garcia II, the owner of used car retailer DriveTime Automotive, holds no formal position at Carvana–he pled guilty to bank fraud in 1990 in connection to Charles Keating’s Lincoln Savings & Loan scandal and is legally barred from employment at any New York Stock Exchange-listed company. Yet, he, along with his son, has maintained effective control of Carvana since bankrolling the company in 2013 as an e-commerce spinoff of DriveTime.
Carvana’s dual-class share structure gives Garcia II 84% voting power, while his son holds most of the rest. Carvana is what’s known as a “controlled company,” in which one or a few parties have more than 50% of voting power to elect directors. Carvana states in its annual 10-K SEC filing that its organizational structure poses conflicts of interest that “may result in decisions that are not in the best interests of stockholders.”
The Garcias’ stock market dealings have raised eyebrows–and drawn legal action. Pension funds that are Carvana shareholders allege in an insider trading lawsuit brought in the The Delaware Court of Chancery that the Garcias rushed to conduct a secondary share offering in April 2020 at below-market prices, and in which the pair of them bought $50 million–or, $25 million apiece–thus unfairly diluting the pension funds’ investment. Carvana and the Garcias have denied the claims. In July, the judge overseeing the case denied Carvana’s request for dismissal.
The elder Garcia sold his Carvana stock through an automated 10b5-1 trading plan, a common mechanism meant to help executives avoid the appearance of insider trading. But in an unusual twist, Garcia II’s plan was modified on two occasions–in November 2020 and May 2021–to increase the pace of his stock sales, as The Wall Street Journal first reported.
“The active modification of a 10b5-1 plan raises the question of whether someone is trying to rebalance their portfolio, time the market, or is in possession of non-material public information,” says David F. Larcker, a professor of accounting at Stanford Graduate School of Business. “Generally speaking, you would like to have some information about why the plan is being revised, and does that make sense, or are they doing it for other reasons that may not pass regulatory scrutiny.” Garcia did not comment on the Journal’s initial report.
Dan Taylor, an accounting professor at the Wharton School who has studied Carvana, shares that assessment. “I think they knew that an increase in interest rates would absolutely pose a significant risk for the company, and I think they foresaw that coming, and consequently raised money and cashed out personally, before that increase in interest rates happened,” says Taylor. “And it’s pretty clear that investors did not fully appreciate just how much the company’s value depends on ultra cheap financing.”
The Garcias’ iron grip on Carvana’s is reflected in the younger Garcia’s management style, according to one former Carvana executive who spoke with Forbes on the condition of anonymity. “You will often hear people talk about the good old boys club and it absolutely exists there,” says the former employee. Higher ups who went against the CEO were quickly shown the door, according to the former employee. “The culture is you either are on board with us and everything we do and say and drink the Kool Aid, or you are not and get out.” Garcia and Carvana did not respond to Forbes’ request for comment.
While the elder Garcia cashed out during Carvana’s ascent, those savvy enough to foresee the company’s downfall made small fortunes betting on its collapse. Daniel Bustamente, a former Wall Street trader, scored a near $1 million profit for his $10 million (assets) hedge fund Delta One by shorting Carvana’s stock.
“The story is that with growth companies, it’s acceptable, to some extent, to lose money for a while,” says Bustamente, “but you’ve got to find your footing. And they just weren’t making a profit.”
Bustamante opened his short position in February, when Carvana stock traded around $150 per share, then closed it in early June at around $30 per share–not for lack of conviction, but to account for the possibility that Carvana would become a meme stock. Bustamente reopened a short with his own funds a few months ago, and has seen his $250,000 bet mushroom into $800,000. He says he’s holding onto his position, with bankruptcy seemingly looming.
Carvana’s stock “is going to zero–it’s a zero for sure,” says Bustamente. “I’m actually surprised it took this long, honestly.”