Carvana Co. (NYSE:CVNA) shares recently experienced a double-digit weekly loss, falling more than 7% on August 18 on top of a similar sized decline the day before, resulting in a two-day drop of more than 14%, per Bloomberg. A slight 8% rebound on August 19 did little to mitigate the damage, leaving shares down almost 10% for the week. Trading volume was far above the norm, with about 17 million shares changing hands versus a 30-day average of 9.9 million, indicating that the selling was not limited to a small number of traders.
A Strong Quarter, Overshadowed
What is unique about the slide is that it has almost nothing to do with Carvana’s business. The selloff came after the company posted a record second quarter, with $7.4 billion in revenue and $513 million in net income, though the gains were almost completely eclipsed by news about one of the company’s outside investors.
An Outsider Investor’s Legal Troubles
The pressure stems from a Wall Street Journal report that federal prosecutors and the SEC were looking into billionaire investor Mark Walter and businesses linked to his financial empire, an inquiry into whether Walter and his companies covered up financial relationships while transferring over $20 billion through insurance companies he controls. Walter is the CEO of Guggenheim Partners and the controlling owner of the Los Angeles Dodgers and Lakers. He indirectly owns 8% of Carvana’s Class B stock through an entity named CVAN Holdings, an investment worth around $2 billion.
To add to the unease, Walter’s investment firm, TWG Global, announced a $6.5 billion asset swap that included its Delaware Life Insurance unit, which was described as an effort to address regulatory issues. This move only fueled speculation that Walter may have to raise cash elsewhere in his portfolio, which could include selling down his Carvana Co. (NYSE:CVNA) stake. Those fears eased somewhat on August 19 after a report showed that Walter’s Carvana stake had been pledged to Citigroup as collateral, potentially making an immediate sale more difficult.
Not Carvana’s First Rodeo, But A Different Kind Of Risk
Carvana Co. (NYSE:CVNA) has previously faced difficulty, including short-seller charges from Gotham City Research as recently as January, as well as other regulatory penalties over the years, which the company has generally dealt with while continuing to operate. What separates the current scenario is that the pressure isn’t coming from Carvana’s own business or governance. Instead, it comes solely from the personal and legal problems of an outside minority shareholder.
Institutional Positioning
Hedge fund ownership increased from 79 funds in the first quarter to 87 in the second, despite the fact that short interest remains significant at 9.70% of float, indicating a market with both institutional accumulation and meaningful bearish stance heading into the investor-led selloff.
The Bull Case
Carvana’s case is based on headline risk that is detached from true fundamentals. The company’s record results show that the core business is performing well. If Walter’s legal problem settles without requiring a stake sale, or if any eventual sale is orderly rather than a forced liquidation, the selloff could result in a temporary overreaction.
The Bear Case
That said, there is the possibility that an 8% investment, worth about $2 billion, may be sold if Walter requires liquidity, resulting in sustained selling pressure regardless of Carvana’s performance. The $6.5 billion Delaware Life asset swap also raises questions about how deep Walter’s liquidity problems are, and the current federal inquiry means that additional details may come out unexpectedly.
Insider Monkey’s Bottom Line
This is a case where fundamentals and stock price are driven by completely different causes, at least in the short run. Carvana’s earnings support the bull case all by themselves, but the overhang of an unrelated shareholder’s legal troubles is a significant risk outside of the company’s control. Investors should watch for developments in the Walter inquiry, especially if CVAN Holdings indicates a desire to sell its stake, as a confirmed, large-scale sale would likely weigh on the stock regardless of how well Carvana’s core business does.
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