By Jeffrey Lee Funk and Gary N.Smith
When Homer Simpson was asked, “How are we going to get out of this hole?,” he replied, “We’ll dig our way out!” Many people who find themselves in holes they can’t climb out of think that the solution is to dig harder, which makes the hole even deeper and more difficult to escape.
Which brings us to Carvana /zigman2/quotes/206651606/composite CVNA +19.94% , the online used-car retailer with a cool name. For many car buyers, including ourselves, the worst part of the experience is the hours spent haggling with relentless salespeople. The income that car salespeople earn comes out of the pockets of the buyers and the dealership, so there is money to be made by both if the salespeople are taken out of the equation — not to mention the many hours buyers squander haggling.
You still can’t buy a new car without going through a franchised dealership but there are reputable companies that sell used cars without negotiations. The nation’s largest negotiation-free dealer is CarMax /zigman2/quotes/204412041/composite KMX +2.16% , which has 225 locations and sold more than 750,000 vehicles last year.
Carvana was launched in 2012 and went public in 2017 with the slogan “Skip the Dealership.” Carvana buys cars at auctions and from dealers, trade-ins and private sellers. In contrast to CarMax, where buyers and sellers have to show up in person, Carvana customers can do everything online through a simple, attractive website in just a few minutes and then choose to have the car delivered to their home or pick it up at one of Carvana’s 33 car vending machines — which are pretty much what they sound like. The buyer goes to a glitzy glass tower filled with shiny cars, inserts an authorization token, and watches the lifts and conveyors bring the car down to the delivery bay, ready to be driven home. Buyers haven’t had an opportunity to kick the tires or take their cars for test drives before the pick up, but they can return their cars no-questions-asked within seven days.
It is all very cool and the buzz and glitz pushed Carvana’s stock price to $370.10 in August 2021 from $11.10 in 2017 — helped in part by the COVID-19 restrictions on in-person car dealerships. Alas, buzz and glitz are expensive, as is maintaining a fleet of used cars. The company’s car vending machines look terrific on social media, but are a lot more expensive than a parking lot with a handful of attendants.
Carvana has been bleeding cash, borrowing money to keep going. After its latest financing attempt flopped, Apollo Global Management came to the money pit and gave Carvana a very big shovel. Carvana will issue $3.3 billion in bonds and preferred stock (with Apollo buying $1.6 billion of that), at a 10.25% interest rate and prepayment barred for five years.
One measure of Carvana’s desperation is that while it is borrowing money at 10.25%, it will be loaning money to car buyers at a competitive 3.9% interest rate. Borrowing at 10.25% to lend at 3.9% is a financial disaster that no sensible company would do if there were any good alternatives. Moody’s has cut Caravana’s debt rating to triple-C and Carvana’s stock price has slumped from its $370.10 peak to $59.56 at Wednesday’s close.
Other loss-making startups are in similar deep holes and reaching for shovels. Losses must be financed, and most unicorns have much bigger losses than does Carvana, both current and cumulative. Carvana’s cumulative losses are now $900 million, a big number, but relatively small compared to many other startups. Looking at losses through December 2021, 46 of the 140 U.S. unicorn startups that are currently being publicly traded have more cumulative losses than Caravana, despite having much lower revenues.
The largest cumulative losses are for Uber Technologies /zigman2/quotes/211348248/composite UBER +4.38% ($23.6 billion), WeWork /zigman2/quotes/222085303/composite WE 0.00% ($14.1 billion), Snap /zigman2/quotes/205087158/composite SNAP +7.90% ($8.4 billion), Lyft /zigman2/quotes/208999293/composite LYFT +2.78% ($8.3 billion), Teledoc Health ($8.1 billion), Airbnb /zigman2/quotes/222990650/composite ABNB +4.58% ($6.3 billion), and Palantir Technologies /zigman2/quotes/221054928/composite PLTR +5.94% ($5.5 billion) followed by four others — Nutanix /zigman2/quotes/207209171/composite NTNX -0.50% , Rivian Automotive /zigman2/quotes/230726939/composite RIVN +3.50% , Robinhood Markets /zigman2/quotes/228268942/composite HOOD +1.10% and Bloom Energy /zigman2/quotes/209802424/composite BE -0.12% — with losses of more than $3 billion. Another 16 have losses greater than $2 billion, 39 have greater than $1 billion, and 77 have greater than $500 million.
Carvana’s $900 million cumulative losses are far less than its 2021 revenues of $12.2 billion, while 79 of the 140 publicly traded unicorns have cumulative losses that are larger than their 2021 revenues, meaning it will be even harder for them to cover their losses than it will be for Carvana. Excluding the startups with no or very small revenues (seven startups), many publicly traded unicorns have cumulative losses that are far larger than their 2020 revenue.
Only 19 of these 140 publicly traded unicorns were profitable in 2021, up from 17 in 2020 and 12 in 2019. An improvement, but not much of one. At this rate it will take decades for most unicorns to become profitable — and investors won’t wait decades.
Private firms’ public problem
Below the surface is even a bigger problem: privately held unicorns. There are now 1,091 private unicorns worldwide, of which about half are in the U.S. Because the most profitable startups tend to go public first, it is likely that the privately held unicorns are in even worse shape than the publicly traded ones.
Bigger shovels make the task even harder. With interest rates rising, many unicorns will have to pay even more than 10.25% to stay alive. What will happen to privately held startups as interest rates rise? Will venture capitalists continue covering losses? Softbank has already announced it will stop funding some of its startups. Rising interest rates and falling stock prices are likely to persuade other funders to do the same — to stop passing out shovels and to leave some startups in their self-dug graves.
Jeffrey Lee Funk is an independent technology consultant and a former university professor who focuses on the economics of new technologies. Gary N. Smith is the Fletcher Jones Professor of Economics at Pomona College. He is the author of “The AI Delusion,“(Oxford, 2018), co-author (with Jay Cordes) of “The 9 Pitfalls of Data Science” (Oxford 2019), and author of “The Phantom Pattern Problem” (Oxford 2020).