Wedbush Analyst Seth Basham joins Yahoo Finance Live to explain why Wedbush downgraded Carvana stock to Underperform and cut its price target to $1.

Video Transcript

SEANA SMITH: Let's take a look at Carvana because shares off 39% right now. It's a top trending ticker on Yahoo Finance. The stock has been halted multiple times today. Wedbush downgraded Carvana, as its largest creditor signed a pact to act together in negotiations. Now Wedbush now has an underperform rating on the stock and a dollar price target. Earlier today, I spoke to Seth Basham, the senior analyst at Wedbush behind that note, asked him about the downgrade and also the risk of bankruptcy. Let's take a listen to what he had to say.

SETH BASHAM: The bottom line is that bondholders are getting together to put up a united front in negotiating with a company, likely over a restructuring of all the outstanding debt. And from an equity holder standpoint, we see that as a growing risk potentially for dilution if the bondholders exchange any debt for equity, or, in a more dire case scenario, in bankruptcy. So we see the equity as being out of favor, and therefore, we downgraded our stock rating to underperform.

SEANA SMITH: Seth, when investors are trying to make the timeline of this, the potential scenarios in their head, when you see the timeline for a potential default bankruptcy, are we talking months, or are we talking a year out? What does that more specifically look like?

SETH BASHAM: Well, in a normal course of action, based on our liquidity analysis, we see the company having enough liquidity to survive through 2023. And in fact, they have a lot of real estate that they could monetize to help extend that timeline.

However, a lot of different moving pieces here could accelerate that, depending on what happens to the market and depending on what happens with some of the terms of the agreements with the bondholders. So we're not looking at that as a top probability right now, but we do think we'll see some sort of restructuring, some sort of capital structure change in the coming months.

SEANA SMITH: Seth, you mentioned the real estate holdings there, about 2 billion that was noted in your note. Would the best alternative, then, to be at this point to raise capital to sell off some of those real estate holdings?

SETH BASHAM: Yes, that's been our stated view for some time. We think that's the best way for them to get extra cash, extend their liquidity timeline, and potentially pave the way for an equity raise. But right now, that's only one of the alternatives that the company is pursuing.

SEANA SMITH: Seth, when you take a look at Carvana, trying to make sense of what has happened over the past year and a half-- because last August, the stock was at 377 a share. Today, obviously, off just around 98% year to date alone. Is this more of a Carvana-specific issue when it comes to what has played out over the last several months, or can some of this be attributed to rising rates and the slowing that we've seen in the overall economy?

SETH BASHAM: Yeah, it's a combination of both, certainly. The used car industry is under a lot of pressure right now. Demand has fallen off the cliff. Used car prices went up dramatically through the pandemic. Interest rates went up. Affordability for the consumer went way down. So now we're seeing a big decline in demand. You couple that with Carvana-specific problems, especially the acquisition they made earlier this year, which was ill-timed and added a ton of interest expense burden to their income statement, that is a more company-specific problem that's leading to some of these situations today.

SEANA SMITH: Yeah, that's the massive $2 billion, I believe, acquisition that they made of Odessa's US auction business. When you take a look at some of the missteps that have happened, comparing that to what we have seen from some of the other competitors in this space, how does Carvana, more specifically, add up to maybe a name like AutoNation, which has fared much, much better so far this year?

SETH BASHAM: Yeah, if we look at some of the other franchised auto dealers or other used auto dealers like CarMax, we've definitely seen them fare better. The used auto dealers are seeing more pressure. However, somebody like AutoNation is doing better because the new car business is not under as much pressure. And they have a huge revenue base from their service business. That helps them offset some of the pressure in used cars.

SEANA SMITH: When you take a look at Carvana, where it's trading today-- it's been halted a couple of times-- what's the best case scenario, then, over the next couple of months?

SETH BASHAM: Best case scenario is that the equity gets very little dilution here, and there's no bankruptcy situation. The company infuses more capital, either through a real estate sale or otherwise. And we see a debt exchange, which leads to less debt burden going forward. So that'd be the best case. I will point out that the Garcias, who are the CEO and his father, they own over 40% of the company's equity. And so they have a very big incentive not to let that equity go to zero.

SEANA SMITH: Our thanks to Seth Basham, Wedbush senior analyst. Dave, Seth was just talking about the Garcias there having a personal incentive not to let Carvana fall to zero. But this chart has just been incredible, and for all the wrong reasons, something that investors clearly do not want to see, looking at year to date losses of over 98%.

This stock at the high was much, much higher than it is today, up above $300 a share. Taking a look at where it is today, Wedbush saying it could go to $1. So did Morgan Stanley's Adam Jonas. Lots of concern about what exactly is ahead and whether or not bankruptcy-- seems like it is-- is likely to be in the cards.

DAVE BRIGGS: It's almost like the best thing that was said about them in recent days was from JPMorgan-- a possibility of imminent Chapter 11 seems low. That's the best thing that's been said about Carvana in recent days because, OK, they can survive through 2023. They have enough cash to get through the next year. That appears to be the upside. But what is the catalyst for positive movement for any sort of comeback? No one has one, no analysts that we read.

And you talk about pandemic darlings, right? You talk about Zoom. You talk about Peloton. You might talk about Netflix. To me, when I close my eyes, that vending machine on your screen right there is the picture of a COVID darling business failure. I'm not talking about the sector, but that right there, a 46-- no $41 billion market cap, now less than 800 million.

SEANA SMITH: It's just been incredible to watch. And we've seen Carvana clearly be a massive underperformer within this space. Many of its competitors has performed well-- or have performed, at least, better. We just heard Seth talking about that. But the sector overall has taken a huge hit. And I think everyone's trying to figure out what exactly this means for used cars going forward. We certainly have seen the prices of used cars come down.

But newer selling cars, that has held up some of its competitors, the fact that that has been a little bit more resilient over the last several months. But I think there's a lot of unknown because a lot of these names, like you were saying, were really bought in up into the pandemic, had really taken off, had scaled a little bit too quickly, way too quickly in Carvana's case, and we're seeing, obviously, the effects of that.

DAVE BRIGGS: But those other three companies I just mentioned, there's a lot of catalysts to potential.

SEANA SMITH: Oh, yeah.

DAVE BRIGGS: Skyrocketing potential--

SEANA SMITH: Totally different scenarios.

DAVE BRIGGS: --where there isn't one here. And it was a perfect storm. Everything that propelled them has now completely flipped and done a 180.