As year-end reports often parse which companies might be most likely to file for bankruptcy protection, retailers, industrial names, and certain laggard firms in legacy industries are often highlighted. The prospects for 2023, however, look to be more concentrated in tech and among some of the market’s youngest firms as the growth at all costs paradigm gives way to a focus on profits once again.
Carvana ( NYSE: CVNA ) is perhaps the best cautionary tale in this respect. Once a market darling, the stock’s nearly 99% slide in the past year progressed more and more rapidly as investors came to suspect that hotly anticipated profits may never arrive. Now, a united band of creditors circle the wounded firm, awaiting a chance to pick its carcass.
However, the Arizona-based online auto retailer is not the only growth stock to see its shares decline sharply in 2022. Moving into 2023, with interest rates likely to remain on the rise, it may not be the last to teeter on the edge of insolvency either.
Liquidation Cycle
While Amazon has undoubtedly changed modern life in many ways, its impact on investor psychology has also been significant. The company’s ability to sustain years of losses and grow into the powerhouse that it has become has offered a lifeline to money-losing businesses, which have been given more slack than ever to continue cash-burning practices in recent years.
In many cases, an attractive end-market or innovative idea is enough to coax both private and public equity investors to shovel money at companies. Billions of dollars put toward metaverse projects, co-working spaces, and other newfangled ideas lay this trend bare and left many “zombie companies” to stagger into 2023.
However, growth into attractive markets or big moonshot bets on the future are no longer in vogue as investors scrutinize profitability more closely.
“Investors have hit the brakes on the growth at all costs mentality,” Modulus Global CEO Richard Gardner told SeekingAlpha. “We’re moving towards a significant recession, and the kinds of VC dollars that were available only a year ago are gone. The name of the game is simple: conserve cash and survive.”
He cited the recent pushback against Meta Platforms' cash-burning push into the metaverse as indicative of present investor sentiment. For companies less cash-rich already, the survival aspect could be a bit more difficult.
Indeed, persistent cash-burning companies that record consistent quarterly losses like Beyond Meat ( BYND ), Peloton Interactive ( PTON ), Chewy ( CHWY ), Wayfair ( W ) and Robinhood Markets ( HOOD ) will face an uphill climb to turn profits after putting a laser focus on market share and product expansion. Each of the relatively young companies have indicated their pursuit of cost-cutting measures to survive, but layoffs and belt-tightening can only go so far.
For those that pile on debt as Carvana ( CVNA ) did in its own pursuit of growth via M&A, the adverse impact on shares is likely to only increase. According to the Swiss Re institute, many are likely to face bankruptcy in the near term if macro conditions continue to deteriorate.
“In a severe recession scenario, a high yield default rate of around 15% - last seen during the global financial crisis – is possible. This comes as firms face weakening demand amidst a higher interest rate environment, with zombie companies most exposed,” the Swiss reinsurer said. “Despite the potential for large financial losses, unprofitable firms should be allowed to default. Keeping them alive will only delay the inevitable.”
Consolidation Cycle
Beyond the cash burn issues and projected “liquidation cycle” that Carvana brought to the forefront, its efforts to disrupt a highly competitive industry also offers helpful lessons.
Carvana ( CVNA ) competed with traditional auto retailers like Lithia Motors ( LAD ), AutoNation ( AN ) and Group 1 Automotive ( GPI ), as well as comparatively better capitalized online competitors like CarMax ( KMX ) and similarly troubled upstarts like Vroom ( VRM ). In short, the sector was a crowded one.
However, the crowded nature of automotive retail pales in comparison to the level of competition arising in the auto space itself, especially in terms of EV manufacturers. Seeking to follow in the footsteps of Tesla, Rivian Automotive ( RIVN ), Lucid Motors ( LCID ), Fisker ( FSR ), Canoo ( GOEV ), Faraday Future Intelligent Electric ( FFIE ), Mullen Automotive ( MULN ), Polestar ( PSNY ), Lordstown Motors ( RIDE ), Arrival SA ( ARVL ), Nikola ( NKLA ), REE Automotive ( REE ), Hyzon Motors ( HYZN ), Arcimoto ( FUV ), Workhorse Group ( WKHS ), and more have come to populate the EV manufacturing space.
The bankruptcy of Electric Last Mile and its subsequent acquisition by Mullen Automotive is unlikely to be the last such liquidation in the space. While the deep-pocketed partners for Rivian in Amazon, Canoo in Walmart, and Polestar in Geely, others are without such a buoy. As many of these firms struggle to chart a path to profits, the market may soon lose patience with the less successful players, forcing a thinning of the EV herd. This is especially so as traditional automakers push more aggressively into the EV space.
Much the same as zombie companies in e-commerce and tech are due for liquidation, the crowded EV space is likely due for consolidation at the very least.
“Bankruptcy isn’t the only option for zombie firms, though. They can sell off assets, too, and that can be an opportunity for healthier firms,” a recent Harvard Business Review report suggested. “Private equity firms aren’t the only ones keeping an eye out for struggling companies looking to sell off businesses; companies with lots of cash or the ability to raise money will also be able to buy low if interest rates continue to rise quickly in the next year.”
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Carvana is a cautionary tale for zombie companies