2023-07-12 02:28:21 ET
Summary
- Carvana Co. has seen a 600% increase in 2023 due to improving financial performance and growth in the electric vehicle market.
- Carvana's success is expected to benefit Root, Inc., with whom they have a partnership for integrated auto insurance, and a $126 million investment.
- While ROOT has a short interest of 18% which is small relative to CVNA's, its days to cover is far greater than CVNA, making it a great short squeeze candidate.
- Due to ROOT's connection to CVNA and small daily volume, I believe that any spillover effect from CVNA will have a materially beneficial impact to ROOT's stock price.
All eyes have been on Carvana Co. ( CVNA ) recently, which is up over 600% in 2023 on recent statements from the company that imply improving financial performance going forward. A short report issued by Kerrisdale Capital has fallen on deaf ears. CVNA's latest news of outstanding growth in the electric vehicle market shows that consumers are using Carvana for a more affordable entry into the electric vehicle space. Hastening the increase in the stock price is the very heavy short interest to the tune of 48 million shares or 69% of the float.
One stock that sets to benefit from CVNA's rise is Root, Inc. ( ROOT ). The partnership between CVNA and ROOT for integrated auto insurance means that any uptick in business for CVNA likely leads to an uptick in business for ROOT. So if Carvana is starting to grab a material chunk of the used EV market, so will Root as its insurance offering is embedded in the platform. The partnership announcement included a $126 million investment made by Carvana into Root in the form of 14 million convertible preferred shares at $9 per share (pre-split) along with eight tranches of warrants. From Carvana's latest 10-Q filing :
In October 2021, the Company purchased Series A convertible preferred shares in Root, Inc. ("Root"), an equity security that does not have a readily determinable fair value. The Company elected to measure this investment using a measurement alternative pursuant to the accounting standards and recorded the investment at its cost of $126 million which will subsequently be adjusted for observable price changes. The Company considered all relevant transactions since the date of its investment and has not recorded any impairments or upward or downward adjustments to the carrying amount of its investment in Root, as there have not been changes in the observable price of its equity interest through March 31, 2023. On August 12, 2022, Root effected a reverse stock split of its Class A common stock and Class B common stock at a ratio of 18:1, whereby each 18 shares of Root’s Class A common stock and Class B common stock were automatically combined into one share of Class A common stock or Class B common stock, respectively (the “Reverse Stock Split”). The shares of Root's Class A common stock issuable to the Company on the conversion of the Series A convertible preferred shares were adjusted proportionally.
Also in October 2021, the Company entered into a commercial agreement with Root, under which the Root auto insurance products were to be embedded into the Company's e-commerce platform. In accordance with the provisions of the commercial agreement, the Company received eight tranches of warrants to purchase shares of Root's Class A common stock (the "Warrants"). On September 1, 2022, the integrated auto insurance solution, which embedded into the Company's e-commerce platform (the "Integrated Platform"), was completed. One tranche of the Warrants, consisting of 2.4 million shares, as adjusted pursuant to the Reverse Stock Split, became exercisable upon completion of the Integrated Platform, and is considered a derivative instrument.
While the impact of the reverse split on ROOT means the convertible price of the preferred shares and warrants are well out of the money, Carvana still has an economic interest in ROOT's stock price. That means all of CVNA's shareholders - including and maybe especially the meme stock traders - have an economic interest in also seeing ROOT succeed.
The correlation in price performance between the two stocks is quite high, though CVNA has pulled away recently:
ROOT saw a substantial rise in price after a report by the Wall Street Journal of a takeover offer for the company at $19.34 per share. A few days later the stock dropped after the company denied receiving an actionable offer that is in the best interests of ROOT's shareholders. Fellow Seeking Alpha contributor Courage & Conviction Investing gets into further details surrounding this bid and outlined a bull case for the company. I recommend reading this piece in addition to my own.
Since the volatility surrounding the takeover offer and denial, ROOT has slowly started churning back up to about $11 per share. There doesn't appear to be any reason for it, other than the connection to Carvana as it rockets into the $30's. When watching the inter-day movements of each stock, it's clear that there is a strong positive correlation, though that's obviously more pronounced on CVNA right now.
One could suggest that Root is a poor man's Carvana, a stock to speculate on for a short squeeze if CVNA is too rich for one's blood at over $30. ROOT doesn't have the short interest of CVNA, with 1.7 million shares short comprising about 18% of the float. But when looking at the numbers on the NASDAQ , one metric stands out that is far superior to CVNA:
Despite having only 1.7 million shares short, the daily volume on ROOT seldom crosses a million shares in a day and averages in the low 100,000's. That means the days to cover are consistently well over 10. While CVNA might have 48 million shares short, it also trades 10's of millions of shares in a day. Its days to cover currently sits at less than two. Given the business relationship and high correlation between the two stocks, there is a decent chance that the entities that are shorting ROOT are also shorting CVNA. So if a short squeeze on CVNA causes them margin issues, that is going to spill over to other positions in their portfolio, including any short on ROOT.
So the individuals going long on CVNA have an interest in going long on ROOT or at least have an incentive to see the company and its stock price succeed. Conversely, CVNA shorts have an interest in seeing ROOT fail, and it's reasonable to believe that there are entities out there that are short both stocks. While the impact might be marginal, ROOT is generally such an illiquid stock that any kind of sustained spillover effect from CVNA would have a material impact on the stock price. It only took 2.8 million shares traded on June 21 to drive a daily range between $5.92 and $12.62.
A speculative bullish bet on ROOT could be in the form of another bid offer coming to light or improving financial and business metrics as outlined in Courage & Conviction Investing's article. Or it could be on the hopes of a sudden squeeze on a relatively small float and thinly traded stock as meme traders on CVNA spill over into ROOT. There are multiple positive investment or trading theses on ROOT right now, which is why I am making a small speculative investment in the stock.
For further details see:
Root: The Carvana Short Squeeze Sympathy Play