Carvana: When Activist Short Sellers Are Right But Early – The Subprime Loan Ticking Time Bomb

By the Activ8 News Team

In the world of activist short selling, being right isn't always enough—timing matters just as much. The Carvana (NYSE: CVNA) story perfectly illustrates this challenge, where two highly respected activist firms have laid out compelling cases against a business model that appears fundamentally unsustainable, yet the market continues to reward the company's short-term financial engineering.

Here at Activ8Finance, we've been following this story for years, and while the stock performance might suggest the activists were wrong, we believe the evidence points to a different conclusion: they're likely right about the destination, just early on the timing.

The numbers tell a remarkable story of market timing versus fundamental analysis. When Kerrisdale Capital first published their "Running on Empty" report on June 12th, 2023, Carvana closed at $21.26. When Hindenburg Research released their final report on January 2nd, 2025, the stock had reached $199.56. Even after a brief decline to $177.16, the stock has continued climbing to $338.26 as of July 1st, 2025—a staggering 1,491% increase from Kerrisdale's initial report.

But beneath this impressive stock performance lies what activists have identified as a fundamental problem: Carvana's heavy reliance on selling subprime auto loans to generate profits. The question isn't whether this model is sustainable—it's when it will break down.

The Kerrisdale Capital Analysis: Early Warning Signs (June 12, 2023)

Stock Price at Report: $21.26

The Subprime Dependency Thesis

Kerrisdale's prescient analysis focused on what they saw as Carvana's unsustainable reliance on loan sales for profitability. Their report highlighted several key concerns that remain relevant today:

The Loan Sales Business Model: Kerrisdale identified that Carvana's profits were increasingly dependent on selling customer auto loans to third parties rather than traditional automotive retail margins. They argued this was not sustainable long-term, especially given the quality of the underlying loans.

Credit Quality Concerns: The report highlighted Carvana's heavy exposure to subprime borrowers and questioned whether the company could continue finding buyers for these increasingly risky loans as market conditions tightened.

Liquidity Pressures: With over $700 million in annual interest expense, Kerrisdale argued that Carvana needed continuous access to loan buyers to maintain cash flow—a dependency that made the business model inherently fragile.

Market Timing Vulnerability: Perhaps most importantly, Kerrisdale identified that Carvana's model was particularly vulnerable to changes in credit market conditions and used car pricing—both of which have since proven to be significant headwinds.

Why Kerrisdale Was Right (But Early)

The core thesis remains sound: Carvana's dependence on loan sales creates a structural vulnerability that becomes more pronounced over time. The stock's subsequent rise doesn't invalidate this analysis—it simply means the timeline for these pressures to manifest was longer than initially anticipated.

The Hindenburg Research Finale: Connecting the Dots (January 2, 2025)

Stock Price at Report: $199.56

The $800 Million Question

Hindenburg's final report provided the smoking gun that Kerrisdale had alluded to: concrete evidence of Carvana's extreme dependence on loan sales and the questionable nature of these transactions.

The Scale of Dependency: Hindenburg revealed that nearly 26% of Carvana's gross profit over nine months came from selling customer auto loans—a staggering proportion that validates activist concerns about the sustainability of this model.

The Quality Problem: The report detailed how Carvana operates "largely in the risky subprime and deep subprime space," with claims that the company approved "100% of applicants we didn't decline for compliance reasons." This lending strategy creates loans that become increasingly difficult to sell as credit conditions tighten.

The Related-Party Concerns: Most troubling was Hindenburg's evidence suggesting $800 million in loan sales to what they believe is a related party—indicating that even Carvana may be struggling to find legitimate third-party buyers for their loan portfolio.

Market Deterioration: The report highlighted that 44% of cars financed since 2022 are underwater, and subprime auto loan delinquencies are at levels higher than the 2007-2008 financial crisis—exactly the conditions that would make Carvana's loans harder to sell.

Carvana's Response Misses the Point

While Carvana dismissed the allegations as "intentionally misleading and inaccurate," their response notably didn't address the fundamental question: what happens when the music stops on subprime loan sales?

The Loan Sales Dependency: A House of Cards?

Understanding the Business Model

To appreciate why activists are likely correct, it's crucial to understand how central loan sales have become to Carvana's apparent success, alongside other financial engineering tactics:

Revenue Recognition: When Carvana sells a loan, it recognizes immediate profit on the transaction. This creates a powerful incentive to originate as many loans as possible, regardless of credit quality, because the company gets paid upfront while transferring the long-term risk to buyers.

The Root Insurance Windfall: Carvana's investment in Root Insurance through warrants has provided significant financial benefits that mask the true performance of their core business. The $158 million benefit in Q1 2025 alone (3.7% of revenue) from Root warrant fair value changes, combined with similar gains throughout 2024, has artificially inflated earnings and provided cash flow that helps sustain operations. This creates an additional dependency—on Root's stock performance—that activists argue is another unsustainable pillar supporting Carvana's financial results.

The Subprime Focus: Subprime loans are attractive to Carvana because they carry higher interest rates, creating more value when sold. However, they also carry significantly higher default risk, making them increasingly difficult to sell as market conditions deteriorate.

The Buyer Dependency: Carvana's model only works as long as there are willing buyers for these loans. As Hindenburg noted, traditional buyers like Ally Financial have been pulling back, forcing Carvana to find alternative (and potentially related-party) buyers.

When Will the Music Stop?

Several factors suggest that Carvana's loan sales model is approaching its limits:

Credit Market Tightening: As delinquencies rise across the auto loan sector, buyers are becoming more selective about the loans they'll purchase, particularly in the subprime space where Carvana operates.

Root Insurance Dependency Risk: Carvana's reliance on Root warrant gains creates additional vulnerability. If Root's stock price declines or the warrants lose value, Carvana would lose a significant source of reported income that has been masking weaker core business performance. This creates a dual dependency—on both loan sales and external equity performance—that activists argue makes the overall business model even more fragile.

Regulatory Scrutiny: The related-party transaction allegations raised by Hindenburg could attract regulatory attention, potentially limiting Carvana's ability to use such arrangements to maintain its loan sales volumes.

Economic Pressure: Rising unemployment or economic stress would directly impact Carvana's customer base (subprime borrowers), making their loans even less attractive to potential buyers.

Competition for Buyers: As other lenders also seek to sell loans in a tightening market, Carvana may find itself competing for a shrinking pool of willing buyers.

The Timing Question: Why Haven't the Wheels Come Off Yet?

Market Factors Supporting the Model

Several factors have allowed Carvana to continue its loan sales strategy longer than activists initially expected:

Low Interest Rate Environment (Extended): The extended period of accommodative monetary policy provided more time for risk-taking in credit markets than activists anticipated.

Used Car Market Dynamics: While prices have declined from peaks, the used car market has remained more resilient than some predicted, helping to support loan values.

Investor Risk Appetite: Strong equity markets and investor appetite for yield have kept demand for asset-backed securities relatively robust.

Management's Financial Engineering: Carvana's team has proven adept at finding new ways to package and sell their loans, including the potentially related-party transactions identified by Hindenburg.

Why This Can't Last Forever

Despite these supporting factors, the fundamental math hasn't changed:

Deteriorating Loan Quality: Each quarter, Carvana originates more subprime loans in an increasingly stressed economic environment, making future loan pools progressively riskier.

Buyer Fatigue: As early loan vintages begin to show stress, buyers will become more cautious about purchasing new Carvana loan pools.

Regulatory Risk: The related-party transaction allegations create regulatory risk that could limit Carvana's flexibility in loan sales.

Economic Cycle: Eventually, economic pressures will impact Carvana's subprime customer base, leading to higher defaults and making the loans unsellable at profitable prices.

The Activist Case: Right Thesis, Wrong Timeline

Why Kerrisdale and Hindenburg Are Likely Correct

The activist short sellers have identified a fundamental problem with Carvana's business model:

Unsustainable Dependency: The company's reliance on loan sales for profitability creates structural vulnerability
Quality Deterioration: The focus on subprime lending in a stress environment is creating increasingly risky loan pools
Market Dependency: The model only works as long as willing buyers exist for these risky loans
Timing Vulnerability: When credit conditions tighten or economic stress increases, the model breaks down rapidly

The Challenge of Timing Markets

The Carvana case illustrates a fundamental challenge in activist short selling: being right about the underlying problems doesn't guarantee immediate market recognition. Several factors can delay the inevitable:

Management's ability to find new buyers or structures for loan sales
Market conditions that temporarily support risk-taking
Investor focus on short-term metrics rather than long-term sustainability
The complexity of the business model making problems less obvious to casual observers

What Happens When the Loan Sales Stop?

The Inevitable Reckoning

When Carvana can no longer sell its loans profitably—whether due to credit market conditions, regulatory action, or simple buyer fatigue—the company will face several immediate challenges:

Cash Flow Crisis: Without loan sale proceeds, Carvana would need to fund its operations entirely through automotive retail margins, which have historically been insufficient to cover the company's cost structure.

Balance Sheet Deterioration: Holding loans on balance sheet would tie up capital and expose the company to direct credit losses, potentially creating liquidity problems.

Margin Compression: Unable to generate profits from loan sales, Carvana would be forced to rely on traditional automotive retail margins, which are significantly lower and more volatile.

Operational Scaling Issues: The company's current cost structure is built around the assumption of continued loan sale profits. Without this revenue stream, significant cost cutting would be necessary.

The Activist Timeline Vindicated

When this happens—and activists argue it's a matter of when, not if—the sharp stock decline will vindicate the fundamental analysis provided by both Kerrisdale and Hindenburg. The timing will have been wrong, but the destination will have been correct.

Conclusion: Patience in Activist Short Selling

The Carvana story serves as a powerful reminder that activist short selling often requires extraordinary patience and conviction. Both Kerrisdale Capital and Hindenburg Research have provided compelling evidence that Carvana's business model is fundamentally unsustainable, built on a dependency on subprime loan sales that cannot continue indefinitely.

The stock's remarkable performance doesn't invalidate their analysis—it simply highlights the challenge of timing market recognition of fundamental problems. For the Activ8 News team, this case study reinforces our belief that the best activist research identifies structural problems that may take time to manifest but are ultimately unavoidable.

As credit conditions continue to tighten and economic pressures mount on Carvana's subprime customer base, the activist thesis appears increasingly likely to be vindicated. The question isn't whether the loan sales model will break down—it's whether patient investors will be rewarded for recognizing the inevitable before it becomes obvious to the broader market.

The activist short seller community deserves credit for identifying and documenting these issues. While the market timing has been challenging, the fundamental analysis appears sound. When the loan sales engine finally stalls, it may happen quickly and dramatically, validating years of careful research and patient capital allocation.

The Activ8 News team continues to monitor this situation closely, recognizing that the most important activist insights often require the most patience to be proven correct.