As Luckin Coffee [LK] battles delisting and share price slumps, should investors and traders steer clear?
Founded towards the end of 2017, Chinese coffee chain Luckin Coffee positioned itself as a homegrown challenger to Starbucks [SBUX] in China and was committed to overtaking its American counterpart. However, it has recently been embroiled in a fraud scandal and faces being delisted from the Nasdaq, forcing its share price to plummet 94.8% for the year to date (through 1 June).
Luckin Coffee listed on the Nasdaq in May last year, a mere 18 months after being founded. Priced at $17, Luckin’s share price opened 50% higher on its debut and hit an intra-day high of $25, before closing at $20.38, according to the Financial Times.
However, the very next day, the share price dropped below its debut value and within a week, Luckin Coffee was facing questions over whether it would eventually deliver meaningful profits.
Expansion efforts weigh on capital
The Xiamen-based company’s commitment to breakneck expansion came at a cost early on.
The company’s strategy was to attract customers by offering heavily discounted products and through rapid expansion. By the end of 2019, it had a total of 4,507 self-operated stores, according to a January trading update. Starbucks, on the other hand, has 4,351 stores in the region, as of the end of March.
Its first earnings release as a public company (Q2 2019) saw total revenue of RMB909.1m, up 648% on the year-ago period’s revenue of RMB121.5m.
Luckin's Q2 revenue - a 658% YoY increase
Revenue from brewed drinks came in at RMB 659.2m, accounting for 72.5% of total revenue, compared to RMB100.5m, or 82.7%, of total revenue in the second quarter of 2018.
Store-level operating loss, meanwhile, was RMB55.8m, decreasing around 32% from a loss of RMB81.7m a year earlier.
Although store operations had improved significantly, the company also reported a net loss of RMB681.3m, up 104% year-over-year on Q2 2018’s net loss of RMB333m.
The loss had widened due to a reported 254% year-over-year increase in general and administrative expenses as well as a 119% increase in sales and marketing expenses.
However, in the company’s following earnings release for Q3 2019 — reported in November — it delivered better-than-expected results. Total revenue was RMB1.54bn, while net loss came in at RMB531.9m.
The third quarter suggested that Luckin Coffee’s strategy was finally starting to pay off, as revenue climbed and net loss was lower than the previous quarter’s.
In early January of this year, the coffee chain furthered its commitment to attracting more customers by announcing plans to introduce smart, unmanned coffee and vending machines powered by a combination of technologies, including facial recognition. “We will continue to grow both own traffic and products, improve brand value, expand the scale of our platform, and create more value for our customers,” Luckin Coffee’s former-CEO Jenny Zhiya Qian said.
But by the end of the month, the company had been accused of accounting fraud by the research group Muddy Waters.
“We will continue to grow both own traffic and products, improve brand value, expand the scale of our platform, and create more value for our customers” - Luckin Coffee’s former-CEO Jenny Zhiya Qian
Following a lengthy investigation, Luckin Coffee announced on 2 April that it had found that RMB2.2bn worth of transactions had been faked between the second and fourth quarters of 2019.
The number of items sold per store per day had been allegedly inflated by at least 69% in the third quarter of 2019 and 88% in the fourth quarter, according to the report by Muddy Waters seen by IBD.
The news caused panic among short-sellers, who sent the stock price tumbling. In one trading day alone, the share price fell 75% from $26.2 to just $6.4 by the 2 April. On 7 April, the Nasdaq made the decision to suspend the stock, following an internal investigation.
Valuation of Luckin's faked transactions between Q2 and Q4 2019
Although the stock began trading again on 20 May as it awaits the outcome of its appeal against being delisted, Luckin Coffee’s future, and share price outlook, appears bleak. This is despite the company shaking up its boardroom and firing its COO — who orchestrated the fraud — as well as its then CEO Qian.
Some experts believe the stock may be wiped out before the company’s appeal has even been heard, as more investors look to sell the ailing share price.
Acquisition or liquidation?
“We continue to see the most likely outcomes as a complete wipe-out for equity holders,” John Zolidis, founder of Quo Vadis Capital, told MarketWatch.
“We ascribe very remote odds to the hope that Starbucks or another party will swoop in to buy Luckin Coffee’s assets prior to liquidation.”
“We ascribe very remote odds to the hope that Starbucks or another party will swoop in to buy Luckin Coffee’s assets prior to liquidation” - John Zolidis, founder of Quo Vadis Capital
On 24 May, Reuters reported that a number of Chinese restaurant companies could be interested in acquiring some of Luckin Coffee’s assets, such as its app and customer data. On 26 May, the share price closed up 53% at $2.13, most likely in response to the news of potential acquisitions. At the close of trading on 1 June, the price was $2.04.
From being one of China’s positive growth stories and valued at $4bn following its IPO, Luckin Coffee’s current market cap valuation is $592m, as of 1 June.
The low price and the uncertainty over the stock’s future even if any of its assets are eventually acquired make for a very high-risk investment.