Luckin Coffee share price: how ‘fabricated’ sales tanked the stock

Luckin Coffee’s share price has plummeted after revealing $310 million in ‘fabricated’ sales figures. What should investors know?

Luckin Coffee [LK] saw a mammoth 75% wiped off its market value as share price investors swallowed the news that it could have been faking sales figures. Luckin had come from nowhere to rival Starbucks as the biggest coffee chain in China. Now it's difficult to see how the coffee chain can rebuild investor trust.

How big is the scandal?

An internal investigation found $310 million worth of sales were ‘fabricated’. If that wasn't damaging enough, the coffee chain said that investors in Luckin’s share price couldn't rely on past financial guidance. Several senior staff have now been suspended, including the COO.

Robinhood points out that Luckin Coffee reported $413 million worth of sales for the first nine months of 2019. Taking away the fabricated $310 million leaves $103 million. That's a huge difference. In a filing with the US Securities and Exchange Commission, Luckin said:

"Certain costs and expenses were also substantially inflated by fabricated transactions during this period."

Luckin Coffee’s share price had been soaring last year and early backers include Blackrock. Unsurprisingly, Luckin's share price has now tanked on the revelations. Investors looking to get in on the Chinese coffee boom might want to look at Starbucks. Its share price enjoyed a spike as Luckin’s - its biggest competitor in the region - crashed and burned.

How long has it been going on for?

Luckin's creative accounting covers the second to fourth quarter of 2019. Questions over Luckin Coffee's business model had already been brewing. In January, Muddy Waters Research made public an anonymous report pointing to fraudulent practices.

The report, compiled by 1,500 on-the-ground whistleblowers, reveals that individual outlets were inflating sales by as much as 88% at the end of 2019.

What has Luckin said?

On Sunday, Lu Zhengyao, the company’s chairman, took to social media to say he was ‘ashamed’ about what had happened.

In a post, Lu said: “I personally blame myself. Regardless of the final findings of the independent committee, I will bear the responsibility that I ought to.” The embattled CEO and angel investor is one of Luckin's biggest shareholders, having backed the start-up in 2017.

“I personally blame myself. Regardless of the final findings of the independent committee, I will bear the responsibility that I ought to” - Luckin chairman, Lu Zhengyao

In a statement, Luckin said: “The company will also deeply reflect and repent, and strengthen our internal controls.” The company has said it will make the results of an internal investigation public.

What’s the fallout?

Luckin had no shortage of investors buying into the company. For some, the aggressive tactics that saw it open 5000 stores in less than 3 years were signs of an ambitious company. MarketWatch reports that an internal PowerPoint showed Luckin's vision was to become "a combination of Starbucks, 7 Eleven, Costco and Amazon".

In a prospectus for Luckin’s IPO last year, the company said that it would be the biggest coffee chain in China by upending the “status quo of the traditional coffee shop model”. Ironically, Luckin had been aggressively aping the Starbucks model - even going as far as opening stores opposite Starbucks locations in China.

But this scandal could be too much to come back from. David Li, Centurium Capital’s founder, told the FT that he was 'shocked' by the revelations. Centurium had ploughed $180m into Luckin through two funding rounds.

According to the FT, lawyers in the US have already been contacting investors with the intention of mounting a class-action lawsuit. The Chinese securities regulator has said it will look into the case.

For some, the red flags were already there. The coffee chain had reported revenue growth of over 500% for two years on the trot. One investor who passed on Luckin told the FT that this “is the typical excess that you find at the end of a bull market.”