Caixin
May 15, 2019 10:30 AM
TECH TALK

Starbucks Challenger Will Need More Than a Little Luck to Succeed on Wall Street

Question: What do you do when your once high-flying rental car business is running out of gas?

Answer: Open a coffee chain selling cups of heavily subsidized brew and try to convince the world you’re the Chinese Starbucks.

That appears to be the answer two of China’s high-powered entrepreneurs are giving to investors as they hope to make a splash later this week with a New York IPO for their Luckin Inc. coffee chain. The pair, Charles Lu and Jenny Chen, are chairman and CEO, respectively, of a company that is now asking Wall Street to cough up a sizable $500 million for a chance to buy into a high-tech chain with just a year and a half of operating history.

The listing is set to price on Thursday, with shares set to debut on Friday, a source with direct knowledge of the deal previously told Caixin.

As a veteran financial reporter living and working in China, and also a Luckin customer, I feel well positioned to comment on this particular offering and its numerous upsides and downsides. I’ll be quite frank from the start and say this particular offering appears to have far more downsides, and even seems to have slight overtones of desperation, IMHO.

My sense of desperation stems mostly from the fact that this company has barely any operating history, and is losing huge amounts of money by following a very made-in-China model of rapidly attracting customers by offering highly subsidized products, in this case cheap cups of coffee. This is easily the fastest I’ve seen a company go to market in all my years of reporting on China, just two years after its founding and well before it has the kind of track record that stock investors usually like to see.

You would never sense any such desperation from looking at the actual IPO path so far. The company made its first public disclosure in late April, saying it planned to raise up to $100 million. It then super-sized that amount to $500 million, giving the impression that people were fighting tooth-and-nail for a piece of the next Starbucks. Late last week sources told Caixin the offering was oversubscribed several-fold, adding further froth to the listing.

To my jaded reporter’s ears, this all seemed like carefully placed hype aimed at drumming up interest in an offering that might otherwise be raising eyebrows for some of the less exciting reasons I’ve already pointed out.

I’ll admit the company itself is actually relatively interesting conceptually. It operates mostly quick-stop, minimalist coffee shops with little or no seating, catering to the coffee-on-the-go crowd. What’s more, you can only buy its coffee through the company’s app, meaning Luckin has an easy channel for offering promotions and getting you hooked through your smartphone.

That formula has allowed the company to expand from zero stores at the start of last year to 2,370 at the end of March. Only Starbucks has more, around 3,600 stores in China. But let’s not forget that Starbucks built that presence up over about two decades, including a major period devoted to developing a coffee culture in a country of traditional tea drinkers.

Some numbers, please

The numbers speak most clearly in this case. The company reported a relatively impressive 478.5 million yuan ($70 million) in revenue during the first quarter, not bad when one considers the figure was almost nil a year earlier. Its net loss for that period was even bigger at 572.8 million yuan, again not a huge surprise considering the company’s youth.

The company’s sales and marketing expenses were also quite turbocharged in this year’s first quarter, totaling 168.1 million yuan, or triple the amount a year earlier. Much of that probably comes from their non-stop promotions. I can personally vouch that I have yet to pay full price for a cup of the company’s coffee, and usually pay anywhere from half to one-third off. Nobody else I know pays full price for Luckin either.

A recent conversation with one of my marketing colleagues seemed to reflect the broader attitude toward this company. On seeing the colleague walk into the office holding a cup of Luckin, I casually asked if she was a fan. “I’m a fan of their prices,” she replied with a laugh, quickly adding she would drop her newfound habit in an instant if she had to pay full prices that are slightly below what Starbucks charges.

Others have expressed similar sentiment, and I have yet to meet any Chinese friends who even care about how Luckin’s brew tastes. It’s actually pretty decent, in my view, and I would probably keep buying even at full prices, mostly due to convenience. But I’m a foreigner, not one of their millions of local target customers who would need to keep drinking big volumes to keep the company going.

Then there comes the question of track record. As I noted at the outset, the company’s chairman and CEO both came out of Car Inc., a rental specialist that at one time looked like it could become the Hertz of China. But more than a decade after its founding and a public listing in Hong Kong, Car Inc.’s latest financials also look pretty unimpressive. Rental revenue was up a scant 6% last year, and the company’s net profit actually plunged by two-thirds, according to its latest annual report.

Perhaps that’s why Car Inc.’s Hong Kong-listed shares now trade nearly 30% below the price from their IPO nearly five years ago.

Luckin will also be fighting an uphill battle following a weak IPO for shared economy giant Uber, another massively money-losing company whose stock has sagged nearly 20% since its trading debut last week. Founded a decade ago, Uber looks like a relative fossil compared with the sprightly Luckin, which has yet to show the world it can survive to such a ripe old age.

At the end of the day I do suspect Luckin may come close to raising the full $500 million and even post a respectable small gain on its trading debut, probably with the help of some of its institutional investor friends. But I honestly can’t see this listing having any legs for at least the next year or two until it has more of a track record, and would expect it to quickly lose half of its value or more over the next few months.

Doug Young has lived in Greater China for two decades, including a 10-year stint at Reuters, where he led China corporate news coverage. Send your questions or comments to DougYoung@caixin.com

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