Caixin
May 24, 2019 08:44 PM
BUSINESS & TECH

Three Things to Know About China’s Starbucks Challenger

The hype surrounding China’s Starbucks challenger seems to have waned after its share price spiked on its debut last week.

Luckin Coffee Inc. closed at $15.79 on Thursday, 7.12% lower than its initial public offering (IPO) price. It made a strong debut on the Nasdaq Friday, with shares soaring nearly 50% when trading started after the expanded IPO raised $561 million.

Luckin opened trading at $25 per American depositary share, pushing its total market cap to $5.8 billion. The company priced its IPO at the top of the projected price range at $17 a share. The strong pricing allowed the company to increase the size of the offering to 33 million shares, up from previous plans to sell 30 million.

After less than two years in business, the Beijing-based startup has become one of the youngest Chinese companies to ever list overseas. It bills itself as a high-tech purveyor of coffee, operating a chain of mostly minimalist shops staffed by one or two baristas. All purchases must be made using the company’s app.

It’s no secret that the money-losing firm aims to displace Starbucks Corp. as China’s largest coffee chain by the end of this year. Luckin has been expanding at breakneck speed — it has opened over 2,000 cafes and plans to roll out another 2,500 by the end of this year. Starbucks has said it will have a total of 4,200 locations in China by then.

 

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Here are the three facts about China’s potential Starbucks-killer that we think you should know:

Co-founder is a car-rental pioneer

The Beijing-based chain was launched in October 2017. One of the founders was Charles Lu Zhengyao.

Lu created the Chinese car-rental firm Car Inc., in 2007, which offers short and long-term rentals in over 300 Chinese cities. The company went public in Hong Kong in 2014, raising over $400 million.

It later spun off a ride-hailing startup, UCar Inc., in 2015, which is now involved in a variety of automobile-related areas — secondhand car sales, dealerships, maintenance services, financing, e-commerce platforms and insurance. UCar was listed on China’s over-the-counter board a year later.

Lu currently is chairman of Car Inc., and CEO and chairman at UCar.

Car Inc. and UCar have been seeing declining profits and a person close to Lu told Caixin he was eager to move into new businesses instead of laying off workers.

Luckin was founded with 1 billion yuan ($144.6 million) from angel investors and Lu’s own pocket.

In October 2017, Luckin opened its first outlet in UCar’s Beijing headquarters, soon followed by a second one at an office block in downtown Beijing.

Luckin kept a low profile until May last year, when it began advertising its buy-one-get-one-free deals and its two A-list celeb spokespersons — actress Tang Wei and actor Zhang Zhen — stirring curiosity among those who wanted to try something new but preferred not to splash their cash.

 

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The startup now boasts a strong lineup of backers: Singapore’s sovereign wealth fund GIC Pte Ltd., Chinese private equity firms Centurium Capital, Legend Capital Management Co. and China International Capital Corp., and the U.S.-based BlackRock Inc.

Caixin understands that Tencent Holdings Ltd. and Alibaba Group Holding Ltd. have expressed interest in financing Luckin. But Luckin turned down such offers, apparently worried about signing away its unique business model.

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Luckin’s coffee costs are dropping

“Starbucks is making easy money in China,” said a Luckin investor who preferred not have his name on record. “But the market is rapidly growing, so there is room for rivals to come for a slice.”

Starbucks coffee is pricey in China, as the company taps the fattened wallets of a booming middle class that pursues markers of social status. It further raised prices in November last year, citing higher operating costs.

In comparison, Luckin’s business model of scale and huge discounts has invited controversy, but the money-losing company has said turning a profit is not a mission impossible.

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The giant video screen on the Nasdaq stock exchange in New York's Times Square is decorated for the Luckin Coffee initial public offering on Friday, May 17, 2019. Photo: IC Photo

Luckin sources said the company’s cost per cup of coffee is now around 12 yuan, down from 18 yuan when the company began. The current cost per cup consists of 5 yuan in manpower costs, 4 yuan of raw materials, and floor space rental of only 2 yuan. On the contrary, Starbucks forks out 11 yuan in rent, 6 yuan in manpower and 4 yuan on materials, adding up to nearly 22 yuan per cup.

Rent is the major differentiator between Starbucks’ and Luckin’s costs. The American chain, which only began dabbling with delivery in China last year, chooses to open shops in areas with a lot of foot traffic — such as near street intersections and busy commercial districts — and rents larger spaces for its customers to lounge and spend time.

Luckin’s app and delivery led model allows it to set up minimalist stores with little or no seating in less-prominent spots.

China’s coffee battleground

In 2017, the average Chinese person consumed five cups of joe a year, while their South Korean and Japanese counterparts had more than 200 cups. In the U.S., it was 381 cups, according to the International Coffee Organization and China’s National Bureau of Statistics.

Consultancy Frost & Sullivan predicts that China’s market for freshly brewed coffee China is set to soar to $154.8 billion in 2023, from $28.4 billion in 2017.

With this opportunity on offer, there is no lack of players dishing out fresh Americanos across the nation.

KFC has its own brand of coffee, as does McDonald’s. The two fast food chains operate nearly 3,000 and 6,000 outlets each in China.

Convenience-store regulars can spend less than 10 yuan to grab a fresh coffee from 7-Eleven and FamilyMart. The latter, which has about 2,000 outlets across China, told Caixin it sold 40 million cups of coffees last year.

Other players include Costa Coffee from the U.K. and Coffee Box, a local brand.

Costa has plans to expand its number of Chinese locations to 700 at the end of 2021, from the current 460. It markets itself in a similar way to Starbucks, touting its spacious locations and distinctive design.

Coffee Box in April said it has received 206 million yuan in funding — jointly raised by its two founders and local venture capitalist firms Qiming Venture Partners and Gaorong Capital.

Originally, the five-year-old chain simply delivered coffee for global brands such as Starbucks and Costa. But it now delivers its own coffee, and operates stores where people can pick up drinks and food, and hang out — though much like Luckin, the stores are small and aren’t designed for extended stays.

Contact reporter Jason Tan (jasontan@caixin.com)

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