Caixin
Apr 03, 2020 10:09 PM
TECH TALK

Opinion: Luck Runs Out for Starbucks Challenger Luckin

I’ve put down my writer’s pen for this Tech Talk column the last two months, partly because anything techy seemed somewhat trivial in the face of Covid-19, and admittedly partly out of lack of inspiration. But the latest shocking disclosure that upstart coffee purveyor Luckin faked nearly half of its revenue last year was just too good to pass up, hence my return to the writer’s desk for now.

I’m certainly not the only one who has been highly skeptical of this company, which was founded by people from a car rental background and has been built largely on hype, in my view, combined with massive cash-burning to bring in new customers.

Many of those people were ordering drinks through Luckin’s app-only system at its shop in our building lobby today, as they raced to use up the smartphone-based coffee vouchers that have become a company staple. I’ll admit I probably have around 100 yuan ($14) worth of such vouchers myself, though I’m crossing my fingers the stores will still be around for the next week or two.

But even that could be iffy if others rush to pull their money out of this cash-burning machine, much the way a run on a bank occurs when people sense trouble, which only hastens the final collapse.

I’ll give a little more color and some background to bring people up to speed on the company that went from nothing two years ago to pass Starbucks last year in terms of China store count. Then I’ll spend the second half of this column looking at what’s ahead, including the future of the company and its top brass, as well as what may come out of the almost inevitable investigation set to follow by the U.S. securities regulator.

Of course, the big losers in all this will be the people who pumped billions into this company along the way, enticed by its potential to someday take its show global and truly challenge Starbucks.

Following its relatively successful IPO last year that raised $560 million, it was at the fund-raising well again as recently as January, when it generated nearly $800 million through the sale of new shares and a convertible bond. Now it seems that bond will never get converted, and there’s a strong likelihood that whoever bought it might never get paid back.

Plenty of people out there are saying “I told you so,” including myself. One of the most high-profile naysayers was notorious short seller Muddy Waters, whose founder Carson Block shorted Luckin’s stock after receiving some anonymous third-party information in late January, Bloomberg reported. Luckin’s shares peaked around mid-January at about triple their IPO price. But following a 75% crash with the faked sales disclosure, they now trade about at about one-third of that price.

The shocking disclosure that brought the company down was an announcement that its Chief Operating Officer Liu Jian may have cooked the books to the tune of 2.2 billion yuan in fake revenue in the second, third and fourth quarters of last year, or around half the total for that period. Liu is clearly looking like the fall guy in this story, with the announcement saying he and some of his employees have been suspended while the investigation continues.

What’s Next?

With all that in mind, we’ll spend the rest of this column looking at what might be next for Luckin, both in terms of the company itself and the ripples it’s likely to make in financial markets.

First, the juicier story about what lies ahead for the company. I polled a few sources who follow these things, and most didn’t want to get too explicit about what might lie ahead. But one who did offer a concrete vision held expectations pretty similar to mine, predicting that Luckin as we know it is pretty much dead.

After this kind of major disclosure, no one will want to give the company more money under its current ownership and management. That means it will probably face an almost instant cash crunch, especially as people like me scramble to redeem all their coupons and don’t buy any new ones. That will paralyze its finances and force either an outright collapse or huge and sudden cost cuts that entail shuttering thousands of shops.

What’s left after that will be a shell of the original company, which most likely would get sold off to raise cash to pay back some of the hundreds of millions of dollars owed to its many creditors.

Then there’s the question of what’s next in terms of investigations. I suspect focus will quickly turn to whether the buck stopped at the COO, or whether it went higher into the company. Perhaps reflecting that, shares of a Hong Kong-listed car rental specialist called Car Inc., which was founded by Luckin founder and Chairman Lu Zhengyao, who also goes by Charles Lu, lost more than half their value on Friday.

I had a look at some of Luckin’s previous stock filings and could only find Ernst & Young listed in its 2019 IPO prospectus, which was filed before the period when the alleged book-cooking occurred. But whoever the company’s auditor was in the last three quarters of 2019 will almost certainly come under fire for allowing such a major fraud to occur under its watch. It could ultimately face serious fines from the U.S. securities regulator, the Chinese regulator, or both once a thorough probe is conducted.

Around a dozen shareholder lawsuits have already been announced in the less than 24 hours after the first disclosure, adding to the circus-like atmosphere that’s quickly taking shape here. But those law firms and the shareholders they represent are unlikely to get their money back, as I seriously doubt there will be much left to squeeze from the company by the end of this year.

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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