Amid board investigations of reports that employees and senior executives fabricated transactions, Luckin Coffee Inc. (Luckin) which is the rapidly expanding Chinese coffee chain, its shares plummeted as much as 81 per cent on Thursday (3 April)
The rapid rise of Luckin as a main competitor to Starbucks is now under the much doubt when Luckin announced the misconduct of its Chief Operating Officer, Jian Liu and employees working under him.
By the end of next year, Luckin wants to open up outlets in 10,000 locations and this may no longer be achievable due seeing that the share collapse on Thursday wiped out 54 per cent of the company’s value since going public in 2019.
The company stated that Mr Liu and the others have been suspended whereas investors should not count on the past financial statements for the nine months which ended 30 September. Based on filing, the ¥2.2 billion (S$443.27 million) transaction took place in 2019.
Earning visibility may be compromised “for the foreseeable future” and that “it will take several years for management to repair its credibility,” Eric Gonzalez, an analyst from Keybanc Capital Markets remarked.
The fabricated sales figure could make up a large portion of the company’s total revenue if the allegations are true. According to estimates by Bloomberg, Luckin reported ¥5.15 billion (S$1.04 billion) revenue for 2019 even though the company only had reported financial data for the second and third quarter last year following its public offering in May.
Inflated figures
Although Luckin remarked that there is no independent verification of the fabricated sales figure by the investigating special board committee, “certain costs and expenses were also substantially inflated by fabricated transactions during this period.”
By the end of last year, the coffee chain has opened around 4,500 stores since its founding in 2017. The strategy adopted 10 years ago with CAR Inc., a vehicle rental was similarly re-adopted by Chief Executive Officer Qian Zhiya and Chairman Lu Zhengyao which involved quickly securing market share from rivals by burning money from investors. The strategy was a success as it won over investors.
However, trouble occurred this year after Muddy Waters tweeted on 31 January that the company had a short on the stock after being privy to an allegedly “credible” unattributed 89-page report highlighting a broken business model and accounting issues with the chain. Following this, shares plummeted even as Luckin refuted the allegations.
According to people in the know, USD$778 million (S$1.11402 billion) was raised by The Xiamen, a China-based company through selling shares and convertible bonds in early January, as well as another USD$645 million (S$923.38 million) through its U.S. IPO.
Analysts have generally remained optimistic about Luckin in spite of the allegations and mandatory closures caused by the pandemic. Before the disclosure on Thursday, six had a buy recommendation on the stock, as opposed to one hold and zero sell recommendations.
Breaking even
Luckin reported revenue last November that was six times more than the previous year. It said that it was doing well to start breaking even at the corporate level in Q3 this year, even though it had reported losses from the adopted strategy that prioritized rapid growth.
As Chinese consumers develop a taste for java, the traditionally tea-consuming country gains importance as a market for coffee retailers. Starbucks has identified China as a market with growth potential, in addition to the US. However, Luckin was aware of Starbucks expansion there.
Reinout Schakel, the Chief Financial Officer, stated at the time: “We expect to take over Starbucks as the No. 1 coffee player in China by the end of this year in number of stores…We have a very strong brand.”
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