What happened to Luckin Coffee? A big blow in its attempt to knock off Starbucks in China

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Update: On April 7, 2020, NASDAQ halted trading of Luckin Coffee (LK) indefinitely.
Update: On May 11, 2020, Luckin Coffee’s Board fired CEO Jenny Qian Zhiya, and COO Jian Liu.

Driven by a tech savvy strategy combined with efficiently laid out stores, Luckin Coffee went from a concept in late 2017 to having more store locations in China than Starbucks by 2020. While Starbucks thrives with a brand based on a store experience, Luckin went the opposite route creating a cashier-less environment with minimal square footage. Luckin charges significantly less for their products and pays their workers less and aspires for speed.

The company’s hope is by requiring all consumers to have their app to make purchases that they can leverage a technical advantage. The idea is to have fast delivery and takeout coffee to be a more efficient and cost effective experience for the Chinese consumer. In the words of CFO Reinout Schakel, “convenience, quality and affordability” is the model for Luckin.

The company stock, trading on the NASDAQ under the symbol LK, has had an incredible rise since its IPO in 2019 and has been hyped by many analysts. Now, Luckin is facing incredible scrutiny after it admitted it is internally investigating “fabricated sales” that could be totaling more than $300 million. After this admission this past Thursday, the stock’s price fell over 70%. Let’s take a look at a timeline of the company’s rise and fall.

A Timeline of Luckin Coffee’s rise (and fall?)

June 2017 – October 2017: The company incorporates and begins operations with its first store location in Beijing.

May 2018: Luckin publishes an open letter accusing Starbucks Coffee Co of engaging monopolistic behavior and unfair market practices. Starbucks writes it off as a “publicity stunt”.

July 2018: By this time, Luckin had 525 stores and ended a $200 million funding round and was valued, already, at $1 billion. Press reports at this time note the company’s emphasis on an all-digital strategy (cash free) and convenience, such as setting up locations primarily existing for delivery and fast pickup.

August – September 2018: In China, Starbucks teams with Chinese e-commerce giant Alibaba to bring coffee delivery services (a weak point highlighted by Luckin seizing that market), Luckin reacts by teaming up with another Chinese tech giant, Tencent.

January 2019: After just over a year in business, the company has over 2,000 stores with a goal of 4,500 by the end of the year.

April 2019: Luckin Coffee files with the United States Securities and Exchange Comission (SEC) to be publicly traded on the NASDAQ stock exchange. The company is valued at $2.9 billion at this time after an announcement of over $100 million of additional funding from asset manager BlackRock.

May 2019: Luckin Coffee IPO’s at $17 a share for institutional investors and opens at $25 a share for individual investors, it peaks out at nearly $26 the first day. It raises about $571.2 million from its IPO.

December 2019: Luckin Coffee is picked as one of Investor Place’s “Best Stocks for 2020”, with a headline stating it will “jolt” portfolios higher. It also notes that one of its forward looking catalysts is the company’s plans to expand into the Middle East and India. By this point, the company is boasting over 4,000 stores and trading between $30-$40 a share.

January 2020: Luckin Coffee peaks at its 52-week high at just over $50 a share in mid-January. The company’s stock price begins to gradually fall as Coronavirus spreads across China and basically shuts down most of the country. It falls even more to 32.49 a share on January 31 after Muddy Waters, a short selling firm, takes a short position after receiving an 89-page anonymous letter accusing the company of fraud.

February 2020: Seeking Alpha critiques Muddy Water’s short report on February 6, Luckin Coffee is trading around $35.

March 2020: Seeking Alpha, in a March 31 piece, doubles down on their Luckin Coffee support for investors with a “time horizon of two years” and does admit it could be a bumpy ride, especially with the Coronavirus outbreak. They call the Muddy Watters report a “bunch of baloney”. The stock closes at $27.19 a share.

April 2020: On April 2, just two days after the defiant Seeking Alpha piece, the company admits that it is investigating “fabricated sales” of over $300 million. The company admitted in a press release that their COO, Jian Liu, in addition to a number of employees reporting to him had engaged in misconduct such as fabricating and adding transactions from Q2 to Q4 2019.

In a press release, Luckin Coffee said COO Jian Liu, as well as “several employees reporting to him,” had engaged in misconduct that includes fabricating transactions, adding that fake transactions from Q2 2019 to Q4 2019 amount to around $310 million. Other costs and expenses during this period were also “substantially inflated.” On Sunday, April 5 the company apologized and pledged to maintain normal operations. China’s securities regulator has now said they are investigating the company. The stock initially fell 80% when the news broke Thursday, April 2 and by Monday, April 6 fell another 15% to close at $4.39 a share.

A Cautionary Tale

The story of Luckin Coffee is all too familiar for many younger investors who have been burned by overhyped tech-driven stocks. Seeking Alpha has certainly probably made many successful calls, but one writer there is literally on record urging investors to “buy the dips” a week before the company’s ultimate NASDAQ delisting.

The takeaway? As an investor you are truly an island. Supposed “experts” often make woefully wrong calls. Do your own research and try to read the critiques of the companies you wish to invest in and take them seriously. Rapid growth is sometimes just too good to be true, especially for companies that rush for high volumes of sales at a loss.