Jul
There has recently been a fairly significant scandal involving one of the top companies in China. This company was being referred to as the Starbucks of China, however, after a surprising development, it came out that this company was forging sales and misleading investors.
They forged online sales through their mobile app to make investors believe that they were more popular than they actually were. We wanted to take a deeper look at what happened in this scandal, how it can impact investors like yourself and how things re likely to unfold moving forward.
Without further ado, let us take a look at Luckin Coffee and what happened when it comes to their recent scandal.
What Is Luckin Coffee?
Luckin Coffee was one of the top coffee brands in China and was drawing comparisons to the global coffee giant Starbucks, with “selling points” such as the fact that:
➢ As of early 2020, the company had about 4,506 stores
➢ They opened their first store in 2017
➢ They are headquartered in Beijing
➢ As of late 2019, they had approximately 8,485 full-time employees and 8,160 part-time employees
➢ Their highest valuation was $2.9 billion (although that has plummeted significantly)
What Happened?
Luckin Coffee was being hailed as the Starbucks of China (a major comparison considering Starbucks has a market cap of about $86 billion, compared to Luckin’s highest valuation of $2.9 billion). They went public last year on the NASDAQ and their shares were surging due to what appeared to be strong sales growth:
➢ They raised almost $600 million through their IPO
➢ They raised another $800 million in January 2020
➢ In April, they announced that $310 million of their sales (about half) for the final three quarters of 2019 were faked
➢ An independent investment firm apparently discovered this by sending 1,500 people to sit in stores and count transactions. Luckin was forced to come forward after this
Apparently, a lot of their orders were taken online via their mobile app, and the company considered technology to be at the core of their business. Luckin had claimed to be disrupting the coffee industry using “artificial intelligence and big data analytics”. These were some of the claims that inspired investors to believe that they could take on a company such as Starbucks on a global scale.
Since the company placed such a high emphasis on technology and most of their sales were going through their mobile app, it was relatively easy for the business to inflate them. However, this scam fell flat after the previously mentioned private investment firm sent people to sit in stores. After that, it became clear that not nearly as many people were coming into stores to pick up orders as Luckin was making it seem.
Directly after the news, the stock plunged 80% and is down nearly 93% for the year 2020. Shortly after the announcement, the Nasdaq decided to delist the company.
What Has Luckin Done?
As this scandal was disclosed in April of 2020, it’s already been several months since the news broke to investors. Since then, Luckin has taken measures to protect their employees, investors and business as a whole. Two of those steps are:
- Removing CEO Jenny Zhiya Qian and Chief Operating Officer Jian Liu from the company and naming a new CEO (Jinyi Guo). This move is not exactly surprising, as a new face to the company will help with the short-term public relations equation
- Contemplating liquidation – Liquidation is just the process of pulling the proverbial plug and selling everything possible to cover all debts and repayments to lenders and investors
Right now, there is a lot of damage done to the Luckin Coffee brand and it is still uncertain whether they will continue operating at all. Their shares have been delisted from the NASDAQ and were halted for over a month. They are also facing investigations from several different regulatory bodies in both the U.S. and China.
It’s no understatement to say that the company is in a heap of trouble. However, they were also a fairly large company (despite the fake revenues) and bankruptcy could put almost 16,000 people out of work. This situation will most likely take a while to straighten out and for leadership to determine the best path of action
What Can We Learn From This?
From the perspective of an investor, this is a great example that you always need to be highly critical when examining businesses. It’s not enough to simply read a prospectus or annual report and take it at face value. It’s important to remember that the people who put together investor relations documents have a vested interest in making themselves look as good as possible.
Here are a few good things you can keep in mind when making investment decisions:
- Perspective – Does what the company says make sense when compared to other companies in their industry? It’s easy to get caught up in investor hype around certain companies but also important to stay grounded and make sure euphoria doesn’t take over
- Trustworthiness – Do you trust the people who are leading the company? Do they have a track record of dependability?
- Reason – Is the company shooting too high? Do they have growth projections that are realistic? Or are they wearing rose-colored glasses? In Luckin’s case, they were projecting to open more stores in 2 years than Starbucks has in two decades
Anne Stevenson-Young from J Capital research stated on CNBC that, “It’s a great morality tale. It seems to me that those of us who spent time in China could see from very early on that Luckin was inflating its numbers. Luckin was a company that was terribly interested in memberships and in tokens, and in the visible growth of foot traffic to the stores — but not in actual revenue,”
This is also a good example of how it can pay to take on the advice of experts. If you’re just a standalone investor, you might not have the time or resources to get critical insight into businesses like Luckin Coffee. On the surface, it might seem like a great investment at the time. However, to the insider’s eye, there might be several red flags.
Consulting with an industry professional can save you a lot of time, stress and (most importantly) money. If you have any specific questions regarding investing in China, please don’t hesitate to reach out to our team via email or phone.
Looking Forward
Scandals like what happened with Luckin Coffee are an investor’s worst nightmare. It’s also even worse that it came from a country such as China, where transparency is already questionable. It is widely believed that, in China, the government influences private companies to bend their behavior to the whim of the government. The government has also been known to not be 100% transparent with the rest of the world either.
One example involving a lack of transparency is represented by the recent coronavirus situation, where most scientists believe that China was not fulling releasing the data that they had available.
It also came at a non-ideal time considering the rising tensions between China and the U.S. in regards to the current trade war. Business people on both sides want to engage in trade, as there are plenty of opportunities. However, situations such as the Luckin Coffee debacle destroy trust on both sides and will unfortunately lead to a less open investing environment.
However, there is a bright side to what happened. Now that a scandal like this has occurred on a U.S. exchange, there is a much stronger push for foreign companies to be fully audited before being able to list their shares to the American public. Hopefully, this means that these scandals will become less and less likely. In 5-10 years, a situation like what happened with Luckin Coffee might be considered laughable. To that effect, measures are already being taken.
In fact, the Securities and Exchange Commission is contemplating banning all Chinese companies from listing on U.S. exchanges altogether. This bill received bipartisan support in the Senate and would make it even harder for U.S. investors to get access to Chinese companies. However, it would also protect U.S. investors from being exposed to fraud.
A move like this could also be seen as a win for the Hong Kong stock exchange. Since Chinese companies will no longer be allowed to leave for the larger U.S. exchanges, more will be listed on the Hong Kong exchange. In the short-term, this will be bad for Chinese companies because they won’t be able to raise as much capital during their IPOs. However, in the long-term, this will help Chinese exchanges catch up in size to those in the United States. This will just create an even more bullish investing environment in China.
We hope that you’ve found this article valuable when it comes to understanding what happened with Luckin Coffee and how things might change moving forward. If you’re interested in reading more articles related to China, please visit our blog and/or the “New Here?” section of ChinaFund.com.