Luckin Coffee: Not Your Lucky Day (OTCMKTS: LKNCY)
Luckin Coffee Inc. (OTCPK: LKNCY) is a coffeehouse chain operating in mainland China. In an IPO in the second quarter of 2019, the company appeared to significantly increase its revenue – until it was allegedly fraudulent in Q2 2020.
Subsequently losing most of its value and forcibly delisted from NASDAQ, Luckin Coffee has since seen its IPO price appreciate while trading over-the-counter.
This article will dig deeper into his story to see if things have really improved.
Ostensibly going from $10 million in revenue to $618 million in revenue over the span of 3 years, Luckin Coffee is said to have dramatically distorted its financial picture.
Reviewing the SEC’s lawsuit against the entity, we find that the company allegedly wrongfully created over $300 million in revenue from the second quarter of 2019 through January 2020. Comparing that to its reported revenue numbers for that period, this implies that the majority of reported income was not actual income whatsoever. While we can quantify this, it is immediately clear that this alleged fraud was so large that it accounted for over 80% of revenue over this period. As such, I don’t see much value in the nickel-and-diming numbers, as we don’t really know what was real and not at the time.
Note the “at least” in the SEC press release on this. That is, they had reason to believe, although perhaps without hard evidence, that the alleged fraud might in fact have been broader than what was discovered.
Additionally, the company reportedly had a “fake transaction database” and even altered bank statements. This apparently takes him to a completely different and high level of fraud. I have no hesitation in saying that this company was obviously a criminal enterprise at that time, although it was never brought to trial.
The company always seemed to come out on top during this period, raising $864 million through debt and equity instruments during this period.
Since then, Luckin has been trading over-the-counter, informally known as “pink sheets”. Investors should be aware that OTC trading means that the company no longer has to deal with audits for its financial reports. Since their operations are in China, we don’t really have a full picture of what’s going on right now.
While revenue growth since then has apparently been significant, we don’t really know that’s the case. Unfortunately, there’s no way to tell, and the fact that the company doesn’t do business in the US prevents us from even verifying this by proxy.
Also, cash looks volatile – and growing. Somehow, the company managed to lose $82.6 million from operations in the second quarter of 2022 after posting a gain of $17 million the previous quarter. Coffee may be a discretionary consumer good, but it usually doesn’t come close to that volatility of a business.
It would be one thing if that money was used for investing – but even these unaudited financial statements indicate that is not the case. The company has not made any capital expenditures in the last 2 reporting periods, instead placing $10.4 million in “other investing activities”. Nor does it explain the large cash loss of more than $80 million last quarter.
Additionally, the company reports negative net debt – which would imply that it has more cash than liabilities.
Yet its cash position continued to weaken quarter over quarter, while its total debt actually increased. It doesn’t add up.
It should also be noted that the last two reporting periods do not report the total number of buildings, full-time employees or machinery of the company – the very heart of its operations and the only visible things that an investor can still glean.
While visibility on China is notoriously difficult, some alternative data may perhaps shed some light on this point. A search on Baidu.com (the main search engine in China) gives a very large number of locations, but the comparable search on Google Maps gives us only 2 results.
That’s a pretty stark disparity; I would be inclined to at least consider these numbers if they were far apart. Since Google Maps leverages satellite imagery, automated field photography, and various other algorithmic methods to generate listings, one would expect it to offer more than 2 locations for such a popular coffee chain.
This image as a whole is ripe with red flags.
Given the company’s history of suspected large-scale fraud, we must be all the more cautious in our analysis. Looking at Luckin makes me skeptical that it really works as described right now. The company omits basic operational details in its latest reporting periods, is losing money at a rapid rate (increasing cash loss by $100 million quarter-over-quarter) and posting numbers of balance sheet that just don’t match; I think they are getting back to it.
While shares of Luckin Coffee Inc. have appreciated significantly, OTC trading is often ripe with pump-and-dump schemes and other types of financial malfeasance. It is the author’s opinion that Luckin Coffee Inc. is exactly that: a pump and dump. As such, it should be avoided by any prudent investor.