China's Luckin Coffee reveals $310m in fabricated sales

The company's stock plunged 75% on April 2 in response to the announcement, closing at $6.40. It had already fallen from $50 in mid-January to $27.19 at the end of March as the economic effects of the coronavirus outbreak caused havoc in public equities markets.

Luckin said in a filing that an internal investigation, still in its preliminary stages, had identified fabricated transactions from the second quarter to the fourth quarter of 2019. Certain costs and expenses were also substantially inflated. The company reported revenue of RMB2.93 billion for the nine months ended September 2019 – up from RMB375 million a year earlier – and it had previously projected fourth-quarter sales of RMB2.1-2.2 billion.

Jian Liu, Luckin's COO, and several employees reporting to him have been suspended for engaging in misconduct, including fabricating the transactions.

Luckin's business model has always been controversial. It became China's second-largest coffee shop chain on the back of an aggressive store expansion program. Founded in 2018, the company had 2,370 stores by the time of its IPO in May 2019. As of last September, there were 3,680 outlets.

This expansion incurred substantial costs, with operating expenses reaching RMB4.74 billion in the first nine months of 2019, up from RMB1.33 billion a year earlier. Store rental and operating costs and sales and marketing expenses – primarily subsidies to attract customers – each accounted for approximately 24%. Over the two periods, net losses rose from RMB950 million to RMB1.76 billion.

Advocates of the model described Luckin as a standout example of new retail. Unit costs would be driven down not only through economies of scale, but also by leveraging technology to deliver supply chain efficiencies and better consumer insights. The former would reduce inventory costs and the latter would lower customer acquisition costs. Moreover, the whole transaction process is automated because ordering and payment are done via app and outlets are mostly delivery hubs.

However, in January, US short-seller Muddy Waters circulated an anonymous report that drew on WeChat conversations and hours of video footage recorded at branches to allege Luckin was inflating sales. Luckin firmly labeled the claims as false, misleading and irrelevant and its stock price rebounded. China International Capital Corporation (CICC) came out in Luckin's defense, questioning the accuracy of the report and saying it expected the company to turn profitable in 2021.

A second short-seller, Ash Illumination, published research in February accusing Luckin of using a loophole in results disclosure requirements to provide very rough figures. Several law firms then launched class-action lawsuits against the company.

Within six months of its inception in 2018, Luckin secured $200 million in Series A funding led by Centurium Capital. Joy Capital, GIC Private, and Legend Capital also participated. A Series B of $200 million – featuring the existing investors plus CICC – came several months later. Days before the company's IPO, BlackRock committed $125 million.

Centurium currently owns 11.43% of Luckin, while Joy and GIC each held less than 1%. Other shareholdings were not disclosed. Centurium completed a partial exit from the company in mid-January, selling 5.52 million shares for $42 apiece. It secured proceeds of $231.8 million, while Luckin raised $434.7 million through a concurrent primary offering. The company also issued approximately $460 million in senior convertible notes.

Luckin was established by Jenny Qian, formerly COO of China Auto Rental (CAR), the country's leading car rental business. Zhengyao Lu, CEO of CAR, was an early backer of Luckin and now serves as chairman, while Liu previously held an executive role at CAR. The company's Hong Kong-listed stock plunged 54% to HK$1.96 on April 3.

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• Topics
• Greater China
• Consumer
• Joy Capital
• Centurium Capital
• BlackRock
• CICC
• GIC Private
• China
• Legend Capital