Investigation confirms fraud at China's Luckin Coffee

An internal investigation found that fabrication of transactions starting in April 2019 resulted in Luckin's net revenue for that year being inflated by approximately RMB2.12 billion ($300 million) – with over half of that coming in the fourth quarter. Moreover, costs and expenses were inflated by RMB1.34 billion. The company reported revenue of RMB2.93 billion for the nine months ended September 2019, up from RMB375 million a year earlier. It had previously projected fourth-quarter sales of RMB2.1-2.2 billion.

CEO Jenny Zhiya Qian and COO Jian Liu were behind the fabrications, according to a statement. Qian and Liu were removed from their posts in May and April, respectively. They perpetrated the fraud by channeling transactions through third parties with ties to company employees. This reportedly involved bulk sales of discount vouchers to entities masquerading as corporate customers. At the same time, payments for raw materials and delivery services needed to satisfy these supposed coffee orders were made to fictitious suppliers.

The Luckin board has sacked 12 additional employees who took part in the fraud at the direction of Qian and Liu, while 15 more are subject to other disciplinary action. The investigation also found sufficient evidence to justify the removal of Zhengyao Lu as a director and chairman, but he survived a shareholder vote. Lu was the founder of China Auto Rental (CAR), the country's leading car rental business, where Qian previously served as COO and Liu held an executive role.

Lu has resigned from CAR, and state-owned carmaker BAIC Group is poised to replace him as the controlling shareholder. BAIC will buy shares held by Ucar, a chauffeured car services business also established by Lu. Warburg Pincus earlier agreed to acquire a stake in CAR from Ucar, but only the first tranche of the two-tranche deal was completed.

In May, NASDAQ moved to delist Luckin – which listed on the exchange just 12 months earlier – in response to public interest concerns. A second delisting notice was issued last month over the company's failure to file an annual report. Luckin called for a hearing to challenge the initial decision but has now withdrawn this request. The company's stock plunged 75% on April 2 in response to news of the fabrication, closing at $6.40. It ended July 2 at $2.52.

Luckin's business model has always been controversial. Founded in 2018, it became China's second-largest coffee shop chain on the back of an aggressive store expansion program. 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. Over the two periods, net losses rose from RMB950 million to RMB1.76 billion.

Advocates 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.

The company raised more than $500 million in private funding ahead of its IPO in May 2019, with Centurium Capital, Joy Capital, GIC Private, Legend Capital, China International Capital Corporation (CICC) and BlackRock all participating. Centurium currently owns 11.43% of Luckin, having generated $231.8 million through a partial exit in January. Joy and GIC each hold less than 1%.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

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