Scandal-Ridden Luckin in Nascent Coffee Comeback. But Will Investors Take a Sip?

With strong first-half revenues and shares within striking distance of its $17 IPO price, Starbucks challenger could be positioning itself for a big-board relisting

Key takeaways:

  • Luckin Coffee’s latest post-scandal financial report shows revenue more than doubled in the first half of the year, as losses narrowed
  • Reformed company’s shares have rebounded to just below their IPO price, as it moves to business model with new focus on franchising

By Mia Shanley

For better or worse, investors tend to have short memories. That’s especially the case with Luckin Coffee Inc. (LKNCY.US), China’s homegrown challenger to Starbucks (SBUX.US), which a year and a half ago admitted to massively inflating sales and filed for bankruptcy earlier this year.

Instead of running for the hills, investors have been busy bidding up the company’s stock this year, helping its shares to stage a major comeback. Those shares are now traded on over-the-counter pink sheets after the stock was kicked off the Nasdaq not long after the scandal broke in the first half of last year.

Despite the many challenges Luckin has faced, its shares have risen almost 75% this year to trade just below $15, putting them within striking distance of its $17 IPO price. Its current market value of nearly $3.7 billion also makes it one of the larger pink sheet companies we’ve seen.

The 2021 rally, coupled with a freshly brewed earnings announcement last week that offered a glimpse into more “normalized” affairs, have led to speculation over whether the barista’s fortunes have improved enough for it to try to re-list on Nasdaq’s main board, or whether it might seek a listing closer to home in Shanghai or Hong Kong instead.

Luckin, which continued to brew coffee at more than 5,000 shops across China while it cleaned out its boardroom and restructured debt, put on a brave face about its future prospects in its latest earnings report, talking up its potential to deliver “sustainable growth and profitability.” Never mind that the company has yet to find such profits in its brief and turbulent history.

Its total net revenues more than doubled in the first half of the year to 3.2 billion yuan ($500 million). Luckin previously slashed its originally reported 2019 revenue after admitting to fabricating a whopping $300 million in sales.

Since then it has made progress to right its wrongs. It agreed earlier this year to pay $180 million in fines to the U.S. Securities and Exchange Commission. And earlier this week Luckin shareholders received court approval in New York to move forward with a $175 million cash settlement with the company over fraudulent accounting, news agencies reported.

The last two and a half years have been nothing short of a roller coaster ride for the Chinese company. It listed on the Nasdaq in May 2019 to much fanfare, only to get slammed by fraud allegations less than a year later. Luckin’s shares reached a high of over $51 in January 2020 – triple their IPO price – as it sold investors on its story of becoming the next Starbucks for the massive China market.

It never made any meaningful profits, selling its coffee at big discounts from its minimalist stores to quickly gain market share. It opened those stores at a breakneck clip to overtake Starbucks in terms of store count. Then came the fraud scandal, causing the stock to plunge and trade below a dollar when it was delisted last June.

Starting Over

Pressing the reset button at the company, whose blue and white coffee cups featuring a deer logo have become well known in big Chinese cities, has gone much faster than many investors expected. And the latest upbeat report shows the company appears keen to sell its story once more.

“The earnings announcement is an important milestone as it enables us to return to normalized financial reporting,” Chairman and CEO Guo Jinyi, a Luckin co-founder who replaced former CEO and co-founder Jenny Qian, said in the earnings statement.

Guo said improved brand recognition, better customer retention and more partnerships in lower-tier Chinese cities helped improve revenues as Luckin’s operating loss in the first-half narrowed to 411.5 million yuan from the 1.6 billion yuan loss a year earlier. Losses and expenses related to “fabricated transactions and restructuring” totaled 154.7 million yuan in the first half of the year, also down 15.6% from the same period last year.

“Today, with a refreshed board of directors and leadership team … we are well-positioned to drive meaningful long-term value for our shareholders,” Guo said.

Founded in just 2017, Luckin has quickly capitalized on a fast-growing number of coffee drinkers in China, traditionally a tea-drinking country, especially in more urban areas and among younger professionals as tastes change. Mordor Intelligence has forecast China’s coffee market will grow at a compound annual rate of over 10% between 2021 and 2026 after taking a hit in 2020 due to strict lockdowns during the Covid-19 pandemic.

However, Chinese consumers still drink just six cups of coffee per capita a year, data from Statista shows, putting the country well behind the U.S. and European countries. Sensing a big opportunity, competition has intensified in the market with an increasing number of domestic brands and international players entering.

One recent high-profile case saw Italy’s Lavazza partner with Yum China Holdings (YUMC.US; 9987.HK), operator of Chinese KFC restaurants, to launch its coffee shop concept in China last year. The homegrown Manner Coffee, a Shanghai coffee chain backed by internet giant ByteDance, is mulling an IPO in Hong Kong as soon as next year, Bloomberg has reported, citing people familiar with the matter.

It also remains to be seen whether Luckin, whose online ordering and take-out only concepts contrast with Starbucks’ more high-end lounge format, can continue to grow its customer base as other chains and even convenience stores roll out similar coffee-on-the-go offerings. Even Starbucks has joined the coffee-on-the-go act with its own “Starbucks Now” concept developed for the China market.

Luckin said its average monthly transacting customers in the first half of the year stood at 10.5 million, up 35.1% on the same period a year ago, even as its store count grew at a much slower 3.3% in the second quarter to 5,259. As part of its turnaround story, the company is doing more business through franchised stores, which now make up nearly a quarter of its total.

Luckin’s latest figures compare with Starbucks’ 5,360 stores in China in the U.S. giant’s latest fiscal quarter through Oct. 3, according to its latest results announced on Thursday.

Luckin’s ability to successfully rewrite its story will depend on whether it can win back investors’ trust given its dodgy past. Pink sheet shares are more lightly regulated than their mainboard peers, and are also typically more lightly traded, posing a challenge for investors who want to trade in big volumes.

Yong Rong (HK) Asset Management Ltd. recently bought into Luckin and is now the company’s biggest institutional shareholder, data shows. Principal shareholders include Beijing-based investors Centurium Capital and Joy Capital.

Given the current tepid enthusiasm for Chinese stocks due to regulatory worries in China and greater scrutiny of U.S.-listed Chinese firms, Luckin might be better suited to a listing in Asia once it gets its house back in order and is ready to serve itself up again to big investors.

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