Luckin, China’s Starbucks Rival, Plunges on Accounting Probe

(Bloomberg) -- Luckin Coffee Inc., the fast-growing Chinese coffee chain, plunged as much as 81% on Thursday after the company said its board is investigating reports that senior executives and employees fabricated transactions.

The company’s announcement that Chief Operating Officer Jian Liu and employees reporting to him engaged in misconduct casts doubt on the foundations of the Chinese coffee chain’s meteoric rise and its emergence as a key competitor to Starbucks Corp.

The chain is aiming to reach 10,000 locations by the end of 2021 -- a goal that may now be unattainable. Thursday’s share decline erased what had been a 54% gain since the company went public last year.

Liu and others have been suspended and investors shouldn’t rely on previous financial statements for the nine months ended Sept. 30, the company said. The transactions in question occurred last year and totaled about 2.2 billion yuan ($310 million), according to the filing.

Keybanc Capital Markets analyst Eric Gonzalez said that earnings visibility may be limited “for the foreseeable future.” In a note to clients, he added “it will take several years for management to repair its credibility.”

If true, the fabricated sales figure could represent a significant portion of the company’s total revenue. Luckin, which has only reported financial data for the second and third quarter of last year after its May public offering, was seen reporting 5.15 billion yuan of revenue for the full year, according to the average of estimates compiled by Bloomberg.

‘Substantially Inflated’

“Certain costs and expenses were also substantially inflated by fabricated transactions during this period,” Luckin said, while noting the special board committee investigating the matter hasn’t independently verified the fabricated sales figure.

The coffee chain, founded in 2017, operated about 4,500 stores by the end of 2019 in China. Chairman Lu Zhengyao and Chief Executive Officer Qian Zhiya have employed a strategy they used with CAR Inc. -- a vehicle rental business -- more than a decade ago: burning money from investors to quickly grab market share from rivals. That strategy has been successful in winning over investors.

Trouble emerged earlier this year, however. The shares plunged after Muddy Waters tweeted on Jan. 31 that it had a short on the stock after receiving what it called a “credible” unattributed 89-page report that alleged accounting issues with the chain and a broken business model. Luckin Coffee denied the allegations.

The Xiamen, China-based company raised $778 million from a share sale and a convertible bond offering in early January, according to people with knowledge of the matter. The company also raised $645 million in its U.S. IPO.

Despite the allegations and mandatory closures related to the outbreak of coronavirus, analysts have largely remained optimistic about Luckin. Prior to Thursday’s disclosure, six had a buy recommendation on the stock, compared to one hold and zero sell recommendations.

Breaking Even

In November, Luckin reported revenue that was six times the year-earlier total. The company, which has reported losses as it engages in a strategy that prioritizes rapid growth, said it was on track to start breaking even at the corporate level in the third quarter of this year.

China is becoming an important market for coffee retailers as the traditionally tea-drinking nation develops a taste for java. With its growth potential, it’s been identified by Starbucks as one of the company’s two key markets, along with the U.S. But Luckin had Starbucks’ expansion there clearly in its sights.

“We expect to take over Starbucks as the No. 1 coffee player in China by the end of this year in number of stores,” Chief Financial Officer Reinout Schakel said at the time. “We have a very strong brand.”

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