Luckin Investors Get the Caffeine Headache They Paid For

(Bloomberg Opinion) -- Take a look at the share price chart of Luckin Coffee Inc. and it’s clear that investors drank too much of the company’s brew. Now they’re suffering a massive headache, and the board’s response is to throw a couple of top executives under the bus.

Going decaf won’t solve the wider problem. Investors in Chinese internet stocks are addicted to the rush that comes from placing money at any outfit with a mobile app in the belief that the nation’s population of 1.4 billion guarantees rich returns.

They need to look a lot more closely. Six weeks ago, Luckin told investors that the company fabricated sales last year of as much 2.2 billion yuan ($310 million).  Luckin announced Tuesday night that the chief executive and chief operating officers had been fired. They also resigned their seats on the board. 

Clearly, Luckin’s directors — whose job is to oversee and regulate the actions of the executives — have found their patsies, and hope that investors won’t take out anger on the rest of the board. In case that happens, though, they did manage to purchase directors and officers liability insurance ahead of last May’s initial public offering.

Founder Charles Lu remains Luckin’s chairman. He’s also a co-founder of rental company Car Inc. and controls its affiliate UCAR Inc. Three years ago, we suggested that investors look under the hood of this pair of Chinese companies, with particular attention to how they book non-operating and net profit.

Luckin was the perfect stock for returns-hungry foreign investors desperate to tap into China’s twin growth stories: consumer and tech. The Xiamen-based company was serving up coffee to a nation converting from tea, and doing so with a sophisticated technology infrastructure. It was billed as Starbucks meets Uber, two big names that any American fund manager could relate to. Its Nasdaq-traded depository receipts tripled from their $17 IPO price to as much as $50 in mid-January. 

The revelation of accounting irregularities, announced by the company April 2, brought the stock crashing down to $4.39 and a trading halt. The China Banking and Insurance Regulatory Commission weighed in, with Vice Chairman Cao Yu telling reporters, as reported by Yicai Global, that Luckin’s actions were wrong, and that the regulator will cooperate with relevant departments to punish any illegal conduct.

This may not be China’s Enron moment, but investors would be naive to think Luckin is an outlier. They should be be aware that with mountains of cash available in the U.S., other companies have ample incentive to primp numbers and tailor prospectuses with fabulous tales of growth, consumer demand and technology.

This is the kind of brew that the gullible have been drinking to the last drop. And when one rush fades, the immediate response is to top it up with another. The only cure is to break the addiction entirely.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Tim Culpan is a Bloomberg Opinion columnist covering technology. He previously covered technology for Bloomberg News.

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