I am fascinated about studies on how big companies fail, I guess it’s from the years of working as a credit/financial analyst. I especially like the most recent ones that are supposed to involve technology startups that, when you really think about it, are not really technology startups. Although it seems to have started its recovery, Luckin Coffee’s saga in my opinion falls under this bucket.
Theranos, which falls more under Healthcare, was treated by both its founder and investors as a technology startup. WeWork, a co-working space provider, was treated by both its founder and investors (or in this case, investor) as a technology startup. Luckin Coffee (which is still alive by the way and legally have not confirmed that they did indeed commit what was being alleged of them), to be fair, used technology as part of its operating model. However, at its core, it operates and competes in the same market as Starbucks and other second wave coffee players.
As I understand, Luckin Coffee required customers to download their app and that’s where all transactions were made. It was often called “China’s Starbucks” since it had more physical stores in the country than the Mermaid, but most of these stores were solely for the making and pickup of the online orders. Its technology driven sales, yes, but it really was just expediting point of sale. Obviously, I haven’t tried the app but I assume there is an option to load money in it for even faster transactions (a wallet feature). Ideally, that would prove advantageous for the company since they have money available for them to use which their customers are not yet needing to use – money they can use for their operations and innovation.
As most tech startups, Luckin Coffee had to burn through a lot of cash for their operations. See, these companies are not profitable in the beginning (and maybe even years after inception) thus the pressure to go public. This is so that they can tap into more liquidity by selling stock relatively easily, which is more beneficial than continuing to take on loans. To be able to keep doing this, they must entice current and potential shareholders by showing what the benefits of investing in them are. Part of this is estimating how much they will earn in a certain period (for US listed companies, this is often quarterly) and when they hit or even exceed that target, it shows that they are a worthy company to invest on and the stock price rises. This was hard in the case of Luckin Coffee since they had to rely on marketing and discounts to entice customers to buy their products over the more established and traditional chains. For a time, however, it seemed that they were able to be profitable simply by the volume of their sales – all until the veil was lifted.
Luckin Coffee allegedly overstated their revenues and expenses and materially sometime in 2019 (SEC), actions that fall under the definition of fraud. It was estimated that Luckin Coffee overstated their revenue by 28% in the period ending 06/30/19 and by 48% in the period ending 09/30/19. However, there was an anonymous report cited by Hedge Fund Muddy Waters where it was alleged that revenues were overstated by 69% in 3Q19 and 88% 4Q19 (Nikkei Asia). This report further alleged that non-coffee products were overstated by 400% and that net loss at a store level was 28% instead of what was seen as them being profitable. In reality, it seemed that Luckin Coffee had to raise its prices to cover their expensese however that would eliminate one of the advantages they had on their rivals – low prices. During these periods, Luckin Coffee was able to raise significant capital through loans and equity based on the alleged falsified numbers.
Luckin Coffee was fined (and paid) $180 Million in December 2020 and it filed for Chapter 15 Bankruptcy protection in February 2021 and has since been restructuring. In April 2021, Luckin Coffee received ~$250 Million in funding from two investors. These investors, however, seem to have connections with former individuals related with Luckin Coffee. This was hinted at the end of the article by Nikkei Asia, that somehow the ousting of key personnel was orchestrated to ensure control of the company that may eventually emerge from Bankruptcy as Private (or maybe not).
Being skeptical may turn most people off, but in some instances (especially in finance) it can prove useful. Had a lot more raised questions about how Luckin Coffee was able to report these numbers after looking at how hard it could have been achieved, then it couldn’t have been such a notorious incident (same goes for the aforementioned Theranos and WeWork incidents). Booming returns seem enticing, but it seldom really is that simple. Don’t let social media flexing alone entice you from dropping a ton of cash into something. Be skeptical.
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Categories: serious Kape