China’s Luckin Coffee shares plunge 80% after false sales report

Luckin Coffee
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Luckin Coffee announced that shares fell by more than 80% after an internal investigation disclosed sales falsification.

According to Luckin Coffee, a company probe revealed that its chief operating officer fabricated their 2019 sales by about 2.2 billion yuan ($310 million).

The disclosure of the regulatory filing led to over 80% crash in premarket trading. Shares have been reportedly down nearly 72%, sweeping away nearly $5 billion from its market value.

Based on the investigation, Jian Liu, Luckin’s chief operating officer, and the employees he supervised, had connived to carry out a misconduct, including altering sales records. Liu and the employees involved in the impropriety have been suspended. Luckin Coffee said it will pursue legal action against those responsible.

Jian was not able to give its comment on the allegation.

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Luckin Coffee, a company built two and a half years ago and aimed to outrun Starbucks as the top coffee chain in China, told investors to not depend on its previous financial records and earnings announcements for the nine months up to September 30.

The Chinese coffee chain previously announced that its net sales for the first nine months of 2019 were 2.9 billion yuan ($413 million).

Luckin Coffee explained that its internal investigation is still at the initial stage and its assessment of the fabricated sales has not undergone verification yet by its independent auditor.

Meanwhile, the company’s special committee decided to keep Kirkland & Ellis as its independent outside counsel. FTI Consulting works with the coffee chain as an independent forensic accounting expert.

In January 2020, Muddy Waters Research said that it bet against the stock due to the fraud and a “fundamentally broken business.”

Luckin responded by calling the short seller’s report “misleading” and “false.”

“Luckin shows exactly why we need short sellers in the market. We believed this report was credible when we read it, and that’s why we took a position,” Muddy Waters founder Carson Block wrote in a statement sent to CNBC.

“This is again a wake-up call for U.S. policymakers, regulators, and investors about the extreme fraud risk China-based companies pose to our markets.”

After pricing shares at $17, the Chinese coffee company raised $561 million in its initial public offering. The stock started trading publicly on the Nasdaq in May, soaring to 18% in its launch.

Then, shares reached a record high level in January at $51.38 but slowed down when the coronavirus outbreak spread in China. The stock plunged an all-time low of $4.90 per share Thursday morning. Without Thursday’s plunge, the stock was performing 54% since its IPO.

Luckin attempted to build a customer base with smaller locations selected for convenience and offering consumer-friendly discounts. In January, the company announced it had more than 4,500 locations in China. As its response to Luckin Coffee’s rise, Starbucks has opened cafes in China that cater to quicker pick-up and delivery and less seating.

What analysts say

KeyBanc Capital Markets downgraded Luckin stock when the fake data news broke.

“Following our conversation with the Company, we believe earnings visibility will be limited for the foreseeable future and it will take management several years to repair their credibility,” analysts led by Eric Gonzalez wrote.

“Previously released financial statements and guidance can no longer be relied upon by investors, which likely calls into question the Company’s overall liquidity.”

Meanwhile, Quo Vadis described the expectations for Luckin’s performance “unrealistic.”

“The company has indicated that it ultimately expects to achieve unit level margins of 30% and to break-even at the corporate level by 3Q20,” wrote Quo Vadis in a note.

“A $9 billion market capitalization for this unproven concept with an uncertain path to profitability is unjustified in our opinion.”

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