China’s Luckin Coffee, Starbucks’ Chinese rival, has been in the news lately for all the wrong reasons. After a skyrocket rise on the stock exchange, the NASDAQ- listed company has hit the rock bottom due to potential allegations of fabricated financial figures. Its fortunes tanked as the share price of the once high-flying stock plummeted from a peak value of $50 to $4.39. Following this, the chain delisted its stock from the stock exchange and fired top C-suite executives including Chief Executive Jenny Zhia Qian and Chief Operating Officer Liu Jian. The events of this scandal reveal an interesting tale about fraudulent malpractices adopted by firms and dashed investor ambitions.
Background
Luckin Coffee Inc. is a Chinese coffee company and coffee chain, founded in Beijing in 2017. The enterprise adopted an aggressive growth strategy to dethrone its competitors and capture a dominant market share, enticing customers with its app-based purchasing model combined with a convenient takeaway and delivery options and freebies such as generous discount coupons. Gradually, the chain overtook the Chinese coffee market leader Starbucks, in terms of the number of outlets and consumer traffic. Seeing massive growth trends, investor expectations for the company were high and analysts touted that Luckin had the potential to go global.
A well-established supply chain network, domination over the coffee market and strong company financials made Luckin coffee a profitable prospect for financiers across the globe. Subsequently, Luckin raised a massive $561 million in its initial public offering (IPO), despite US-China trade tensions, in less than two years. The coffee chain planned to use the IPO proceeds for customer acquisition, store network expansion, advertising and research and development.
Trading under the stock name LK, the enterprise sold 33 million American Depositary Shares (ADS), as compared to the anticipated 30 million, at a share price of $17. The IPO was seen as Luckin’s primary step towards tapping international financial markets to bolster coffers.
Financial Fraud
Beginning January 2020, a short-selling firm Muddy Waters published a research report, questioning the accounting strategies of Luckin coffee and claiming that the business had falsified its financial and operational figures. The document raised dubiety on the correctness and transparency adopted in the preparation of financial statements. Amidst strict guard, the firm was accused of inflating the sales figure by 77 per cent on an average, in the last two quarters of 2019. Luckin coffee countered the report and declared that these malicious allegations without substantial evidence were levied to hamper the repute and performance of the company.
On April 2, 2020, the results of an internal audit revealed that a couple of the key executives of the company forged 2.12 billion yuan and 2.2 billion yuan (approximately $3 billion) of sales and revenues respectively, in 2019, which in turn erased more than $11 billion of its market value within three months. The accounting fraud prompted the China Securities Regulatory Commission (CSRC) to launch an investigation into the matter. It corroborated the report findings and promised to take punitive actions against the defaulters, stressing the need to defend fair competition, uphold market ethics and protect consumers. In the meanwhile, the U.S. stock market halted the trading of all Luckin shares over the default probe. In lieu of misconduct and flouting business ethics, key officials of the company were sacked and the company received a delisting notice from the NASDAQ, barely 14 months after its debut on the exchange. Following this, the Chinese Ministry of Finance launched a deeper investigation into the operations of Luckin and 23 other associated companies, to disclose any potential malpractices or deceit.
The Aftermath
The scandal created ripples across the world, especially for American investors who baulked at the unregulated and guarded financial operations of the firm. The incident highlighted the dire need for consumer protection and the availability of accurate data statistics using impartial regulators, for investors to make informed choices. The mere unmonitored inflation of numbers on the financial statements by a rapidly growing enterprise on the largest stock exchange of the world is a cause of worry and tension.
Amid the rising tide of straining political and trade ties between China and the U.S, the latter’s Senate passed a bill in May that could significantly prohibit the listing of certain Chinese companies on the U.S. stock exchange, or raising capital from American investors. Among other clauses, these companies would be subject to audits by U.S. regulators, once every three years. If any form of non-compliance is recorded on the part of these firms, they will be barred from listing themselves on the stock market. This tightened scrutiny of Chinese companies by Washington provoked a broader spat between the world’s two largest economies, exacerbating the already existing feud.
Luckin Coffee is now undergoing corporate and operational restructuring. Beginning with changes in the boardroom, the company is striving to improve and expand both its functioning and its repute. Luckin is still operating in China, via its 4000 plus outlets, albeit under the global scanner this time.
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