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Luckin Coffee alleged fraud prompts plummeting share price

Claims that financial statements vastly exaggerated sales and profits

Luckin Coffee has been in the spotlight since the company revealed in an SEC filing that it has carried out an internal investigation into an alleged USD310 million fraud on the part of its former chief operating officer. The news resulted in its stock price falling by over 80% on April 2.

The company’s sales and expenses are believed by the board to be inflated. The company is known for its spectacular growth and its losses. In 2018, a revenue of USD125 mln and USD475 mln were reported. Investors have been told that the recent financial statements are now believed to be unreliable.

Luckin Coffee was founded in 2017 and launched an IPO in May 2019 with a USD650.8 million offering on Nasdaq. The news of the fraud came after two new independent directors were appointed. The company had over 4,500 stores by the end of 2019.

On January 31, 2020, Muddy Waters published a report to reveal Luckin’s fabricated revenue, showing Q3 and Q4 sales inflated by 69% and 88%, respectively.

It is reported that Luckin’s China operations were continuing as normal. China’s securities watchdog has said it will investigate the company.

Analysis

There are several questions being discussed in Chinese media. The motivation of the fraud and participants should be looked into. Would the former COO solely responsible for it? Is it a possible collective managerial act? The potential low level of penalty may have attracted some opportunists to take the risk.

IEG Vu understands that to get listed in a foreign stock exchange continues to be seen as being “international or even global” and equates to a “glorious crown”. In return, the listed company will have a chance to use this foreign publicity to generate more publicity at home, seemingly leveraging foreign endorsement to boost domestic sales and positive reputation.

However, this refers to the initial concept of some Chinese companies but by no means all.

There are concerns about the emergence of the ‘geek economy’ and the related ‘money burning projects’ in China over the past few years. It means that some business models are created and have captured investors’ imagination/dreams by using flowery words but nothing solid in the project. That said, there is no true value or breakthrough innovation in the business itself.

Additionally, selling China’s growth potential and selling a China dream is a good story and some international investors would love to listen. Indeed, many Chinese companies have emerged and have become strong international players by generating ample funds and publicity in overseas stock exchanges over the past 15 years.

Some Chinese sources are concerned about the negative impact as to once again Chinese companies’ credibility and integrity are affected, at a time when some medical supplies are reported to be fake or substandard.

Finally, there is the effect on Louis Dreyfus, which recently agreed a joint venture with Luckin.

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