Shares of Luckin Coffee (OTC:LKNC.Y) surged in their market debut Friday, opening at $25 a share, 47% higher than the initial public offering price. As of 1:10 p.m. EDT, those gains had moderated to 24%.
The fast-growing challenger to Starbucks (NASDAQ:SBUX) in China priced its IPO at $17 on Thursday, at the high end of its previously announced range of $15 to $17. Coming during a week when the U.S.-China trade war has escalated again, the stock's spike shows investors are still enthusiastic about Chinese growth stocks.
Just 18 months old, the start-up is one of the fastest companies ever to reach a $6 billion valuation. Luckin raised $561 million in the IPO.
Founded by Jenny Qian Zhiya, a co-founder of the Chinese ridesharing service UCAR, Luckin takes a tech-driven approach to the Chinese coffee market, focusing on its app and on convenient pickup and delivery. The company is specifically not following Starbucks' approach to the Chinese market -- that company sees its stores as a "third place" away from home or work where customers can relax, meet with friends, or take a date. Among Luckin's stores, 91% are pickup locations; they have limited seating, and are designed to support delivery services and to-go orders.
The company has blanketed China with new openings in a blitz rarely seen in the retail or restaurant industries. As of March 31, the company had 2,370 stores in 28 cities across China, and plans to add 2,500 more locations this year. If it reaches its goal, Luckin would be larger than Starbucks in China by store count. (Starbucks currently has approximately 3,900 stores in China, and plans to add about 375 by the end of the calendar year.)
A huge opportunity
Luckin's price surge on its opening day suggests there is investor optimism for the opportunity in the Chinese coffee market. But the company is burning cash quickly as it rapidly expands. In its most recent quarter, Luckin posted revenue of $71.3 million and a net loss of $82.2 million. In 2018, the company brought in revenue of $125.3 million but lost $241.2 million. With a market cap of $6 billion at its opening price, the company trades at a price-to-sales ratio of more than 30, based on its last four quarters. However, revenue is on track to grow by more than 150% this year.
Luckin expects to capture the market opportunity not just by ramping up its store count, but also by convincing the Chinese to drink more coffee, which it expects to happen as the country rapidly urbanizes and its middle class expands (along with discretionary income). In its prospectus, the company said that per capita coffee consumption for mainland China, still a largely tea-drinking nation, is minuscule at just 6.2 cups a year; compare that to per capita figures of 209 in Taiwan, 249 in Hong Kong, 279 in Japan, and 388 in the U.S. Luckin pointed out that per capita coffee consumption tripled in Japan from 1963 to 1970 as that country urbanized. It expects a similar evolution in China.
The Chinese start-up isn't the only one that spies opportunity in China. Starbucks has repeatedly touted the country as its most important growth market, and former CEO Howard Schultz has said that he believes China will one day become the company's biggest market, ahead of the U.S.
Costa Coffee, the British chain acquired by Coca-Cola last year, is also focused on expansion in China, where it hopes to have 1,200 locations by 2022.
Starbucks has taken note of Luckin's challenge. Last year, the coffee giant forged a partnership with Alibaba to provide delivery from more than 2,000 Starbucks stores in China, and to open delivery kitchens (which just fulfill delivery orders) inside existing Hema supermarkets, essentially copying a Luckin strategy.
After Luckin's splashy IPO, the competition for the Chinese coffee consumer may just be starting to heat up. The Chinese interloper is now flush with $561 million in cash and has boundless expansion ambitions. For investors looking to cash in on the Chinese coffee opportunity, Luckin gives them a pure-play option to bet on. But with its valuation and losses, it carries significantly more risk than Starbucks does.