Shares of Luckin Coffee (LKNC.Y 3.29%) fell on Monday on an otherwise positive day for the markets as the scandal-ridden Chinese coffee company received another lump of bad news: Chairman Lu Zhengyao will reportedly now face criminal charges in China after authorities apparently discovered emails from Zhengyao instructing employees to commit fraud.
Luckin had rocked the investing world back on April 2, when it launched an internal investigation into its own accounting practices. That eventually led to the admission that the company had fabricated as much as 40% of its sales. The scandal led to the resignation of the company's COO, Liu Jian, and subsequent findings then led to the firing of CEO Qian Zhiya. Zhengyao had initially stayed on as chairman, but it seems likely now that Zhengyao won't be there to oversee a potential turnaround, either. That poses the question, "Who is running Luckin at this point?"
A larger-than-life figure
Luckin's alleged fraud emanating from the top isn't surprising when one considers Lu Zhengyao's history. Zhengyao is an entrepreneur with a background in various auto-related businesses, including Car Inc. (699), a car rental service that went public in Hong Kong in 2014, then Ucar, a ride-hailing company that employs its own in-house drivers, which went public on China's local exchange in 2016.
In each case, Lu started with a concept and moved as fast as possible to offer discounts and grab up market share, even at the expense of big losses, using top-line growth to raise even more money and grow even faster. After going public, Zhengyao would then usually cash out shortly after an initial surge of enthusiasm, leaving new investors buying him out at the top. For instance, after Car Inc. surged about a year after going public, Lu and other investors then cashed out a collective 42% stake for $1.6 billion.
When he did venture into coffee by backing former Ucar employees to start Luckin, the playbook was the same: grow as fast as possible, offer discounts to get market share, then raise more money for further expansion. As the company's biggest shareholder and chairman, Zhengyao was likely calling the shots at Luckin as well. It seems highly unlikely that lower-level employees would undertake a bold sales fraud without instructions from higher-ups.
If the allegations prove true, part of Zhengyao's trademark expansion strategy might have entailed inflating sales figures in order to raise money. Now, it's an open question as to whether Lu had always used that practice at his previous ventures as well. While Ucar's stock price has been on the steady decline ever since Lu conveniently cashed out much of his stake back in 2015, as revenue growth stagnated and earnings have declined, the stock plummeted to a newer low after the Luckin scandal broke. Ucar's shares are now trading around 2.00 Hong Kong dollars, more than 75% below their 2014 IPO price of HK$8.5.
Where this leaves Luckin
Now without a CEO, a COO, or a chairman, it's unclear exactly who is running Luckin day to day. That's usually not a great aspect of a business in which to be invested. The question on many investors' minds is whether the stock has fallen so far that it's cheap enough to buy.
That's a dubious question, considering investors have only received financial information as of last Sept. 30, and we now know at least the company's income statement was inaccurate. Yet looking at the balance sheet, Luckin had about $775.6 million in cash and securities as of last September. The company then raised $418.3 million in American Depository Shares (ADS) and another $446 million in convertible notes in January. Therefore, all of these offerings add up to about $1.64 billion in cash against the $446 million in convertible debt, which will likely need to be paid back, since it's highly unlikely the notes will convert. That leaves net cash of around $1.2 billion, which is slightly less than Luckin's market capitalization today.
However, that $1.2 billion figure doesn't incorporate any cash lost in operations over the past two quarters. Per the company's last financial statements, Luckin burned $17.2 million in operating cash in the quarter ended in September and $157.5 million in operating cash over the nine months ended in September. However, that's just operating cash losses, which doesn't account for capital expenditures to open new restaurants, which the company doesn't specify in its financial statements. That capex number is likely significant given the company's previous breakneck pace of new restaurant openings.
Thus, it's quite possible the company has burned lots of cash over the last eight months, especially since the coronavirus outbreak caused China to go on a severe lockdown from mid-January to mid-March. I'd bet Luckin's net cash is likely below $1 billion today, and perhaps significantly so.
Still too risky for my taste
While Luckin's stock has made some massive moves to the upside in recent days off its lows, the company's financials and net cash position are still a mystery. Now, without a COO or CEO and with the company's chairman and lead shareholder likely leaving to face criminal charges in China, Luckin's stock is far, far too risky for any responsible investor.
While it's entirely possible that a new team can come in and revive the company, giving Luckin the potential for big upside, it's also a decent bet that the stock could head much lower from here, especially after its bounce off the late-May lows. At this point, investing in Luckin is thus only appropriate for the most speculative investors who are willing to lose all of their principal.