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Luckin's Chairman Is Pulling Out All the Stops to Retain Control and Avoid Scrutiny

By Billy Duberstein – Jun 21, 2020 at 11:20AM

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The company will host an extraordinary meeting of shareholders soon to determine the fate of its founder and Chairman. But get this -- he wants to be ousted!

According to The Wall Street Journal, beleaguered Chinese coffee chain Luckin Coffee (LKNC.Y -0.37%) will hold an extraordinary meeting of shareholders on July 5, which apparently is designed to oust four of its directors, including controversial Chairman Lu Zhengyao ("Charles Lu"), while also electing two new independent directors.

Along with Lu, shareholders will also decide whether or not to oust three other directors, including early investors David Li and Erhai Liu, along with independent director Sean Shao, who was leading the internal investigation into Luckin's recent accounting improprieties.

However, one should keep in mind that it is Charles Lu himself who apparently called this meeting, in order to oust himself!

Why would that be? Because the new meeting apparently isn't meant to kick out the old, maligned leaders and bring in new blood to help take control of the company. Instead, the "ousting" of Charles Lu appears to be a scheme to keep control of the company through proxies, all while shielding himself from scrutiny for his role in the accounting fraud that came to light on April 2.

A surprised woman's eyes go wide while reading the paper and drinking a cup of coffee.

Luckin's saga takes a Machiavellian new turn. Image source: Getty Images.

Two new "independent" directors

Though the July 5 meeting was apparently called with the express purpose of ousting Charles Lu, the meeting was actually called by Haode Investments, which itself is an investment entity controlled by Lu that holds some of his Luckin shares. In addition, the two new "independent" director nominees, Ying Zeng and Jie Yang, a lawyer and vice dean of China University's business school, respectively, were nominated by -- you guessed it -- Haode investments.

While it's not exactly clear what the exact motives are here, from this outside observer, this appears to be maneuver that would allow Lu to keep control of the company via these two proxies on the board, all while keeping Lu at an "official" distance from the company, which may allow him to evade further scrutiny for his role behind Luckin's alleged fraud. Recently, it was reported that Chinese authorities were launching a criminal investigation into Lu's dealings in Luckin, after emails were uncovered that apparently revealed his instructing employees to commit fraud.

It's perhaps not a coincidence, then, that according to the Journal, Lu has apparently "not complied with requests by the special committee to interview him and gain access to his phone and laptop," according to people familiar with the matter. And who was heading that special internal committee to investigate the wrongdoing? Sean Shao, who is on the list of directors to be ousted in the July 5 meeting. Could these shenanigans be what led to the abrupt resignation of another independent director, Tianruo Pu, just on Friday? Pu said that the resignation was for "personal reasons" in the official press release.

Cloud Lu pull it off?

As of March 31, Lu owned about 36.8% of the voting power in Luckin through his holding of super voting Class B shares.  However, Lu may soon see his voting power diminish, as a consortium of banks are now in the process of seizing Lu's shares held in investment companies in the Cayman Islands, against which Lu borrowed about $324 million in loans.

According to the Journal, a Cayman Islands court just ordered that 131.25 million Class B shares worth about $63 million be liquidated. The shares are held by Primus Investments, another investment entity of Lu's which held about a quarter of his Class B shares. The consortium of bank lenders have also filed a winding-up petition against Haode Investments, which holds more shares and was the entity that called the special meeting.

Thus, it seems as if Lu is hurrying to force an outcome through the impromptu July 5 meeting before banks to which he owes a margin loan liquidate more of his holdings and reduces his voting power even more.

Get out the popcorn -- don't touch the stock

The saga of Luckin Coffee is certainly entertaining -- from the sidelines. With no recent financials published and a delisting imminent, investing in Luckin is pure speculation at this point. Add in the fact that there appears to be a power struggle going on at the top, and the picture gets even murkier.

If Lu is eventually brought up on criminal charges and forced to leave the company and liquidate his holdings, investors will be left with a company without a leader -- after all, Luckin's prior COO and CEO have been fired or resigned, so it's unclear who might run the company in the aftermath. If they survive the July 5 meeting, perhaps early investors David Li and Erhai Liu could appoint someone.

On the other hand, if Lu is able to pull off his maneuver, he won't technically be running the company, yet one would have to wonder if Lu would still be pulling the strings through his two board nominees. If that's the case, then it would be hard for investors to keep their trust in management or the company's financials going forward, given that the same leader that oversaw the initial fraud would effectively be pulling the strings.

Thus, the whole affair seems like a lose/lose for Luckin shareholders for the foreseeable future, until the leadership, financial, and legal pictures are all sorted out.

Billy Duberstein has no position in any of the stocks mentioned. His clients may own shares of the companies mentioned. The Motley Fool owns shares of and recommends Luckin Coffee Inc. The Motley Fool has a disclosure policy.

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