Investors in China's Luckin Coffee (LKNC.Y -0.64%) have had to deal with a lot of surprises this year. Revelations of fraudulent accounting practices led to a long suspension in trading of the shares on the Nasdaq exchange. Top executives were ousted from the coffee store chain's C-suite. And finally, Luckin shareholders got what many had considered to be the final straw: notice that the stock would get delisted from the Nasdaq.
After all those things happened, many expected that the stock would simply disappear on what they saw as an inevitable path toward zero. Yet after more than a week of trading on the over-the-counter market, Luckin has defied those bearish calls. Instead, the stock has more than doubled. Here are some of the reasons why.
Image source: Luckin Coffee.
1. Trading hasn't dried up
For many stocks, getting delisted from a major exchange means accepting an alternative for trading that has far less liquidity. That makes it difficult for institutional traders to get good executions when they want to buy and sell stocks, and it typically forces individual investors to deal with wide bid-ask spreads that are costly for frequent traders.
That hasn't happened with Luckin. Even over the counter, trading volume has remained above 10 million shares per day. For those looking to trade shares, bid-ask spreads remain at a reasonable $0.01. For those looking to speculate on the company's future, the only thing that's changed is the ticker symbol.
2. Investors expect that Luckin will try to go private
Chinese stocks have struggled for a while, and many investors believe that their poor performance has left them undervalued and underappreciated. For companies that are frustrated about what they see as unwarranted low share prices, the natural choice is to make an offer for a buyout. Even paying a sizable premium, going private can give insider buyers a bargain as well as all the advantages of not being publicly traded. The fact that U.S. lawmakers have started to scrutinize Chinese companies with stock listings in the U.S. is also an incentive to go private.
Earlier this month, Chinese internet company SINA (SINA) announced that it would look to go private. The buyout offer came from CEO Charles Chao through a controlled entity, with the $2.7 billion price representing a 12% premium to where the stock was previously trading.
Critics have noted that several Chinese companies have made similarly cheap buyout offers to go private. Then, they've turned around and quickly done IPOs within China or Hong Kong at much higher valuations. That's bad news for long-term investors in those stocks. However, for those looking for a quick profit, paying $1.50 per share for Luckin stock when it got delisted in the hopes of getting somewhat more in a going-private deal could turn out to be a profitable short-term trade.
3. Shareholders hope new management could help Luckin recover
Lastly, those watching Luckin have seen a huge shakeup across the company's entire management. The company fired CEO Jenny Qian and COO Jian Liu in May. Just this past weekend, Luckin founder and board chair Charles Lu left the board of directors along with three other members. At first glance, it might seem like Luckin has hit the reset button and can now make a go at restoring its business. That confusion has some shareholders optimistic about the coffee chain's promise, and they're willing to gamble that the stock could regain at least part of the 95% it lost.
Unfortunately, there's still a lot of controversy involved. Even though Lu left the Luckin board, he played a key role in naming the directors who replaced him and his colleagues. If Lu is in control, then it could hamper a recovery rather than facilitating it. Nevertheless, there's a lot of uncertainty and a lack of transparency with what's going on in Luckin's boardroom.
Dangerous speculation
Most troubling is the fact that shareholders still don't have any real answers about Luckin's fraudulent accounting and the current state of the actual coffee business. Until we know that, it'll be impossible to feel confident about whether the rise in Luckin's share price is justified. For now, stock market investors seem willing to take the bet that a company that once looked promising might return to its former glory -- even if the odds are long that things will turn out well.
