The outlook for Luckin Coffee (LKNC.Y 3.60%) seems to be improving after the company announced a restructuring plan for it's financial obligations with some of its creditors that could help it climb out of bankruptcy. Let's dig deeper to find out what this deal could mean for equity investors.
Details of the restructuring
In February, Luckin Coffee filed for Chapter 15 bankruptcy protection, a section of the U.S bankruptcy code that deals with foreign companies. This move allows Luckin to shield its assets through negotiations with creditors while management works to keep the operational momentum going on.
Now, the company is making impressive progress toward fulfilling its objectives.
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On March 16, Luckin announced an agreement with key creditors to restructure 59% of its $460 million in convertible notes due 2025. These bondholders will recover roughly 91% to 96% of par value through cash, new debt, and Luckin Coffee shares.
According to Luckin's press release, cash recovery will represent 32% of par value, or principal amount of the debt, which could be around $87 million in total. The debt is in the form of one-year notes (23% of par) and five-year notes (30% of par). Both pay interest rates of 9%. But the one-year notes will give bondholders the option to convert a portion of their value for shares in the event of a future capital raise.
What does this mean for stockholders?
Luckin's restructuring plan looks like good news for shareholders. If it is approved, the deal could significantly reduce Luckin's debt and the possibility of insolvency -- especially if coupled with management's plans to raise at least $250 million in new equity funding.
The downside is dilution, which reduces shareholders' claims on future earnings. But Luckin may not need to raise additional capital. Recent filings suggest the company's balance sheet is already in good shape.
According to Luckin's liquidator's report in the Cayman Islands, the company boasts $743 million in cash and equivalents as of November 2020, which is significantly more than its total debt of $460 million. Fines, such as the recent $180 million penalty to settle fraud charges with the SEC, could hurt liquidity. But management expects to be cash-flow positive by the first half of 2023, so there seems to be light at the end of the tunnel.
Is the stock a buy?
Luckin Coffee is turning itself around by closing underperforming stores, strengthening its store-opening criteria, and optimizing cost control. It is also rapidly growing, with net revenue growing 18%, 50%, and 36%, on a year over year basis, for the first three quarters of 2020, respectively. The series of quarterly revenue growth is further evidence that management is working to put the past behind it.
But while I'm cautiously optimistic about Luckin's future, the stock is still risky. The new agreement must be approved by the Cayman court and enforced in the United States before it can go into effect. And high levels of equity dilution could also be a problem for equity holders. However, should Luckin mange to come out of bankruptcy on favorable terms, it should act as a huge tailwind for its stock.
