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Luckin Coffee Is Not 'Too Cheap'

    • 1871 posts
    June 1, 2020 1:43 PM AEST

    There are investors out there who believe Luckin Coffee (LK) is too cheap, even considering the extraordinary circumstances surrounding the business. I sympathize with those investors — but I don't agree with them.To get more news about luckin coffee news, you can visit shine news official website.

    On paper, I can see a bull case. Luckin raised some $865 million in cash in January. At Thursday's close of $2.06, it has a market capitalization of $650 million. We don't have anything close to updated numbers, as Luckin still hasn't released fourth quarter 2019 results. But given disclosed balance sheet as of the end of Q3, as reported the company's cash, even net of debt, exceeds the current market capitalization.

    Meanwhile, there is a business of some kind here. Luckin has admitted to a staggering amount of fabricated revenue. RMB2.2 billion in sales were made up, which is nearly half of total sales for the last three quarters of 2019 (including the midpoint of Q4 guidance). But the company's 4,000-plus locations still exist. So do millions of customers. And, presumably, Luckin can change tack after undertaking what literally might be the most aggressive growth plan in history. (Luckin went from zero stores to 4,507 locations in about 26 months.)

    But the bull case seems far too simplistic. The balance sheet probably is in good shape, but at this point investors can't take any of Luckin's numbers purely at face value. That obvious issue aside, there's a very real concern as to whether the business model makes any sense — or can ever drive any profit. And it seems foolhardy, to say the least, to expect the company to pivot toward profitability after executing a massive and widespread fraud in a bid for growth.

    To be sure, LK stock may catch a bid. I'm sure traders will have fun with the name, as they already have. (The stock has moved an average of 32% in six sessions since a six-week trading halt came to an end.) I'd expect volatile yet sideways trading to hold for at least the near future. But, as a long-term investment, it's incredibly difficult to make a reasonable, rational, case for LK stock, even 95% below the highs.
    In its third quarter report in November, Luckin reported that it closed the quarter with $775.6 million in cash. In January, it announced it had received total net proceeds of $865 million combined via a secondary offering (at $42 per ADS) and issuance of convertible debt.

    There has been some cash burned along the way, however. The company reported free cash flow of negative 477 million RMB (~$67 million at current exchange rates) in Q3. Assume that rate held for the three following quarters through June 30th and Luckin would finish the second quarter of 2020 with something like $1.44 billion in cash. Debt was minimal at September 30 — about $33 million — and the convertible bond issue totaled $460 million.

    In other words, Luckin could have close to $1 billion in net cash coming out of this year's Q2 — a sum roughly 50% greater than its market capitalization. That's an interesting point in favor of the bull case, or at least the "this is not a short to zero" argument.

    Of course, that math may vastly oversimplify the situation. The obvious retort is that Luckin's cash balance (and cash flow) may be as fabricated as its revenue. In disclosing inflated sales, Luckin also said that "certain costs and expenses were also substantially inflated by fabricated transactions". There's not much reason why the fraudulent revenue and the inflated costs have to exactly net out. Free cash flow could have been much worse than -$67 million in Q3 — which means elevated burn in the eight months since the end of that quarter.

    That said, there's likely still a significant amount of cash on the balance sheet. First, consider the source of the cash: equity and debt offerings (along with a private placement concurrent with the IPO last May) with total proceeds of $1.5 billion. Whatever an investor thinks about the role of Credit Suisse (CS) and Morgan Stanley (MS) in January's secondary offering, it's unlikely those firms wired the offering proceeds to the personal account of a Luckin executive or some shell company in the Cayman Islands. (A shell company besides Luckin, of course, which is incorporated in the Caymans.) I'd assume the cash from these heavily-publicized, widely-bought offerings actually reached Luckin's corporate coffers.

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