🍟 9/12/2022 – China’s King Of Coffee

DEEP DIVE

The King Of Coffee In China 

In 2019, Luckin’ Coffee IPO’d at a $2.9 billion valuation just 16 months after being founded. But after a massive fraud scandal, their stock would tank 93% and be delisted from the NASDAQ.

Somehow…the company has survived, and is now the largest coffee brand in China. Not only are they eyeing a return to US capital markets, but they’re also franchising.

A breakdown on the full Luckin’ story..

Coffee in China

Historically, coffee is far less popular in China than America., with upwards of ~95% of caffeine typically being consumed via tea based beverages.

But ever since Starbucks entered the country in 1999, coffee has slowly grown in popularity. Today, thanks to Chinese millennials gaining exposure to western culture, the beverage is more widely consumed.

This is reflected by the fact that China is now the largest international market for Starbucks with 5400 stores, and competitors have started to pop up.

Luckin’s Origins

Luckin’ opened their first store in January 2018 in Beijing, China. It’s a quick-service coffee concept with a tech-forward approach. Stores have a sleek, upscale design, and customers can only pay via the Luckin’ app – 

By January 2019, they had 2,500 stores and raised a total of $350M from the likes of Blackrock and Point72. This set them up with a compelling story for US investors:

  • Rapid growth
  • Technology wrapped
  • Cash on the balance sheet
  • Legit competitor to Starbucks in China

They IPO’d in May 2019 on the Nasdaq at $17/share AKA a $2.9B valuation. Later that year they’d report profitability per store was increasing via 400% growth in customer traffic.

By January 2020, Luckin’ stock hit $50/share, a $9B market cap just 2 years after it first opened.

If you think this sounds too good to be true – you’re right.

Luckin’ Exposed

On January 31st 2020 – an ominous report was released by famous short-seller, Muddy Waters Capital. An unattributed source had compiled 10k+ hours of video surveillance, alleging Luckin’ was fraudulently inflating revenue to push the stock price up.

The report made waves all over the internet, forcing a response from Luckin’ management. Evenentually, an internal investigation was launched to quell the rumors. On April 2nd 2020, the results of the investigation came out:

Investigators found the CEO & COO had fabricated $310 million worth of revenue the previous year! The (simplified) overview of the scheme is this:

Luckin’ inflated the number of orders per store, and the average price per order, then offset that revenue with inflated marketing expenses. 

Before the stock market turbulence this year, revenue growth was all investors seemed to care about, hence Luckin’s incentive to inflate revenue and not profitability. 

The ramifications were as you’d expect:

  • $180 million in SEC fines
  • Delisted from the Nasdaq
  • $9M in fines to the Chinese govt
  • All executives involved were fired
  • •Stock dropped ~93% to $1.39/share!

The Aftermath 

Without getting too deep into the financial engineering that took place, the bottom line is that Luckin’ was able to restructure their debt and survive. Stores in China never closed down throughout the entire process.

Luckin’ even nabbed a $240M investment from PE firm Centurium Capital in April 2021 after showing positive revenue growth. 

As of January 2022, Centurium is a 30% equity holder with over 50% of the voting rights – it also marked a 100% break from all the prior management involved in the scandal. CEO Guo Jinyi described it as “a new beginning”.

This new beginning included a pivot to franchising, and a revamp of marketing efforts, as evinced by their partnership with olympic sensation Eileen Gu.

Today, Luckin’ now has more stores than Starbucks in China – 7,200  total locations, 2000 of which are owned by franchisees! Meanwhile Starbucks owns all of its ~5700 stores.

Luckin’ stock, which still trades on OTC exchanges in the US, is around $17.80/share, higher than it’s IPO price! And at the end of May, Luckin’ claimed they were profitable for the first time ever in Q1 of 2022.

What To Watch For

Luckin’ has stated they remain “committed to U.S. capital markets”. This time around, they’d have to go through a more intense listing process given their history. Not to mention, the US has instituted a policy called “the “Holding Foreign Companies Accountable Act”, which requires a mandatory audit for any foreign company.

So yes, Luckin’ will likely be returning to Wall St in the near future. And this time around, they’ll have a franchise offering to go with it. I’m sure the marketing will be enticing – a tech-forward, small square footprint coffee concept that beat Starbucks in China.

But given their history, I’d tread very lightly with this brand.


FRANCHISE HEADLINES

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A few weeks ago I jokingly tweeted about a concept called “Side Chick” – a food truck that is only open on Sunday’s and that will park in front of Chick-Fil-A’s. Well….the meme has apparently become reality, as someone out there has brought it to life. Check out the hilarious website here!

Vegan QSR Eyes National Expansion

I really think there’s an opportunity for a plant-based QSR to make it big. Noomoo (pronounced No-Moo), an LA based vegan burger franchise, is attempting to do just that. They offer plant based burgers, chicken sandwiches, and milkshakes.

Subway Wakes Up 

Since inception, Subway’s focus has been on expanding their store footprint, at the expense of many of their franchisees. But now, after seeing their store count in the US diminish by close to 4K units over the last 3 years, they’re focusing on “operational excellence and an experience-oriented approach”. 

It’s about time Subway is focusing on improving things at the store level, and not simply looking to grow system wide royalties!

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