Reasons for Luckin Coffee's Pre-Market Trading Suspension What Happened with Luckin Coffee's Trading Halt

FrontStreet Coffee - Luckin Coffee Trading Suspension

On April 2, 2020, Luckin Coffee (Nasdaq: LK), the U.S.-listed Chinese coffee chain, announced that an internal audit had found its COO and others had fabricated data involving approximately 2.2 billion RMB. The stock collapsed in pre-market trading — at one point down 85% — and closed down 75.57%, evaporating 35.2 billion RMB of market value in a single day; over two consecutive sessions it lost 90% of its value.

Wags quipped that while you used to buy Luckin coffee at an 18% discount, you could now buy Luckin stock at one. Rising like lightning and falling like lightning, this is Luckin's worst crisis yet — and its fallout reaches far beyond Luckin itself.

Luckin's Biggest Crisis

Why did Luckin expose itself? In short, because the cover-up could no longer hold.

As early as January 31, 2020, the international short-selling firm Muddy Waters released a report alleging inflated revenue. The 89-page document drew on the work of 92 full-time and 1,400 part-time investigators, who collected over 25,000 receipts and more than 10,000 hours of in-store surveillance footage. It concluded that Luckin's Q3 and Q4 2019 sales figures were inflated by 69% and 88% respectively.

Anyone who follows capital markets knows Muddy Waters. Over the years the firm has shorted numerous Chinese concept stocks, including New Oriental, Huishan Dairy, Anta Sports, and TAL Education Group (parent of Xueersi).

Its track record is impressive. According to statistics from 21st Century Business Herald, of the 18 companies Muddy Waters has shorted, 9 still trade normally, 1 has been suspended, and 8 have been delisted (including those acquired or returned to A-shares). Curiously, founder Carson Block has a legal background, and the firm's name comes from the Chinese idiom about muddying the waters to catch fish.

The Threefold Impact of the Luckin Incident

The trouble facing Luckin is unlikely to stop at what has been disclosed. Looking ahead, there will be at least three major consequences.

First, the disclosure pins the misconduct on Chief Operating Officer Liu Jian and several employees reporting to him. Could a COO's authority really stretch far enough — and quietly enough — to sustain actions this risky for this long? What was the motivation? Without any specialized knowledge, an ordinary observer can reasonably question the official account, and class-action lawsuits look unavoidable.

Second, Luckin's fall has dealt collateral damage to Chinese concept stocks across the board. On the day the stock plunged, many already fell; for the listed ones, valuations took a hit, and for those still private, listing plans were shelved under the shadow of "fraud."

And beyond outright fraud, practices like pledging stock at market highs are hardly unique to Luckin — they are common among Chinese concept companies. As one friend lamented, if Luckin triggers class-action suits, other companies operating the same way will likely not escape involvement.

Examining the Luckin Model

Behind Luckin's rapid rise and fall lies a multi-layered game of technology, capital, and finance. From founding to IPO took only a year and a half — once considered a miracle. Deconstructed, though, the miracle is simply a strategy of winning through speed, built on a compelling China story.

In September 2018, Luckin became China's first coffee chain valued at $1 billion. At the time, co-founder Guo Jinyi told the Financial Times that Luckin was focused on rapid expansion rather than profits.

In 2018 Luckin planned to reach 2,000 stores by year-end, while Starbucks had about 3,300 stores in China, opening roughly 50 new ones a month. Luckin's store count soon overtook Starbucks'; it now exceeds 4,500 and keeps growing — a pace that leaves UK-based Costa Coffee or Peet's Coffee far behind.

Expansion did not slow after the IPO. As early as mid-2019, founder and CEO Qian Zhiya declared that Luckin would reach 10,000 stores by 2021. Founding to IPO in eighteen months — a true blitzkrieg. As the Chinese saying goes: in martial arts, only speed is unbreakable.

But without this fraud scandal, how much longer could the wind-like speed have lasted?

Fraud is not the only thing worth reflecting on. Luckin's rise rode the rising tide of global capital markets in recent years — when China's growth story wears a new technological cloak, Western investors' imaginations run wild. The recent sharp slide in U.S. stocks drew attention, but the market had been climbing for over a decade, one of the longest bull runs in its history, feeding the primary market's optimism too. Strip away the internet-era styling and Luckin's story is an old one: China's enormous market — the same pull that drew foreign enterprises hunting for "one billion consumers."

In the new era, with the halo of internet models plus capital backing, success looked effortless — but the ones ultimately footing the bill are secondary-market investors. Are they the only ones paying? Every major event has effects beyond itself; economists call this externality.

China-U.S. financial ties, strained by the trade war and the pandemic, already showed signs of decoupling. Now, because of one Luckin, the image and valuations of Chinese companies will collectively bear the loss.

On April 2, 2020, Luckin filed a report with the U.S. Securities and Exchange Commission. It stated that the board's special committee — presumably acting after the SEC questioned the company in the wake of Muddy Waters' allegations — had found that COO and Director Liu Jian, along with several employees reporting to him, engaged in misconduct including fabricating certain transactions, falsifying 2.2 billion RMB in sales from the first through fourth quarters of 2019. After the news broke, the stock crashed in pre-market trading — down as much as 85% — and within 40 minutes of the open it had triggered 5 circuit breakers and fallen 75.57%, wiping over 35.2 billion RMB off its market value. Luckin Coffee has since announced a trading suspension.

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