Luckin Coffee Performance Fraud Analysis: Why Luckin Coffee Falsified Results

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FrontStreet Coffee-Luckin Coffee Fraud Analysis

On April 2nd, Luckin Coffee self-reported performance fraud, with its NASDAQ stock price plummeting by 76%. At this time, it was less than a year since Luckin's listing on the US stock market.

According to Luckin's statement, starting from the second quarter of 2019, the company's Chief Operating Officer (COO) Liu Jian, along with several employees reporting to him, engaged in certain improper behaviors, with sales related to fraudulent transactions amounting to approximately 2.2 billion RMB. According to the company's previously disclosed performance reports, the company's revenue in the second and third quarters was 2.4 billion RMB, which means that 92% of the revenue in these two quarters was related to fraudulent transactions. It's naturally not surprising that the company's stock price plummeted by nearly 80%.

The main reason Luckin exposed its own scandal was that the performance fraud could no longer be concealed. On February 1st this year, the famous short-selling institution Muddy Waters released an anonymous third-party report that provided evidence of the company's performance fraud and analyzed the inherent flaws in Luckin's business model. Especially regarding the company's performance fraud, this report provided five "ironclad evidences," pointing out that the company's sales in the third quarter of 2019 were exaggerated by at least 69%, and by at least 88% in the fourth quarter, among other findings. After Muddy Waters issued the report, Luckin's stock price fell by 11% at the time, but Luckin quickly denied all allegations, and the company's stock once rebounded by 16%. However, two months later, the paper could no longer wrap the fire, and Luckin ultimately admitted to performance fraud.

For domestic consumers, if Starbucks' appeal mainly relies on its brand, Luckin's appeal is primarily based on price. To maintain low prices while expanding rapidly, Luckin could only rely on continuous cash burning. When the market began to raise increasing doubts about Luckin's cash-burning model, especially after listing, investors needed to see not only Luckin's expansion speed but also improvements in profitability, not just endless cash burning and losses. It was under this pressure that Luckin delivered a financial report in the third quarter of last year that responded to and reassured investors. Against the backdrop of being temporarily unable to achieve comprehensive profitability, the company announced that it had achieved store-level profitability in the third quarter. Specifically, the company lost 530 million RMB in the third quarter but achieved store-level profitability (excluding marketing expenses) of 190 million RMB. But it ultimately proved that Luckin Coffee's so-called profit improvement was actually just financial fraud.

This, in turn, also shows that Luckin did not have real confidence in its business model. In the US stock market, where the cost of violation is extremely high, Luckin would rather take risks and gain investor recognition through financial fraud rather than through its own operations, which in itself is a denial of its business model, indicating that it cannot see hope for profitability either.

Conclusion

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