Luckin Coffee Fraud Explained

[Music] what's up guys and welcome back to wall street millennial many investors buy foreign stocks for the purposes of portfolio diversification in particular chinese companies have become popular as people want to own a piece of the world's second largest economy with the u.s stock market being the biggest in the world new chinese companies are ipointing on major u.s exchanges on almost a weekly basis the new york stock exchange expects 60 chinese ipos in 2021 alone however investors must be especially cautious about chinese listings the chinese government is notoriously relaxed in regulating their company's accounting standards and the country has far more than its fair share of fraudulent companies in this video we're going to be taking a look at one of the most blatant examples of chinese fraud that was exposed just one year ago in 2020 we're talking about none other than the now bankrupt looking coffee throughout the 2010s starbucks was growing rapidly within china the market was rapidly expanding and it became clear that there was tremendous amounts of money to be made in the chinese premium coffee segment in 2017 two chinese entrepreneurs jenny chan and charles liu decide to make their own coffee company to compete with starbucks they opened their first store in january of 2018. they made a premium customer experience with the interior of the store having a sleek and modern design similar to that of starbucks their key differentiator was their focus on technology the stores didn't accept cash and customers could only pay with the luck and coffee app customers could order on the app ahead of time and pick up their coffee as soon as they arrive at the store they also claim to use artificial intelligence to pick the best locations for new stores optimize pricing and perform supply chain forecasting in july of 2018 just a half year after opening their first store they raised 200 million dollars from investors including the sovereign wealth fund of singapore they used this money to advertise aggressively hiring celebrity promoters and posting digital advertisements throughout chinese media channels they also use aggressive discounting to lure customers new customers received a voucher for a free drink whenever they signed up on the app their marketing strategies seemed to have been working well as it allowed them to grow rapidly in october of 2018 they opened their 1300 store making them the second biggest coffee company in the country second only to starbucks in january of 2019 they had 2 500 stores and looked to be on track to surpass starbucks within just a few years they raised an additional 150 million dollars from institutional investors including blackrock which they would use to open more stores by the middle of 2019 they had a compelling story to tell investors besides their savvy marketing they also developed new technologies such as automated coffee kiosks they had developed a strong brand and became the number two coffee company in less than three years they took this investment story to the u.s where they ipo'd on the nasdaq for dollars per share under the ticker symbol lk this gave them a valuation of 2.9 billion dollars notably this was the first time since the tech bubble of the late 90s where a company achieved a 3 billion valuation in less than 3 years after being established the ipo was quite successful in the third quarter of 2019 the company reported a nearly 400 percent growth in customer traffic while their aggressive advertising caused them to post net losses they claimed their profitability on a per store basis was rapidly increasing in light of the bullish news the stock peaked at over 50 dollars per share in january of 2020 giving the company a valuation of 9 billion however not everyone was buying looking coffee's success story on january 31st 2020 the short selling firm muddy waters tweeted a link to an anonymous 89-page report the report alleged that the company had artificially inflated their profits by up to 88 percent the author of the report said that they hired hundreds of people within china to conduct over 10 000 hours of video surveillance based on how many people entered each luxem store every day and how many items the average customer bought they made an estimate for how much revenue each store and thus the entire company was making looking was reporting revenue of 88 higher than the estimates that they made based on the video evidence from this they concluded that looking was fraudulently inflating their sales to push up the stock price and raise money from unsuspecting investors based on third party advertising data they also found that looking coffee inflated their advertising expense by 150 percent it might seem weird that a company would inflate their expenses as this decreases profitability however at the time investors didn't care about net profit and as long as revenue was growing the stock could continue to rise inflating the advertising expense helped them explain why their cash reserves were declining despite the fact that they are supposedly making so much revenue lucky coffee vigorously denied the allegations they claimed that the report was malicious and the authors did not understand the company's business model in operating environment to clear up the controversy they announced an internal investigation to prove their reported financials were legitimate since the short report was anonymous many people doubted its credibility and initially gave lucken the benefit of the dow the embattled company also received unlikely support from citron researchers andrew left left is predominantly a short seller but sometimes he goes long stocks he thinks are undervalued on the same day that the report was released citron tweeted they were long-looking coffee and confident that it was not a fraud through their own research they thought the coffee chain's business was on fire and the anonymous short report would fall short on accuracy on april 2nd 2020 luckin released the findings of their internal investigation they confirmed that the co had in fact fabricated 310 million dollars worth of sales in 2019 this cleared away any doubt that the company was fraudulent in the stock tank 80 percent that day within a few weeks the company fired its ceo and ceo who were both involved in the fraud the company also received a notice from the nasdaq saying that they would soon be de-listed luckin actually saw a boom in their business in the days following the fraud being exposed their app's daily downloads searched from 45 000 a day to 325 000 as new customers wanted to cash in on their free promotional drinks before the company went under unfortunately since these drinks were free luckin was not able to make any revenue from them one beijing resident told reuters quote i'm not that into coffee but it'd be a pity to lose the chance for a free drink after all you don't know how much longer looking can hold on in september of 2020 the chinese government fined lucken and a few related companies 9 million dollars for the fraud in december the sec settled with the company to pay 180 million dollars in penalties for intentionally deceiving investors despite the revelations of fraud the company continued to operate its stores while the stock was delisted from the nasdaq it still trades on the over-the-counter markets under the ticker symbol lk ncy surprisingly its price has experienced a strong rebound increasing 800 since its lows on may 22nd the company continues to burn through cash without being listed on a major exchange it is very difficult for them to raise capital in february of 2021 they filed for chapter 15 bankruptcy protection in new york this move will protect them from u.s creditors while they restructure their business within china the bankruptcy proceeding will not impair the company's day-to-day operations in china where it continues to run retail locations while the company has posted updates about their legal proceedings and restructuring plans it appears that they have not published any financial results for 2020 or 2021 so we have no idea how their business is doing this makes it all the more curious why investors were willing to bid the stock price back up to 12 on the over-the-counter markets in response to the luck and coffee debacle as well as other high-profile frauds former u.s president donald trump signed into law the holding foreign companies accountable act this law requires all foreign companies listed in the u.s to be audited by the us's public company accounting oversight board or pbaoc currently the chinese government does not allow the pbaoc to conduct audits of companies headquartered in mainland china if the two countries cannot come to an agreement about these issues by 2023 many if not all chinese companies listed on major u.s exchanges could see their stocks de-listed alright guys that wraps it up for this video what do you think about luck and coffee's fraud why do you think that luck in stock was able to rally 800 off its all-time lows let us know what you think in the comment section below if you like the content make sure to like subscribe and share this video as always thank you so much for watching and we'll see in the next one wall street millennial signing out

Channel: Wall Street Millennial

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Length: 8min 50sec (530 seconds)

Published: Thu Jul 08 2021