INSIGHTS: Is Luckin’s rushed IPO a path to sustainability or a pig in a poke?

On April 22, 2019, Luckin Coffee, the darling of new retail boosters, filed their IPO prospectus with the US SEC. Just 18 months old, the coffee delivery and pickup company has forced reigning champion Starbucks to reconsider its China strategy. With big name celebrities and tons of discounts, Luckin has created an online to offline coffee empire spanning over 2,000 stores by 2018 and aiming for an extra 2,500 in 2019.

Bottom line: The company’s gone from zero to hero in a year and a half and is cruising for a big IPO. But it’s bleeding money to buy size. The rise and IPO of Luckin follows a similar pattern of UCAR which listed on the Hong Kong Stock Exchange only 18 months after its founding. Given the recent behavior of UCAR and Luckin backers, are its managers building a business—or selling the markets a pig in a poke?

A (relatively) brief history:

• October 2017: Luckin Coffee is founded in Beijing by former Car Inc COO Qian Zhiya and former CMO Yang Fei.
• June 11 2018: The company raises a $200 million Series A from Joy Capital, the Government of Singapore Investment Corporation (GIC), Legend Capital and Centurium Capital. Joy, Legend and Centurium all have connections to Car Inc.
• August 2 2018: Starbucks announces partnership with Alibaba to deliver coffee.
• September 7 2018: Tencent via WeChat Pay announces partnership with Luckin.
• September 19 2018: Ele.me starts delivering Starbucks coffee.
• December 12 2018: Luckin raises $200 million in a Series B, led by GIC and China International Capital. This round gave them a $2.2 billion valuation.
• April 18 2019: The company raises $150 million in a Series B+ from BlackRock and an unnamed investor. The round put them at a $2.9 billion valuation.
• April 22 2019: Luckin Coffee files for an IPO with the US SEC. To be listed on the Nasdaq under the symbol “LK,” the company set a placeholder amount of $100 million to be raised in the filing. Rumors from February put the IPO at $300 million.

Burning cash: According to their prospectus, Luckin isn’t doing well. Revenues growth is slowing considerably. Net losses remain large, but are growing more slowly.

• In 2018, net losses were RMB 1.6 billion (about $240 million). Revenues were RMB 840 million with operating expenses of RMB 2.4 billion.
• In Q1 2019, they recorded net losses of RMB 551 million. Revenues were RMB 478 million with operating expenses of RMB 1 billion.
• Quarter to quarter, revenues are stagnating.
  • At its peak (Q1 2018 to Q2 2018) revenues grew by 10x
  • From Q4 2018 to Q1 2019, however, revenue only grew by 1.03x
• However, net loss growth is slowing down as well.
  • Latest quarter on quarter net loss growth was only 0.8x.

Loans on a limb: Burning cash, as you might imagine, brings significant cash flow problems. Right before the IPO, the company and its chairman use their own assets to ensure continued operations.

• April 3 2019: Luckin Coffee registered RMB 45 million worth of movable assets as collateral to Zhongguancun Technology Lease Co., Ltd.
• April 12 2019: Luckin Chairman and UCAR CEO Lu Zhengyao sought a loan of at least $200 million from Goldman Sachs, Morgan Stanley and others. Sources told Reuters Lu offered the banks a mandate in the upcoming IPO in exchange for the loan, which was reportedly to be backed by Lu’s Luckin shares. Reuters’ sources commented that “it is not uncommon for Chinese companies to raise loans from banks hoping for a mandate on an IPO, [but] it is rare for executives or shareholders to request such personal financing.”

A roasted silver lining: Luckin’s SEC registration statement lays out a plan to build a roastery JV with Louis Dreyfus Company Asia. As part of that agreement Louis Dreyfus BV will purchase Class A shares equal to $50 million at the IPO price.

• Why this is important:
  • This could be the only clearly profitable venture that Luckin will have in the near-term.
  • The coffee market in China is extremely fragmented, with coffee passing through up to eight middle men before it reaches the consumer.
  • Louis Dreyfus BV is in the top three green coffee sellers globally. A tie-up with them would give Luckin direct access to a consistent supply of beans that they can use in their own operations or expand to sell to other merchants.

Shifting strategy:

• China’s coffee market is only growing. According to a 2018 report by CBNData (in Chinese), online consumers of coffee products grew by 70% from 2015-2017. Offline, the “convenience store” model (cheaper, faster and targeting white collar workers) is gaining traction.
• Luckin started as delivery-focused company, but by Q1 2019 91.3% of all stores were pick-up stores.
  • Customers can use the Luckin app to “book” a coffee. They show up around the time it’s supposed to be ready, show a QR code, and walk away.
  • Pick-up stores can also serve as general fulfillment centers, delivering products within 30 minutes within a two kilometer radius.
• Following the convenience store model, Luckin is positioned to take advantage of high traffic office buildings, commercial areas and university campuses.
• However, traditional convenience stores already offer coffee drinks. Usually these are of the instant variety, the most popular of all coffee drinks in China. According to CBNData, 84% of coffee consumed in China is some variety of instant.
• Their only direct competitor in the delivery/pick-up space is Coffeebox. They, however, closed up to 40% of their pick-up stores (in Chinese) in February.

Once consumers are habituated to ordering from Luckin, the idea will probably be to stack other food/ beverage categories onto the stores, which become a dense chain of mini fulfillment/distribution centers for orders taken online, resulting in higher revenue per square foot (sort of like how Alibaba talks up Hema’s 50% higher revenue per store due to online orders).

—overheard on TechNode Squared Slack group

Pig in a poke? Luckin has been and continues to be a fascinating company. It’s clear their management is very effective at growing a company and the model has a lot of potential. However, there are still big questions that need to be answered:

• Can the company survive?
  • Personal loans for the chairman and physical assets as collateral for a lease suggest a company teetering on the edge.
• How long will it take to actually generate a profit?
  • The “lose until you win” approach has been the standard tech startup model. Amazon was able to do it, but more recent tech startups are having a hard time, including Didi and the infamous Ofo.
  • JD.com, who went public just barely out of the red, still has ever-growing costs and their position in the market is already quite large.
• Is the IPO just a way for early investors to cash out?
  • This isn’t the first time Luckin founders have brought a company from zero to IPO in 18 months.
  • Funded and operated by the same network as CAR Inc, the company hasn’t had enough third-party due diligence.

Questionable claims: Luckin’s prospectus cites two reports by consulting firm Frost & Sullivan, a firm associated with questionable numbers in past IPOs.

• Their reports claim Luckin is the second largest firm in its market and the fastest, that 70% of coffee consumed in China in 2018 is pickup or delivery, and that 82.4% of participants claimed they started drinking coffee more often after becoming Luckin customers.
• Yicai Global has reported that Frost & Sullivan has repeatedly worked on IPOs for companies later suspended from trading on suspicion of fraud, or shown by later data to have less market share than claimed.
• In a statement to Technode, Frost & Sullivan dismissed Yicai’s reporting as “seriously inaccurate.” It also denied participating in its clients’ alleged financial fraud.
• Frost & Sullivan claims of market size have also been repeatedly questioned:
  • An August 2017 Frost & Sullivan Report claimed that Secoo, a online luxury retailer, had a 25% market share in 2016 and called it Asia’s biggest online integrate upscale products and services platform in terms of GMV. Motley Fool analysis shows that in that same year, Secoo had RMB 3.47 billion GMV while Alibaba had over RMB 3 trillion and JD.com had RMB 658 billion. Frost & Sullivan told Technode that Secoo was not comparible to Ali and JD because of its exclusive focus on luxury products.
  • Huya, in their April 2018 prospectus filed with the US SEC, claimed to be the largest game live streaming platform with 86.7 million monthly active users in Q4 2017, based on Frost & Sullivan market research. However, data from Jiguang Big Data (in Chinese) shows that Douyu has consistently had a higher market penetration rate than Huya, starting as early as February 2017, as well as significantly higher DAU from September 2017 to February 2018. 30 day user retention was also higher for Douyu than Huya.

Go further:

• Why it’s time to wake up and smell the coffee on Luckin
• From jail to java: How Luckin’s CMO is hacking China’s coffee market
• Luckin may not last, but its model will
• 2018 China Coffee Industry Insight Report (in Chinese)
• 5 Reasons I’m Selling Secoo Ltd. (Implicating Frost & Sullivan)
• What Luckin Coffee’s IPO might mean for Starbucks
• *China Coffee Market Analysis: China’s coffee boss isn’t Starbucks! (in Chinese)