A slide in share price for Chinese beverage chain Luckin Coffee continued on Monday despite hitting back against fraud allegations from an anonymous report publicized on Friday by short seller Muddy Waters Research.

Why it matters: The swooning share price underscores investor concern over the sustainability of the Starbucks rival’s business model. Since its establishment in 2017, the Xiamen-based company has invited controversy over its cash-burning expansion strategy, its top management, and more.

  • The fraud allegations come amid an outbreak of a deadly respiratory flu epidemic that has immobilized China, weighing on offline businesses as well as the broader market.
  • Luckin claims to be the largest coffee chain in China with 4,507 stores as of the end of 2019. Its rival Starbucks has 3,600 outlets in the country.
  • That the author of the report has remained anonymous casts a shadow over its credibility. Another short seller, Citron Research, which said it received the same report shared by Muddy Waters, continues to hold a long position on Luckin.

Luckin Coffee firmly stands by its business model and is confident in benefiting from the strong growth of China’s coffee market in the future. Luckin Coffee’s pioneering business model has enabled the company to become the leading and fastest growing player driving coffee consumption in China.

—Luckin Coffee statement

China Tech Investor 23: Is Luckin Coffee a real business?

Details: Muddy Waters Research tweeted a link on Friday to an anonymous report which claimed the coffee chain is defrauding investors by fabricating operational and financial numbers, after which Luckin shares sank more than 19%. The report was a result of mobilizing 92 full-time and 1,418 part-time staff to document 11,260 hours of store traffic surveillance video for 620 Luckin stores across the country.

  • The report claimed Luckin’s number of items per store per day was inflated by at least 69% in Q3 2019 and 88% in Q4, and that items per order declined sequentially in Q4 to 1.14 from 1.38.
  • Luckin released on Monday a statement in response to the fraud allegations, denying all allegations in the report, calling it misleading, flawed, and meritless.
  • The company specifically refuted claims over figure inflation on metrics including the number of per items per store per day, effective selling price, revenue, and net revenue primarily during Q3 and Q4 2019.
  • Luckin shares closed 3.51% down on Monday after a short intra-day spike triggered by its response.

Context: The share price tumble follows a steady climb that began in November, when its price more than doubled to historical high of $50 apiece in mid-January from around $19.

  • Amid the surge, Luckin Coffee raked in an additional $865 million in net proceeds, only eight months after its debut on Nasdaq.
  • Muddy Waters is a equity research firm specializing in US-listed Chinese companies. The company gained prominence with reports about paper product manufacturer Orient Paper and educational service platform New Oriental Education & Technology Group.

Emma Lee is Shanghai-based tech writer, covering startups and tech happenings in China and Asia in general. We are looking for stories related to tech and China. Reach her at lixin@technode.com. More by Emma Lee

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