Luckin Coffee plunges on internal probe into ‘fabricated’ sales

Luckin Coffee has revealed that an internal investigation found hundreds of millions of dollars of sales last year were “fabricated”, wiping almost 75 per cent from the value of the company touted as China’s rival to Starbucks.

The coffee chain, which listed on Wall Street less than a year ago, put investors on notice that they should no longer rely on previous financial statements that have appeared to show exceptionally rapid growth.

The company’s chief operating officer has been suspended after a special committee was formed to investigate its accounts and the initial findings were delivered to the board.

Early stages of the investigation indicated that “aggregate sales amount associated with the fabricated transactions from the second quarter of 2019 to the fourth quarter of 2019 amount to around Rmb2.2bn” ($310m).

The disclosure marks a spectacular fall from grace for the delivery and takeaway coffee company, whose brand has been promoted by movie stars. Earlier this year Luckin strongly denied allegations in an anonymous report that cited possible fraudulent behaviour.

According to the committee’s findings, Luckin’s chief operating officer and several employees reporting to him “had engaged in certain misconduct, including fabricating certain transactions”, beginning in the second quarter of last year.

Some costs and expenses were also “substantially inflated” by fabricated transactions during the period, Luckin said. Along with the COO, Jian Liu, other employees have also been suspended.

The disclosure is a blow to investors who backed Luckin in its stock market launch and rode a subsequent surge in its share price. Among its investors are Louis Dreyfus Company, one of the world’s biggest traders of coffee and orange juice. 

The company has expanded aggressively in China, undercutting its larger rival Starbucks on price. By the end of last year the Xiamen-based chain had over 4,500 outlets, more than doubling the total within a year. This year Luckin sold convertible bonds to fund further expansion, including into unmanned stores.

Yet the chain has remained unprofitable, with margins compressed by rental, delivery and marketing costs, as well as discounts to lure customers. For the first nine months of 2019, Luckin recorded a net loss of $247m.

At the end of January, an anonymous report made public by US short seller Muddy Waters cited possible fraudulent behaviour at the group. At the time, Luckin denied the allegations, describing them as “misleading and false”.

The report alleged that the company had inflated the number of items sold per customer order along with other metrics, including advertising expenses and revenues from “other” products.

The shares surged late last year and touched a record $50.02 in the middle of January, leaving them at almost three times the listing price of $17 in the company’s initial public offering on the Nasdaq last May, through which it raised $560m.

The rush for the exits on Thursday pushed the stock down 74 per cent in early trading in New York, to less than $7.

Louis Dreyfus’s stake in the group was recently revalued. It has a deal to supply fresh orange juice to Luckin stores in China and the two companies are also building a coffee roasting plant in Fujian province.

Louis Dreyfus could not immediately be reached for comment.

The special committee has retained Kirkland & Ellis as outside counsel, which is being assisted by FTI Consulting as forensic accountants.

[optin-cat id=7010]