Stained by Fraud Scandal, Luckin Coffee Is Seeking a Path Out

From an investor darling to a market pariah, Luckin Coffee’s history has been a roller coaster ride. (Source: Luckin Coffee)

One year after being delisted from the Nasdaq following an accounting scandal, tarnished Chinese coffee chain Luckin Coffee on June 30 published a restated 2019 financial statement, its first financial report since the company admitted to fabricating transactions in April 2020.

In the statement, Luckin confirmed for the first time that it inflated its annual costs and expenses by 1.34 billion yuan ($206.61 million), while its revenue was overstated by 2.12 billion yuan. The filing also showed that in 2019, the chain brought in 3.025 billion yuan in net revenue, an increase of 260% compared to the previous year. While that may sound like a mind-blowing figure, it pales in comparison to the 500% annual revenue growth the company reported prior to the fraud scandal. On the other hand, Luckin spent twice as much as it earned that year, with its annual losses hitting 3.212 billion yuan, throwing the sustainability of its high-growth yet cash-burning model into question.

From an investor darling to a market pariah, Luckin Coffee’s history has been a roller coaster ride. Established in 2017 by entrepreneurs Charles Lu and Jenny Qian, Luckin was born with a silver spoon in its mouth amid a Chinese technology investment mania. As its business was built around a mobile app, the startup presented itself as a technology company, and raised hundreds of millions of dollars from high-profile investors including Joy Capital, BlackRock and Singaporean sovereign wealth fund GIC.

The upstart aspired to challenge Starbuck’s dominant position in China, the tea-drinking country which only relatively recently started savoring the aroma of coffee. It rewarded new subscribers to its app with vouchers for free coffee and offered daily discounts that could lower the price of a grande latte to just 9 yuan, or $1.39 – roughly a third of a similar Starbucks drink’s price tag.

Cherry Huang, a senior college student who studies in the eastern province of Zhejiang, recollected that Luckin’s heavy subsidies introduced her to the pleasures of java-drinking when she was a cash-strapped freshman in desperate need of caffeine to cope with exam stress. “A friend told me that Luckin provided every first-time buyer with a free drink, so I gave it a try,” Huang said. “The coffee was surprisingly delicious. Since then, Luckin has become a permanent item on my shopping list with its high price-performance ratio and later an essential part of my college life.”

The Xiamen-based company’s strategy of aggressively giving away discounts seemed to work, driving its name recognition nationwide in a brief span of time. As of December 2018, a year after its founding, the chain had opened 2,000 stores in Beijing, Shanghai, and other cities across China and sold more than 85 million cups of coffee to almost 12 million consumers. In May 2019, this energetic Chinese challenger to Starbucks successfully launched a $561 million IPO in the U.S.

Unfortunately, Luckin’s glory days didn’t last. In April 2020, the company dropped a bombshell by admitting that it fabricated 2019 sales by about 2.2 billion yuan. The shock announcement brought a juddering halt to Luckin’s explosive growth. The company’s shares were delisted from the Nasdaq. China’s Ministry of Finance punished Luckin with an undisclosed fine. The U.S. Securities and Exchange Commission slapped it with a $180 million penalty to settle fraud charges. In February this year, the company filed for bankruptcy.

But the scandal hasn’t knocked Luckin out of the ring: today, it remains the country’s second-largest coffee chain with a sizable presence in major Chinese cities. Its stock, which is currently trading on the pink sheets, has recovered to nearly $15 per share. The brand continues to lure young Chinese consumers on the brink of converting to coffee from tea with a blizzard of Instagram-ready espresso-based beverages and splashy marketing campaigns.

How did Luckin survive the turmoil?

After the scandal broke, the company went through a radical shake-up. Chairman Mr. Lu, chief executive officer Ms. Qian, chief operating officer Jian Liu and other employees, who either participated in or had knowledge of the fraud, were removed. Jinyi Guo, another co-founder, board member and former acting chief executive of Luckin, has since been appointed as its new chairman and chief executive officer.

SEE ALSO: Luckin Coffee Faces Internal Strife, CEO Guo Jinyi Urged to Step Down

Following its C-suite shuffle, Luckin named Alvarez & Marsal (A&M), a Cayman Islands-based consultancy which oversaw the bankruptcy of Lehman Brothers, to administer its restructuring. As its high-speed rise ended, Luckin has also promised to stop burning cash for growth, and raised prices to turn a profit. Technode reported that starting from May, Luckin allows its store heads to apply to raise prices up to 3 yuan for each drink. The company also stopped giving free drink coupons to first-time buyers.

In the meantime, Luckin has ramped up promotions for its regular customers in a bid to win their loyalty. Graduate student Sarah Wang told Pandaily that the local Luckin branch at her alma mater, Tianjin University, allowed students to get discounts by buying together in bulk. “Luckin pushes freebies and coupons to me via SMS on a regular basis,” Wang added. “Those moves helped the chain retain its appeal to me and my peers.”

Luckin’s auditor A&M claimed that an “increased number of our transacting customers, purchasing frequency per customer, higher effective selling prices of freshly-brewed products and our increased efforts in enriching our product portfolio” drove the company’s growth in revenue from April to November 2020.

Luckin currently debuts two new lines of drinks per month. Its proven ability to keep coming up with creative products ensures that customers will never get bored with the brand. This summer, it unveiled a new beverage featuring coconut milk and espresso, shaken together and topped with ice. Named “Fresh Coconut Latte”, the invigorating drink is going fast at Luckin’s bricks-and-mortar shops and has inspired many social media posts. On China’s Twitter-like social media platform Weibo, the hashtag #Fresh Coconut Latte# has been reviewed more than 59 million times. Shoppers lucky enough to purchase the beverage shared photos eagerly, while food bloggers created recipes and taught netizens how to DIY it at home.

Cherry Huang threw herself into the Fresh Coconut Latte fever as well. She posted photos of the drink on her WeChat and Instagram pages, making no secrets of her excitement. The 22-year-old also complained that as the drink achieved increasing popularity, it became harder and harder to get.

As part of its efforts to attract young customers, Luckin also signed an endorsement deal with Russian model Lelush who participated in a Tencent-produced reality TV show. In contrast to other competitors, Lelush showed no passion to win and gave listless performances on stage, which accidentally resonated with China’s exhausted and disillusioned Gen Z and made himself one of the hottest stars of the country’s Internet. Fans of Lelush expressed their support for the slacker icon by purchasing Luckin’s products and sharing posts with the hashtag #LuckinCoffee’sAmbassadorLelush# on Weibo, which served as free advertising for the company.

In April, the company received new investments from Centurium Capital and Joy Capital, both of which were early-stage investors in Luckin. Centurium Capital invested $240 million and Joy Capital put in an additional $10 million in senior convertible shares. According to a statement released by Luckin, as of June, the company boasted more than 5,200 stores across China and its cumulative number of unique customers topped 75 million. In June alone, Luckin sold more than 10 million cups of the Fresh Coconut Latte, marking a monthly record.

Tang Xiaoxu, an investment manager at venture capital firm Meridian Capital, said in an interview with Pandaily that Luckin Coffee has changed Chinese people’s beverage consumption habits by offering cheaper and sweeter coffee. “Illegal practices aside, Luckin’s business model is actually feasible,” Tang noted.

Tang also felt confident about the future prospects of China’s coffee industry. “People may stop drinking bubble tea at a certain age, but they will continue drinking coffee after they turn 35 years old,” Tang said. According to the International Coffee Organization, Chinese consumers drink fewer than seven cups of coffee a year on average, a fraction of the 314 cups Americans drink, suggesting considerable potential yet to be unleashed in the sector.