The best recipes for stock bubbles need a fanciful growth story. Take the South Sea Company in the eighteenth century, whose shares inflated over 10 times in a matter of months on hopes that it would bring back a vast hoard of gold and silver from the Spanish colonies, despite its modest trading rights. The fact that it failed to do so, and the exposé of fraud, caused a tremendous bust, hurting swathes of investors including Isaac Newton. “I can calculate the motions of heavenly bodies, but not the madness of people,” said the discoverer of gravity, after running up £20,000 of losses (equivalent to $3 million today).
The short-sellers targeting Luckin Coffee have repackaged some of these classic themes recently – accusing the high-profile unicorn of spinning rosy stories, and calling it a “fraud” and a “fundamentally broken business”. In a much-read 89-page report doing the rounds online, the anonymous author alleges that the Xiamen-based coffee chain cooked its books to convince investors that its business reached an inflection point during the third quarter of 2019. The author contends that Luckin dangled the prospect that it would soon dial down its cash-burning promotions and move into profit, helping it jack up its Nasdaq-listed shares by more than 160% in a little over two months and raise another $1.1 billion through bond sales and a secondary placement in January.
According to the report, Luckin exaggerated the number of items sold per store each day by at least 69% and 88% in the third and fourth quarters respectively. It also inflated its net selling price per item by 12%. That allowed it to report profitability at “store level” during the third quarter – a first for the firm.
“Luckin knows exactly what investors are looking for, how to position itself as a growth stock with a fantastic story, and what key metrics to manipulate to maximise investor confidence,” the report warned, claiming that its research team had mobilised more than 1,500 people to monitor 620 Luckin stores and collected nearly 26,000 receipts from customers for its investigation.
Investors are divided about the report’s allegations. On February 1 Carson Block’s Muddy Waters said the findings were “credible” and disclosed a short position on Luckin. The comments helped to send Luckin’s shares down 37% from a peak of $50.02. Andrew Left’s Citron Capital – another well-known short-selling hedge fund – says the findings fall short on accuracy, however. Left, who is long Luckin’s shares, told Reuters in a subsequent interview that the company’s stock price could double to $60 as China recovers from the coronavirus outbreak. In Wuhan alone, it has been forced to shut 200 outlets.
Here the perspective is more that Luckin’s stock plunge is down to the broader fear of how China’s consumer sector is being battered by the spread of the virus. After all, Starbucks is reported to have closed half of its 4,292 stores in mainland China in response to the coronavirus threat.
The Financial Times has also pointed to the impact of the outbreak on coffee sales as a whole, highlighting last week that global coffee futures were down a fifth since the start of the year – driven largely by fears of slowing coffee bean imports from China (which have tripled over the past decade to about 65,000 tonnes).
Until the start of this year, Starbucks had been a proxy for growing demand for coffee from the Chinese. It reported steady growth in the China market for the three months ended in December, with revenues up 13% on the back of a 3% increase in same-store sales and a 16% surge in store count nationally. The coronavirus will surely put the trend into decline – though analysts will be looking at Starbucks’ partnership with Ele.me, the food and beverage delivery platform, to see if worried consumers are calling in more orders from home. Delivered orders made up 9% of Starbucks’ Chinese sales last quarter. But even that lowish percentage will face pressure: if half Starbucks’ outlets have stopped brewing that will slash the number of locations from which online purchases can be fulfilled.
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