Luckin Coffee (NASDAQ:LK) is stuck in a state of suspended animation. The Nasdaq halted trading of LK stock on April 7. At the time, the Nasdaq said that the halt was for “news pending” which usually indicates that a press release is coming and that trading will resume soon after.
But that hasn’t happened for Luckin. Instead, the Nasdaq changed its advisory to “additional information requested” which can lead to much longer halts.
When the Nasdaq asks for more details, the company in question has to meet the exchange’s concerns before trading resumes. Apparently this hasn’t happened yet, as Luckin has remained halted for weeks now.
The Freeze and LK Stock
There are several factors that could be contributing to the extended trading halt. For one thing, the Nasdaq may have more concerns about the veracity of Luckin’s results. The company admitted to certain major discrepancies, but perhaps the stock exchange fears that even more will come out.
Also, there’s an interesting matter with Luckin’s stock. Luckin chairman Charles Zhengyao Lu had borrowed more than $500 million from Goldman Sachs (NYSE:GS) using his Luckin stock as collateral. With a sudden 75% plunge in the value of Luckin, that margin loan fell deeply underwater.
Goldman Sachs seized the Luckin shares. But it will still end up losing $100 million or more on the transaction because it will have to sell those recovered Luckin shares at a low price. It’s possible the Nasdaq has kept trading halting to help Goldman find a buyer for this massive block of distressed stock in an orderly manner.
Additionally, on Monday, the Wall Street Journal reported that Chinese state commerce regulators are now investigating Luckin. The regulators seized company records. It’s unclear at this time what this investigation may lead to. However, the Nasdaq may decide to keep trading suspended until there is more clarity on Luckin’s potential liability on that front.
What Could Go Right for Luckin
The longer the trading halt drags on, the worse it looks for the company. But there’s still the possibility that things will turn out alright.
For one thing, last week, Luckin updated the world on its situation, noting that an additional board member had resigned. That’s hardly great news, but it could be setting the stage for a clean sweep of the management team with totally new people taking over.
More broadly, Luckin could still be working to finish investigating the extent of the accounting misdoings that occurred and then restate its financial documents.
It’s not unheard of for a company to resume trading and regain some value after filing clean amended financial results. Luckin shares have already taken a massive blow. Any signs that the company is intent on solving its problems and getting back to business could cause a substantial rally.
A Worst-Case Outcome
There are much darker potential outcomes as well. For a worst-case scenario, consider the example of Sino-Forest. Sino-Forest claimed to be one of the largest timber companies in China. Its stock was listed in Toronto, and it generated fantastic returns for its shareholders for more than a decade. It was worth billions of dollars at its peak and had famous investors such as John Paulson among its institutional holders.
In 2011, however, Muddy Waters Research, a famous short seller, accused the firm of fraud in June. Notably, this is the same Muddy Waters that exposed the fraud at Luckin, as well.
In any case, by August 2011, Sino-Forest shares had lost most of its value, and the Ontario Securities Commission launched an investigation and halted the stock. Incredibly, shares would not begin to trade again for more than a year.
In that time, Sino-Forest had numerous key employees quit, and the company declared bankruptcy. Between the trading halt and when it reopened, virtually all of the remaining value of the shares disappeared.
It’s far from certain that Luckin will play out this way. For one, Luckin clearly has thousands of real coffee shops across China, and generated substantial revenues even after we back out the inflated figures. That’s in contrast to Sino-Forest, where it was hard to determine what forestry assets it actually controlled.
Two, Luckin listed its shares in New York, not Toronto. Historically, the Nasdaq exchange has preferred to avoid long trading halts. Normally, it’s common practice for the Nasdaq to delist companies that commit fraud so that trading can quickly resume on the Pink Sheets exchange. The Pink Sheets have much lower requirements for its member companies.
LK Stock Verdict
Given the trading halt, this is a weird situation. You can’t buy or sell Luckin until it resumes trading. And we don’t even know if that trading will ultimately happen on the Nasdaq, or if the company will be demoted to the Pink Sheets exchange.
While we wait, if you’re involved in Luckin, this is a great time to study up on other companies that have run into financial trouble in the past.
What common ties connect various companies that have committed accounting fraud over the years? For one thing, anyone that brushed off the Muddy Waters allegations against Luckin back in January should reconsider dismissing short sellers going forward. They often bring new and important information to the market.
If you knew about the Sino-Forest saga, it could have kept you out of harm’s way with Luckin.
And if you own other stocks that have been targeted by short-sellers, consider taking a deeper look into those allegations to make sure that you don’t get hit with another Luckin-style wipeout at some point in the future.
Financial markets are fairly well-regulated and monitored for wrongdoing. But plenty of things slip through the cracks. Regardless of how Luckin turns out once shares resume trading, let this experience help you make better investments in the future.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he owned shares of Goldman Sachs.
