The Freeze on Luckin Stock Isn’t Just a Lesson, It’s an Opportunity

Trading Luckin Coffee (NASDAQ:LK) has been halted since April 7. Current shareholders cannot sell their LK stock. Or any potential would-be buyers cannot buy into the share price.

The Freeze on LK Stock Isn't Just a Lesson, It's an Opportunity

Source: Keitma / Shutterstock.com

If you are a current investor in Luckin Coffee stock, you probably are quite well aware that the company is being accused of having fabricated sales figures.

Today, I’d like to discuss what may be in store for Lukin stock and the company in the coming weeks.

LK Stock and American Depositary Receipts (ADRs)

The Xiamen-based company started operations in Oct. 2017. Since its early days, LK stock has been touted as the Starbucks (NASDAQ:SBUX) of China.

In May 2019, LK stock went public in the U.S. as an American Depositary Receipt (ADR) at an opening price of $25. A Barron’s article at the time said that Luckin Coffee offered 33 million American Depository Shares in its IPO. And Luckin raised $571.2 million through the IPO.

According to the U.S. Securities and Exchange Commission:

“An ADR is a security that represents shares of non-U.S. companies that are held by a U.S. depositary bank outside the United States (“U.S.”). ADRs allow U.S. investors to invest in non-U.S. companies and give non-U.S. companies easier access to the U.S. capital markets. Many non-U.S. issuers use ADRs as a means of raising capital or establishing a trading presence in the U.S.”

The first ADR in the U.S. took place in 1927. And there are currently more than “2,000 ADRs available representing shares of companies located in more than 70 countries.”

In China, listing requirements are quite strict and lengthy. Chinese stock exchanges would have required Luckin to have been profitable over the three years prior to the proposed IPO date. In other words, it could have not listed in China. The group possibly initially chose the U.S. due to easier listing requirements for ADRs.

The LK share price hit an all-time high of $50.38 on Jan. 17, 2020. But the story has changed since then.

Fraud Allegations

In late January, short-seller Muddy Waters released a report accusing Luckin Management of fraud. It also said the group had a “fundamentally broken business.”

Later in February, when LK’s management denied any wrongdoing, Needham analyst Vincent Yu raised its price target on Luckin from $27 to $40.

But on April 2, management said that it was investigating reports that senior executives and employees fabricated transactions totaling $310 million (or 2.2 billion RMB). It also urged investors to not rely on its previous financial statements for the nine months ended September 30, 2019.

The press release said “beginning in the second quarter of 2019, Mr. Jian Liu, the chief operating officer and a director of the Company, and several employees reporting to him, had engaged in certain misconduct, including fabricating certain transactions.”

Put another way, Q2 2019 corresponds to the time when LK stock had its IPO. Now it is easy to realize why the people named could have wanted to pump the share price, especially at the time.

Following the press release of early April, the stock tanked from a closing price of $26.20 on April 1 to an opening price of $4.91 the next morning. When trading got halted on April 7, it was at $4.39.

On April 27, the headquarters of the scandal-hit chain was raided by regulators in China. Could Chinese authorities be nervous that this scandal may tarnish the reputation of other Chinese companies listed in the U.S.?

Luckin Stores Are Still Open in China

Indeed on April 21, the SEC put a public statement that warned investors on various risks due to investing in companies from emerging countries. It said,

“Our ability to promote and enforce … standards in emerging markets is limited and is significantly dependent on the actions of local authorities—which, in turn, are constrained by national policy considerations in those countries. As a result, in many emerging markets, including China, there is substantially greater risk that disclosures will be incomplete or misleading.”

I personally expect to see increasingly tighter listing requirements for small and young non-U.S. companies in the future.

Meanwhile, we do not yet know when the investigations may finalize or what the eventual outcome might be for LK stock.

However, Luckin stores are currently open in China. And regular customers are not yet ready to give up on their daily coffees. Many know China as a nation of tea-drinkers. But coffee consumption has begun to take off in the country. And taste buds will not change simply because Luckin Coffee has made a mess of investor confidence.

As InvestorPlace’s David Moadel has recently discussed, consumers or even investors may not write the group’s obituary just yet.

It will likely be weeks before a thorough investigation will be complete. And the LK share price may approach zero when trading finally begins.

But then another public or private group may easily enter the scene and buy the company which is still serving Chinese consumers.

The Bottom Line on LK Stock

In hindsight, investors who bought LK stock since its IPO may now be wondering whether the group completed the listing rather early in the company’s history. Instead should the business have focused on building market share and raising cash through other market mechanisms?

Needless to say, this is a difficult wait for current investors in Luckin Coffee stock. However, the experience may also serve as a lesson to encourage companies, underwriters, regulators, and investors to conduct even stricter due diligence in the future.

Tezcan Gecgil has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation. As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2020/05/freeze-on-lk-stock-lesson-opportunity/.

©2021 InvestorPlace Media, LLC