It’s been a terrible year for Chinese coffee chain Luckin (NYSE:LK). LK stock is down a whopping 92% so far this year as the company struggles with the consequences of its fraud scandal.
This week major banks won a legal battle that will force Luckin Chairman Charles Lu to liquidate millions of dollars worth of Luckin stock in order to reimburse the creditors.
The move will put Lu in a precarious position ahead of a major vote scheduled for July 5, which could remove him from the company. Luckin’s nosedive, fraud scandal, and the resulting flurry of bad news has many bottom-feeders sniffing around LK stock.
Is there a contrarian play there? Absolutely. But is it a smart one? Not in my opinion.
Bad News LK Stock Isn’t Over Yet
The next two weeks could bring an onslaught of bad news for Luckin shareholders as the firm continues to slog through the damage it’s fraudulent transactions caused. The ordeal couldn’t come at a worse time, as the novel coronavirus weighs on the global economy, and puts Luckin in a terrible position for a comeback.
In two weeks, Lu and some of his colleagues will be up for review at an extraordinary general shareholders meeting. The July 5 meeting is expected to end with Lu and some other directors voted out and two new board members stepping in. The shake-up could, in a way, be a good thing for LK stock.
Someone has to pay the price for the fraud scandal, and it seems Lu and a handful of other employees and directors will take the blame. By eliminating those people from the company, it gives Luckin somewhat of a fresh start.
But it seems that fresh start is only a facade. While Lu could be ousted, it turns out he’s the one who called the meeting— he wants to create space between himself and Luckin so the company can get back on its feet. But Lu will still be a silent controller, which, in my view, makes the whole thing even shadier.
Fraud Scandal Highlights Need for More Scrutiny
When investors discovered that Luckin was cooking its books, it shined a light on one of the key risks among Chinese companies listed on the U.S. exchange. They’re not subject to the same kind of scrutiny as their American counterparts, which adds a layer of risk no matter how you slice it.
As InvestorPlace’s Dana Blankenhorn pointed out, not every Chinese company is pulling the wool over investors’ eyes. There’s certainly an element of politics to it, as Blankenhorn notes, but investors should be aware that even the bigwigs like Alibaba (NYSE:BABA), don’t have to disclose the same way that U.S. firms do.
Of course, plenty of US firms cheat— just look at Wells Fargo (NYSE:WFC) and its fake account scandal, or worse, General Motors’ (NYSE:GM) ignition switch issues— but being exempt from SEC regulation makes it easier to fly under the radar.
The Case for Luckin
Of course, there is a contrarian play for Luckin stock. Back before the fraud scandal was exposed, the firm looked like a good play on China’s growing affinity for coffee. It offered investors an alternative to Starbucks (NASDAQ:SBUX) that was catering to China’s massive middle class.
If Luckin survives this accounting fraud, that case still exists. But that’s a big if.
Contrarians with a strong stomach for risk and excess cash to blow might consider LK stock. But then again, they could also go to the casino to empty their pockets.
The Luckin fraud ordeal shouldn’t cause investors to abandon all Chinese stocks. After all, there are plenty of big names with great track records that make for excellent value plays in the wake of the pandemic.
Luckin simply isn’t one of them. The company will be lucky if it escapes being delisted on June 25 and even luckier if it doesn’t eventually go bankrupt. The case for LK stock is rife with risk and uncertainty and doesn’t make for a good bet for most investors.
Laura Hoy has a finance degree from Duquesne University and has been writing about financial markets for the past eight years. Her work can be seen in a variety of publications including InvestorPlace, Benzinga, Yahoo Finance and CCN. As of this writing, she did not hold a position in any of the aforementioned securities.
