It turns out Luckin Coffee (NASDAQ:LK) and LK stock was all a scam.
At one point in January the company was worth $12 billion. It opened for trade June 3 at about $2.40 per share, a market cap of $638 million. If you can get that, sell now.
Luckin admitted on April 2 that many of its 2019 sales were fake. It was done by selling vouchers for coffee to companies with ties to chairman Charles Lu, who also controlled a car rental outfit. The fraud began before Luckin was listed on the Nasdaq Exchange.
The fraud caused an immense reaction in the United States, where moves are now underway to delist all Chinese stocks.
Is it time to worry?
While the Luckin Coffee fraud caught some U.S. hedge funds by suprise, it’s not a unique event.
Bernie Madoff, whose entire business empire was a Ponzi scheme, was the chairman of Nasdaq for three years. The 2008 financial collapse, and subsequent Great Recession, resulted from phony mortgage insurance.
The kind of fraud Luckin Coffee engaged in is surprisingly common. Catching such frauds has created a profession, Certified Fraud Examiners. A U.S. Department of the Interior official says a CFE combines the skills of a forensic accountant, a private investigator and a good journalist.
The search for fraud has driven the rise of short sellers like Citron Research and Muddy Waters. These shops spin allegations that often prove true, but sometimes blow up in the shorts’ faces.
Bad Timing Hit LK Stock Hard
The Luckin Coffee fraud was discovered as the U.S. and China were engaged in a trade war. A phase-one trade deal looks dead. The Luckin scandal was a huge gift for China trade hawks.
On May 20, the U.S. Senate unanimously passed the Holding Foreign Companies Accountable Act. Its sponsors admit it’s not aimed at England or France.
The Nasdaq, where 40 of 155 Chinese IPOs since the year 2000 grossed under $25 million, is now moving to tighten its rules. It’s also moving to delist Luckin.
The fallout has hit some of the biggest, and best Chinese companies. Alibaba (NYSE:BABA) and JD.com (NASDAQ:JD) both fell over 10% as President Donald Trump thundered about Chinese fraud. Both have since recovered, as writers here at InvestorPlace have written reassuring columns. New accounting rules could be a “blessing in disguise” for Alibaba, wrote Wayne Duggan. Delisting may be a bluff, it would be difficult, and Alibaba may simply comply with the new rules, he wrote.
Just how seriously American investors take the threat could be seen in action of Pinduoduo (NASDAQ:PDD), which rose after earnings May 27. This move came despite missing estimates and showing an alarming cash burn.
The Bottom Line on Luckin Coffee
I was never sold on Luckin stock. Even at my most optimistic, in March, I wrote there were “better bets.”
But Trump’s administration seems set on pursuing a trade war. Securities and Exchange Commissioner Jay Clayton has called the bill to delist Chinese stocks that don’t allow U.S. audits “sensible.”
The key word in the above paragraph is “seems.” The administration’s latest move, barring China-flagged planes from arriving in the United States, is weak tea. It bypasses the larger problem the Luckin scandal illustrates.
The tell here comes from Trump himself. He suggested moves to delist companies like Alibaba might “backfire,” even while saying he’s considering them.
The bottom line here is that Chinese crooks are bad, but you should also worry about American crooks.
Dana Blankenhorn has been a financial and technology journalist since 1978. His latest book is Technology’s Big Bang: Yesterday, Today and Tomorrow with Moore’s Law, essays on technology available at the Amazon Kindle store. Follow him on Twitter at @danablankenhorn. As of this writing he owned shares in JD and BABA.