Luckin Coffee Has Rallied, But Will the Good Times Last?

Luckin Coffee (NASDAQ:LK) is back from the dead. For almost a month, the Nasdaq exchange had halted trading in LK stock. It appeared that investors holding Luckin might get stuck with a worthless position.

Luckin Coffee Has Rallied, But Will the Good Times Last?
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Luckin, as you may know, committed a massive accounting scandal. Former members of the company’s management team engaged in an elaborate scheme to generate hundreds of millions of dollars in fictional revenues. In turn, they used this phantom revenue story to pitch the stock and ultimately conduct a secondary offering at a grossly inflated price. This constituted fraud, pure and simple. Luckin fired the people responsible, and the stock collapsed.

As a next step, you might expect the Nasdaq to delist Luckin and the coffee vendor to end up in obscurity. But that’s not what’s happened, or at least not so far. Instead, Luckin shares have roared back. They’ve as much as quadrupled in recent days, and now trade around the same level where they were previously halted at. So, what’s going on?

No Imminent Bankruptcy

A lot of folks had assumed that the fraud and delisting meant that Luckin would soon be going bankrupt. But that’s probably not the case. The company raised nearly $1 billion from investors in January in a secondary offering. It’s possible that the corrupt ex-management team pilfered some or most of that money. But to date, we have no evidence of that.

It’s likely that Luckin still has somewhere around $2 per share of cash on its balance sheet. We don’t know for sure — and it’s reasonable to not trust anything after a company admits to fraud in some of its financial accounts.

That said, as long as there is a reasonable possibility that Luckin is sitting on hundreds of millions of dollars of cash, it’s unlikely that shares will go straight to zero. That’s particularly true since Luckin’s bond offering doesn’t mature until 2025, giving them time to get their financials in order.

This makes Luckin markedly different than, say, Hertz Global (NYSE:HTZ) where that company has already filed for bankruptcy and has many billions of dollars in seemingly unpayable liabilities. There, traders should get out of the way before they get burned.

It’s extremely rare that an already bankrupt company stock makes a lasting recovery. But Luckin still has a fighting chance, at least for now. It’s easy to make a case for LK stock maintaining a $2 or $3 valuation thanks to its cash balance.

Brand Value

Luckin Coffee operates around 4,000 locations in China. While short sellers correctly identified that the company was dramatically overstating its sales, the business itself was real. The stores exist, the smartphone app is functional and well-designed, and the company has built something of a brand for itself in China. No one disputes those facts.

The race is still on to create the Starbucks (NASDAQ:SBUX) of China. Starbucks itself may win that crown — it’s making a fine push for the title. But if a Chinese firm is going to do it, Luckin is a reasonable candidate. And if Luckin’s management team can’t get the job done, an outside investor might be interested in taking it over to get the brand and store locations.

The Verdict on LK Stock

There are numerous folks out there saying that Luckin’s stock is essentially worthless thanks to the fraud that occurred. I understand that opinion. However, I disagree. The store network and brand retains some value. And unless the cash they raised earlier this year disappeared, there’s that as well.

Hence, it’s easy to defend a valuation above $0. The cash alone is probably somewhere in the neighborhood of $2 per share. Plus, there’s some sort of option value if new management is able to clean up the business.

So why not buy Luckin today? For all the positives, there’s still the fact that a massive fraud occurred here. And as foreign investors, it’s hard to know whether the new management team will be up to the task of fixing things, even assuming they are completely honest.

Given the damage to the company’s credibility, it will be hard for them to raise money again in the future, and the company was burning tons of cash prior to the fraud being revealed. Luckin has enough cash to survive for a while, but it still hasn’t gotten anywhere close to generating profits or positive operating cash flow.

As such, it’s a long shot that the turnaround will succeed. The history of small-capitalization growth companies recovering from fraud is not great, and that’s doubly true of emerging market companies. I get why the stock isn’t at zero, and traders made a good play swooping up the shares in the initial panic. Up near $5 per share and beyond, however, the risk outweighs the reward.

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 held no positions in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2020/06/luckin-coffee-stock-rallied-but-for-how-long/.

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