Luckin Coffee (OTCMKTS:LKNCY) ranks as one of this year’s most notorious equity market characters as Luckin stock was forced from a prestigious Nasdaq composite listing to trading over-the-counter. That was the result of a massive accounting scandal in which it was revealed the Chinese coffeehouse operators was faking its revenue.
Luckin stock recently got a lift when Chairman Charles Lu – allegedly the architect of the false revenue scheme – and three other board members were sent packing. That itself is an interesting situation because just a few days earlier, Lu survived a similar vote.
It’s speculation, but not out of the realm of possibility, that Lu himself engineered his own ouster to take some of the heat off himself. He’s at the center of criminal probes being conducted by U.S. and Chinese authorities and is short of friends on Wall Street as Credit Suisse Group (NYSE:CS) and Morgan Stanley (NYSE:MS) are probably out the $300 million loaned to Lu on margin.
Fresh faces in high-ranking roles are probably necessary for short-term sentiment, but equity investors remain in a rough spot with Luckin and headlines confirm things are likely to get worse before improving.
Luckin the Liquidated
Compounding the risk for investors is that the company once called the “Starbucks (NASDAQ:SBUX) of China” is now in liquidation mode – something Luckin was forced into by an unidentified bondholder. The company is calling a group of advisers and lawyers to see what it can wring out of its business as it stands today, but these moves rarely result in the company returning to its pre-scandal share price.
In a filing with the Securities and Exchange Commission at the end of the second quarter, Luckin claims to have $780 million in cash, much of which is derived from its 2019 initial public offering (IPO) and a convertible bond sale. That cash stash might appear to be a good starting point for a salvage operation, but investors would do well to curb their enthusiasm because Luckin’s aren’t yet audited.
In fact, Ernst & Young Hua Ming LLP, the coffeehouse operator’s auditor, said it audited the company’s results for 2017 and 2018 – prior to the 2019 IPO, but it hasn’t reviewed last year’s numbers. Actually, EY said on July 16 it bears no responsibility for what it called Luckin’s “fraudulent misconduct.”
EY itself is scrambling amid the Luckin scandal. The July 16 statement was the second time the accounting firm commented on the matter. In April, EY claimed that when it was reviewing the 2019 results for Luckin, it found evidence of management chicanery in the form of inflated income and costs.
Put all that together and it’s clear Luckin faces severe trust deficits in the investment community and that leads to increased risk.
Bottom Line for Luckin Stock
For the adventurous, sophisticated and risk-tolerant, there is a way to play Luckin and that’s via a convertible bond. The company sold $400 million worth of convertible debt in January at a par price of $1,000, but it recently traded at $34.25, or pennies on the dollar in bond speak.
Even with the Luckin convertible, there’s considerable risk. First, because the stock was delisted by Nasdaq, the convertible bonds were booted from the SPDR Bloomberg Barclays Convertible Securities ETF (NYSEARCA:CWB). That’s about as much of a vote of confidence as the $34.25 price on those bonds, which is to say it’s a vote of no confidence.
Second, convertible bonds get converted into stock meaning that type of debt tends to behave more like equity than do traditional corporate bonds. Translation: the more negativity that Luckin stock faces, the more unappealing the convertibles become.
Todd Shriber has been an InvestorPlace contributor since 2014. As of this writing, he did not hold a position in any of the aforementioned securities.