This year, we’ve seen how the IPO market can be a great place to find big-time winners. Keep in mind that 18 offerings have more than doubled, including stocks like Bigcommerce (NASDAQ:BIGC), Vaxcyte (NASDAQ:PCVX) and Vroom (NASDAQ:VRM). But of course, the IPO market can be quite risky as well. Just look at Luckin (OTCMKTS:LKNCY). Luckin stock has been a nightmare for investors.
The company, which is a coffee chain in China, pulled off its IPO in May 2019. At first, the stock seemed like a no-brainer as its growth rate was torrid. Luckin stock price would hit about $51 by Jan. 20.
But a few months later, there was a bombshell announcement: an internal investigation revealed that the chief operating officer had fabricated about $310 million in sales. Luckin’s shares would plunge and quickly be delisted from Nasdaq (the shares are now trading on the over-the-counter market).
It’s true that the stock has climbed lately but investors should be wary. While the company does appear to have enough cash for operations, the future still looks far from promising.
So, let’s take a look at three reasons to stay away:
Luckin Stock Problems: Flying Blind
The last financial report for Luckin was back in the fiscal third quarter of 2019. Yes, it’s been about a year without any indication of the company’s financials. And the last report that did not have any evidence of fraud was back in the first quarter of 2019.
Of course, this makes it nearly impossible to get a sense of the investment potential for Luckin stock. Thus, for any investor who makes a purchase, he or she is taking on substantial risk.
It is also far from clear when Luckin will publish its financials. For other companies in similar situations, it can easily take a couple years to get everything back on order.
Even if the company is able to clean up its problems, there will remain other problems. Perhaps the biggest is the market opportunity. The fact is that the country does not have a coffee culture. The preferred beverage is tea.
Granted, there has been growth in coffee demand, primarily from younger generations. But the interest has been generally about coffee being a symbol of wealth and status. In other words, there is some cache to having purchased premium coffee from Starbucks (NASDAQ:SBUX). This is even the case with McDonald’s (NYSE:MCD).
However, as for Luckin, it’s a low-cost operator. And more importantly, given its embarrassing fall from grace, the brand has taken a big hit.
The Trust Factor
When it comes to public markets, there are a variety of safeguards to protect investors. A company must have an auditor, for example, as well as certain accounting systems in place. There are also extensive federal disclosure laws.
But such things have their limits. If a company truly wants to a commit a fraud, it can be tough to prevent it. This is why there is considerable trust when investing in public companies. And whenever there is a major breach, it is incredibly difficult to regain confidence. In some cases – such as with the notorious Enron – the result is a shutdown of the company.
So, for Luckin stock, the company will face a long road back. Let’s face it, Wall Street analysts will be reluctant in providing coverage. The U.S. stock exchanges will also be skeptical about any relisting.
Something else: It is far from clear what Chinese regulators will ultimately do (there are several investigating ongoing). Thus, there may ultimately be severe penalties imposed.
In the meantime, Luckin will have to spend much time for restructuring its operations, which will be expensive and distracting. This will mean less attention and resources for its core business – and this will likely mean slower growth.
On the date of publication, Tom Taulli did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Tom Taulli (@ttaulli) is an advisor/board member for startups and author of various books and online courses about technology, including Artificial Intelligence Basics, The Robotic Process Automation Handbook and Learn Python Super Fast. He is also the founder of WebIPO, which was one of the first platforms for public offerings during the 1990s.