Luckin Coffee (OTCMKTS:LKNCY) filed for Chapter 15 bankruptcy protection on Feb. 5 with the United States Bankruptcy Court for the Southern District of New York. Chapter 15 was added to the U.S. Bankruptcy Code in 2005 to provide cooperation between U.S. courts and foreign courts in cross-border insolvencies. Luckin stock dropped 45% on the news.
It’s very possible that LKNCY could go to zero.
The last time I wrote about Luckin was just after Christmas. At the time, I was in awe of speculative investors who bet on the stock despite plenty of evidence that it and the coffee business were both on their last legs.
“By now, you’ve probably heard the news that Luckin Coffee settled with the Securities and Exchange Commission. Paying a $180 million fine, Luckin stock promptly doubled on the news,” I wrote on Dec. 27, 2020.
“While I wouldn’t have bet on the fraudulent coffee chain after it was delisted from the New York Stock Exchange, I do believe speculators deserve a little credit for taking a chance on a positive settlement.”
Populist Wave Lifted Luckin Stock
Since my article, Luckin stock had gained another 78%, closing Feb. 4 trading just below $13. The populist uprising pushed Luckin’s valuation to $3.2 billion despite the fact it was going on 14 months without an audited 2019 financial statement.
I understood the price jump after the settlement with the Chinese government. However, for investors to put so much faith in the unaudited statements provided by Alvarez and Marsal in its December report as Joint Provisional Liquidators seemed to be a bit of an overreach.
The Chapter 15 filing suggests that when the full story is written, it won’t be good for shareholders. What I do know is that Starbucks (NASDAQ:SBUX) will ultimately be the main beneficiary of Luckin’s imminent downfall.
Given the latest piece of news, I wonder who precisely is betting on Luckin stock, and more importantly, why are they doing so?
All Bets Are Off
It’s hard to tell who was betting on Luckin stock.
All of the major institutional investors that held shares earlier in 2020 have all moved on. Melvin Capital Management, the people who got buried by a GameStop (NYSE:GME) short — the hedge fund needed a $3 billion infusion of capital — owned 40 million Class A ordinary shares (5.2% of Luckin stock) in March 2020. It held none by the end of June 2020.
Outside of Luckin insiders? I don’t have a clue. Maybe it’s all Robinhood investors.
My InvestorPlace colleague Josh Enomoto recently said that he believes Luckin will trade between $10 and $20 due to a new generational paradigm. The latest news puts this theory in doubt.
“[W]e’re living in a new generational paradigm. You’d hope that some of the values and principles from prior generations would have been carried forward by younger demographics. But the evidence suggests otherwise,” Enomoto wrote on Jan. 21.
“For instance, according to the Federal Trade Commission, millennials are “25% more likely to report losing money to fraud than people 40 and over generally, and much more likely to report a loss on certain types of fraud.”
Essentially, Josh argued that because nobody cares about the fraud that’s been committed against investors combined with a negative-interest-rate environment, the floodgates would open as investors put their excess capital to work.
In Josh’s defense, his argument was before Luckin filed Chapter 15. There’s no way he could have seen this coming. I certainly didn’t despite the fact I thought its business was on its last legs.
After the Chapter 15 filing, I wouldn’t be putting my money anywhere near Luckin, but clearly, plenty of people will, hoping to secure a second speculative victory in less than a year.
Clouds in The Coffee
The first of two reports by Alvarez and Marsal laid out the company’s position as of Sept. 30, 2020. InvestorPlace contributor Vince Martin covered some of the report’s findings.
On the top line, the company estimates that net revenues in 2020 will be at least RMB 3.8 billion ($587.2 million), possibly as high as RMB 4.2 billion ($649.0 million). On the bottom line, it expects to lose between RMB 1.4 billion ($216.3 million) and RMB 1.7 billion ($262.7 million) on earnings before interest, taxes, depreciation and amortization (EBITDA) basis.
At the store level, 60% of the 3,898 self-operated stores were profitable in November 2020; Alvarez and Marsal expect that Luckin’s store-level profitability will continue to improve.
Further, it has 894 stores that are operated by others in partnership with the company. That will help reduce its cash burn. That said, Luckin is not expected to reach a cash flow break-even until the first half of 2023, nearly 30 months from now.
That’s a long time for any company. For Luckin, with its internal fighting, that’s an eternity. However, Alvarez & Marsal’s second report pointed out that Luckin had $775 million in cash at the end of December. This compares with $467 million in convertible bonds outstanding.
The Chapter 15 filing suggests it’s business as usual.
“All Company stores remain open for business, offering products with high quality, affordability and convenience to its customers in China. The filing of the Chapter 15 Petition is not expected to materially impact the Company’s day-to-day operations. The Company continues to meet its trade obligations in the ordinary course of business, including paying suppliers, vendors and employees,” Luckin’s Feb. 5 press release stated.
So, as Vince suggested, it’s possible that in 2025, the fraud will be in the rearview mirror, the bankruptcy behind it, and Luckin’s building toward its goal of between 4,800 and 6,900 stores.
The Bottom Line
Vince’s Martin’s Jan. 29 article suggested that you could make much worse speculative bets than Luckin Coffee. Prior to the Chapter 15 filing, I would have agreed. It wasn’t the worst lottery ticket out there.
However, at $13, I wouldn’t have bought it. Now that it’s at $7 and likely to fall further, I definitely wouldn’t. What was a speculative bet has become a death wish.
Luckin stock’s day of reckoning is here.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.