In January 2020, Muddy Waters Research said it had received an “anonymous” report on Luckin Coffee (NASDAQ:LK). The company posted an extensive 89-page paper implying that LK stock was both a fraud and a broken business.
There are some key takeaways from this very intriguing story about Luckin Coffee, and how it has made so many different waves. The lessons are very sobering indeed.
Don’t Go Against Muddy Waters Research
One of the key takeaways from this story: don’t ever take lightly an extensive Muddy Waters research report. Rival research company Citron Research immediately poo-pooed its rival’s research on Luckin Coffee in January. It kept its position in the stock.
Muddy Waters said it was shorting the stock, expecting it to fall. Three months later, Luckin announced fired its CEO and COO and the stock was prevented from trading on NASDAQ. LK stock last traded at $4.39 on April 6. That was when it was halted. It’s down 86% from Jan. 31, when the Muddy Waters report was published.
Citron Research lost big. Its credibility is in tatters after it defended Luckin Coffee two hours after the tweet from Muddy Waters Research.
Don’t Trust Some Chinese Companies
Another major takeaway: Don’t trust some Chinese companies listed on Nasdaq or the New York Stock Exchange. CNBC made that argument when it analyzed the LK stock debacle in April.
But CNBC does not say what these stocks will be in the future. It quotes Carson Black, the founder and CEO of Muddy Waters Research, who said, “This is again a wake-up call for U.S. policymakers, regulators, and investors about the extreme fraud risk China-based companies pose to our markets.”
According to him, all Chinese listed stocks are an “extreme fraud risk.” He cast a skeptical eye at Chinese e-commerce giant Alibaba (NYSE:BABA) back in 2014, according to The New York Times, saying that BABA could defraud investors if management wanted to.
“China is to stock fraud as Silicon Valley is to technology,” he said, noting he had no evidence of Alibaba fraud, but used the company to illustrate his point.
In fact, CNBC correctly points out that about a decade ago many Chinese companies started going public in the U.S. via reverse mergers. Many of them turned out to be frauds.
For example, in early April, Muddy Waters Research was instrumental in a Wolfgang Research critical report on iQIYI (NASDAQ:IQ). The report charges the “Netflix of China” of fraud and inflating its numbers. So far iQIYI is denying the report is true. IQ stock tumbled 14% after the report.
Can the SEC Really Regulate Foreign Companies?
The U.S. may not be able to effectively regulate Chinese companies that list on U.S. exchanges.
According to the The Wall Street Journal, the SEC admitted in a recent statement that it has limited ability to promote and enforce its standards in emerging market countries. The statement warns investors of “heightened risks” from stocks based in these countries, as a result.
The CNBC article was even more critical on the ability of the SEC to oversee auditing in China. The Public Company Oversight Board is supposed to inspect and audit foreign auditing companies.
But according to CNBC, “China is one of the few countries that has not been cooperating with the board.” The article interviews Sen. Marco Rubio of Florida and his dislike for non-complying foreign listed companies listed in the U.S.
What You Should Learn From the LK Stock Fraud
First, don’t easily turn away from Muddy Waters reports, especially in regard to Chinese companies.
Second, don’t invest in Chinese companies. Third, don’t trust the SEC to regulate foreign companies.
Bottom line: if you end up having an urge to invest in Luckin Coffee after it starts trading, do this first. You should read the 89-page report that Muddy Waters published. It is very sobering and likely to dissuade you from ever investing in that stock.
As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide, which you can review here.
