[Editor’s Note: This article was updated on June 22, 2020.]
The story of how Luckin Coffee (NASDAQ:LK) stock came to have lost 90%-plus of its value year-to-date is a cautionary tale worth rehashing. It’s a story of serious initial lies that compounded into even bigger, more audacious lies propped up by an opaque web of business connections. Yet amazingly, investors are willing to continue to buy LK stock even after these lies have been exposed.
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Importantly though, Luckin’s fraud will strengthen a collective push for stricter U.S. oversight of Chinese companies listed on American exchanges. In the end, investors should stay far away from Luckin. The only investors who stand to make money on LK stock are highly-skilled, risk-tolerant short-term traders.
Luckin fabricated a network of fake employees, businesses and orders to create false revenues. The story is as amazing as it is sad because real people were defrauded of their money in the process.
LK Stock: The Catch-22 of Chinese Growth
Luckin was able to rise to IPO level less than two years after its founding. This is extraordinary growth. And part of the allure of Chinese investment is the speed and scale of growth. Companies that can go from founding to IPO in two years have amazing capabilities, or at least if they are legitimate, they do. Money will pour into such companies, as it did in Luckin’s case.
As investors now know, Luckin was built on a foundation of lies propagated by an unscrupulous leader, furthered by complicit employees.
And this is the dilemma represented by Chinese investment. The country and its economy have grown at a rapid pace. Investors are eager to pump money in at the prospect of reaping high returns. But the other side of that coin is that business transparency is severely lacking.
Chinese companies operating in China are under no mandate to expose their dealings to outsiders. This is somewhat understandable.
Yet, Chinese companies listed on public U.S. exchanges also are exempt from rigorous SEC scrutiny and oversight while U.S. companies are not. The end result is that it’s much easier for Chinese companies on U.S. exchanges to cook the books.
Heightened Calls for Increased Oversight
Amid this fiasco, a bill passed U.S. Senate making listing more difficult for Chinese companies on American exchanges. The thrust of this legislation is that the Public Company Oversight Accounting Board, part of the SEC, will gain more access to Chinese financial statements. China has long denied the PCOAB access to financial statements of publicly traded Chinese firms on U.S. exchanges.
U.S. short seller and China watchdog Muddy Waters, LLC made significant accusations against Luckin in January. They came to the conclusion that Luckin was fabricating sales based on 11,000 hours of footage, 25,000 order receipts and observation of 1,500 customers.
That a short seller first raised flags will certainly strengthen calls for increased oversight. This seems to be a clear indication that oversight is lacking by U.S. agencies in the sphere of Chinese equities. Changes to U.S. oversight of Chinese companies are on the horizon. But this should also serve as impetus for investors to take extra effort in conducting due diligence on foreign companies generally.
Investors watching the current investor sentiment and price movement of LK stock should see similarities with Hertz (NYSE:HTZ) stock. Both companies are wildly volatile thanks to their poor decisions and have stocks nearing a price of zero. Yet investors continue to jump aboard.
Both of these companies face delisting from their respective exchanges. And if and when this happens, these stocks will drop to zero in value.
Why Are Investors Still High on Luckin?
Investors may be playing games they don’t understand. Current interest rates are so low that people can’t help but flock to the stock market. So these kinds of investments look attractive because they can appreciate very quickly.
Also, more inexperienced investors are piling on believing that there is a get-rich opportunity at their fingertips in Luckin and Hertz. Thus, markets react in these instances to the demand spike, and price sharply increases. But markets will correct and Luckin will likely fall again.
These investors are buying based not on the intrinsic value of Luckin or Hertz, but rather hope. Nothing has changed with these companies. Investors hope that unpredictable circumstances will somehow conspire catalyzing actual fundamental growth to occur.
Mismanagement and LK Stock
Luckin’s audacious accounting lies, and Hertz’s overspending on fleet which the company simply wants to write off, are the real fundamental truths underpinning them. These companies are, at best, poorly run. And the truth hurts.
To be sure, there is a vast ocean of difference between Hertz management decisions and the outright fraudulence undertaken by Luckin. But while both companies are in a world of trouble and face exchange delisting, investors with little business trading them are doing so.
Investors purchasing these companies with buy-and-hold, long-term intent are simply providing funds for shrewd, practiced traders to withdraw via complex trades.
Takeaway on LK Stock
Ultimately, there is no fundamental news that should drive investors to buy Luckin shares. Nothing has changed, the company is subject to ongoing litigation.
That there are many who currently show interest is a product of several factors and part of a dangerous trend. Not only should investors stay away from Luckin Coffee shares, but also most Chinese companies while the new regulations shake out.
And although people lost money due to Luckin’s fraud, the silver lining is that in the end more oversight is coming. This will at least allow investors with interest in Chinese firms to do their due diligence more thoroughly.
As of this writing, Alex Sirois did not own any of the aforementioned stocks.