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Luckin Coffee Fraud and Business Model Analysis Summary

Core Content

Luckin Coffee (NASDAQ: LK) was exposed as a fundamentally broken business that engaged in financial and operational fraud after its USD 645 million IPO in May 2019. The company manipulated key metrics to artificially inflate its performance and attract investor confidence, leading to a stock price increase of over 160% within two months. It later raised an additional USD 1.1 billion in January 2020, further demonstrating its ability to exploit investor expectations.

Main Fraud Evidence

• Smoking Gun Evidence #1: The number of items per store per day was inflated by at least 69% in 2019 3Q and 88% in 2019 4Q, supported by 11,260 hours of store traffic video. Surveillance was conducted over 981 store-days with 92 full-time and 1,418 part-time staff.

• Smoking Gun Evidence #2: "Items per order" declined from 1.38 in 2019 2Q to 1.14 in 2019 4Q, indicating a decrease in average order value.

• Smoking Gun Evidence #3: Luckin inflated the net selling price per item by at least RMB 1.23 or 12.3%. Actual store-level losses were 24.7%–28%, and the real selling price was only 46% of the listed price, instead of the 55% claimed by management.

• Smoking Gun Evidence #4: Luckin overstated its 2019 3Q advertising expenses by over 150%, particularly on Focus Media. This may have been used to inflate revenue and store-level profit.

• Smoking Gun Evidence #5: The "other products" revenue contribution was only about 6% in 2019 3Q, representing a 400% inflation, as shown by customer receipts and VAT data.

Red Flags

• Red Flag #1: Luckin's management cashed out 49% of their stock holdings (or 24% of total shares) through stock pledges, increasing the risk of margin calls and stock price drops.

• Red Flag #2: Luckin's chairman and related private equity investors previously withdrew USD 1.6 billion from CAR Inc (HKEX: 699 HK), while minority shareholders suffered significant losses.

• Red Flag #3: Luckin's chairman transferred RMB 137 million from UCAR to his related party, Baiyin Wang, which now owns a coffee machine vendor near Luckin's headquarters. UCAR, Borgward, and Baiyin Wang are responsible for paying BAIC-Foton Motors RMB 5.95 billion over the next 12 months.

• Red Flag #4: Luckin raised USD 865 million for its "unmanned retail" strategy, likely to siphon cash from the company.

• Red Flag #5: An independent board member, Sean Shao, was associated with several US-listed Chinese companies that caused losses to public investors.

• Red Flag #6: Luckin's co-founder and CMO, Fei Yang, was previously imprisoned for illegal business operations. His former company, iWOM, is now a related party of CAR and conducts transactions with Luckin.

Business Model Flaws

• Flaw #1: Luckin's focus on core functional coffee demand is misplaced. China's caffeine intake is largely from tea, and the market for core functional coffee is small and only moderately growing.

• Flaw #2: Customers are highly price-sensitive, and retention is driven by promotions. Attempting to reduce discounts and increase same-store sales simultaneously is not feasible.

• Flaw #3: The company's unit economics are flawed and unlikely to achieve profitability.

• Flaw #4: Luckin's vision of becoming part of everyday life through coffee is unlikely to materialize due to a lack of core competence in non-coffee products. Its platform lacks brand loyalty, and its labor-light model is only suitable for older tea drinks, not the newer "Generation 3.0" products.

• Flaw #5: Luckin's franchise business for Luckin Tea is at high compliance risk as it was launched without the required two fully operational directly-operated stores.

Store Traffic Analysis

• Successful Store Days: 981 store-days were tracked, with an average of 263 items per store per day, based on 230 average orders per store per day and 1.14 items per order. This is significantly lower than the reported figures.

• Failed Store Days: 851 store-days were visited but failed due to missing footage (over 10 minutes) or other issues.

• Store Distribution: Luckin's 4,507 directly-operated stores were spread across 53 cities. The tracked store-days covered 38 cities, where 96% of the stores are located.

• Location Types: The majority of stores were located in office areas (56%), followed by mall (26%) and others (18%).

• Operating Days: The average weekday operating days per week were 5.00, and weekend days were 1.79, resulting in a 7-day weekly average of 230 orders per store per day.

Conclusion

Luckin Coffee's financial and operational fraud, combined with a fundamentally flawed business model, highlights the risks associated with its growth strategy and financial reporting. The company's reliance on aggressive discounts and lack of sustainable profitability make it vulnerable to market changes and regulatory scrutiny. The evidence suggests that Luckin's reported performance was significantly overstated, raising concerns about its long-term viability and investor protection.