Luckin Coffee Accuses COO of Fabricating Sales, Inflating Expenses

    Some $5 billion of the company’s market value disappeared after the news.

    Finance | April 2020 | Ben Coley
     Street view of Chinese people leaving a Luckin Coffee shop in Wuhan China.

    istock/Julien Viry

    Luckin formed a special committee to oversee the investigation.

    Chinese coffee chain Luckin Coffee has accused its chief operating officer of fabricating sales to the tune of 2.2 billion in yuan, or $310 million.

    The brand initiated an internal investigation after issues were raised during an audit. COO Jian Liu, and the employees who followed his orders, were suspended.

    “The company will take all appropriate actions, including legal actions, against the individuals responsible for the misconduct,” Luckin said in a statement.

    Luckin’s stock price dropped more than 70 percent after the company made the investigation public. The allegations destroyed more than $5 billion, or 75 percent, of the company’s market value.

    The investigation found that sales between Q2 and Q4 were fabricated. In addition, costs and expenses were inflated. However, the numbers have not been independently verified by an independent auditor and are subject to change, the company said.

    WHERE IT STARTED: Luckin faces down fraud report

    Luckin reported a net revenue of 2.93 billion yuan, or $413 million, in the nine months ending September 2019, which was up from 375 million yuan, or $5.3 million, in the year-ago period, according to the Wall Street Journal.

    The company said investors should no longer rely on previous financial statements and earnings releases for the nine months ending September 30, 2019, and the two quarters starting April 1, 2019 and September 30, 2019, including the prior guidance on net revenues from products for Q4 2019. Kirkland & Ellis is serving as independent outside counsel and it is being assisted by FTI Consulting as an independent forensic accounting expert. Luckin said the investigation is at a preliminary stage.

    In January, short seller Muddy Waters received an 89-page anonymous report alleging several instances of fraud. The report, which Muddy Waters posted to its Twitter account, claimed the number of items per store was inflated by at least 79 percent in Q3 and 88 percent in Q4. The document was supposedly supported by more than 11,200 hours of videotaping. More than 90 full-time and 1,400 part-time staff members were used to run surveillance and record traffic. 

    “When Luckin Coffee went public in May 2019, it was a fundamentally broken business that was attempting to instill the culture of drinking coffee into Chinese consumers through cut-throat discounts and free giveaway coffee,” the report stated. “Right after its $645 million IPO, the company had evolved into a fraud by fabricating financial and operating numbers starting in [third] quarter 2019.”

    Luckin formed a special committee to oversee the investigation. Chairman of that special committee is Sean Shao, who the report states is/was on the boards for “some very questionable Chinese companies listed in the U.S. that have incurred significant losses on their public investors.”

    After the report became public, Luckin denied the allegations and said, “The methodology of the Report is flawed, the evidence is unsubstantiated, and the allegations are unsupported speculations and malicious interpretations of events.”

    Luckin operates more than 4,500 stores in China after being founded only a few years ago. Last spring, the company went public, raising approximately $645 million in the IPO. The company prides itself on eliminating the cashier-customer interaction by handling the purchase process digitally. More than 90 percent of its units are pick-up stores around office buildings and universities to target its millennial customer base.