LKNCY.US

Charles Lu and Jenny Qian, Luckin executives who were ousted in a finance scandal, are back in the coffee business with a fast-growing chain of new stores

Key Takeaways:

  • Cotti Coffee is boosting its market share with a big publicity campaign, rapid store openings and low prices, the same formula used by Luckin Coffee
  • The new brand, founded by Charles Lu and Jenny Qian, might struggle to access financing after the sales scam at Luckin Coffee

 

By Tina Yip

First they shook up the car rental business, before launching an upstart coffee shop chain that vied with Starbucks (SBUX.US) for dominance in China. But the entrepreneurs behind the spectacular rise of Luckin Coffee (LKNCY.US) fell back down to earth with a thud in a financial scandal nearly three years ago.

Now Charles Lu and Jenny Qian are on the comeback trail, boldly attempting to conquer the coffee shop business again, this time as competitors to Luckin. Their latest venture is a rapidly growing chain under the brand name Cotti Coffee. Can the disruptors do it again, despite the lingering stigma of the Luckin scandal?

The business duo came close to beating Starbucks in the Chinese market. In 2019, Luckin Coffeehad more than 4,500 outlets in China, overtaking the roughly 4,100 stores in the Starbucks network. But the executives were ousted in July 2020 after the accounting scandal broke, and revelations about fabricated sales triggered a wider U.S. regulatory probe of Chinese companies.

With their industry experience, the pair had no trouble cloning the concept behind Luckin’s early success. Cotti’s website is explicit about its managers’ background in the coffee business, saying the company was built “by Luckin’s founder and former CEO, Ms. Jenny Qian, together with Luckin Coffee’s original core team, with registered capital of $200 million”.

On Oct. 22 last year, Cotti’s first outlet was launched in an office block, Fuzhou International Financial Center, in China’s southeastern province of Fujian. Lu has been upfront about his ambitions, saying “the coffee dream team starts the journey again” as the firm touted for business with a publicity campaign and a competitive price per cup. The brand became the sponsor of Argentina’s national soccer team and openly challenged Luckin by retailing its coffee at a mere 9.9 yuan a cup.

Back in the subsidy game

By this April, Cotti had expanded to 1,199 outlets across China, around 8 times more than in December last year. The company is about to open 365 stores and has plans for 520 more.

It’s a familiar blend of a publicity push, competitive pricing and high-speed store expansion. Lu and Qian applied a similar strategy in 2017 to secure five rounds of financing for Luckin, raising nearly $1.4 billion and finally taking the coffee brand public in New York within just two years.

Drawing on capital to support heavy subsidies is a theme running through Lu’s career. Starting in 2007, he used this tactic to turn Car Inc. into China’s biggest car rental company in less than six months. After multiple rounds of financing the company listed on the Hong Kong Stock Exchange in 2014. The allure only faded after the Covid outbreak and the controversy over Luckin’s finances. At an earnings presentation in 2020, Car Inc. CFO Cao Guangyu said bluntly that the Luckin scandal had made refinancing impossible. Eventually Car Inc. was privatized and delisted by the private equity giant MBK Partners.

With a bitter aftertaste from the Luckin scandal, will investors want to consume another business brew from Lu’s team? There has been no indication that Cotti needs capital right now, but any fund-raising would be challenging, judging by the experience of two other Lu brands.

After his departure from Luckin, Lu founded noodle shop Qu Xiaomian in 2021. The chain was reported to be seeking up to 100 million yuan ($14.5 million) in the market to secure a valuation of 1 billion yuan, but the efforts fell flat.

It was a similar story at his ready-to-cook food brand “Shejian Yingxiong”, which had plans to open 3,000 stores in five months. The company gained 2.1 billion yuan in two rounds of financing, but the rapid expansion has not materialized. Financing efforts stalled and the company launched a wave of business closures.

Luckin was heavily fined over the scandal, which also turned Lu from a billionaire into a potential credit risk. Publicly available information on an official Chinese judicial website shows 10 enforcement rulings against Lu. The sums amount to more than 4.5 billion yuan, of which more than 3.4 billion yuan is outstanding. The website has no records relating to Qian.

Hard to access finance

That may explain why Cotti’s website did not mention Lu by name, choosing to focus on Qian, his business partner. The commercial relationship goes back a long way. Qian worked for Lu when he was CEO of Car Inc. and was later promoted to the positions of executive vice president and COO.

Commenting on the scandal impact, a Chinese private equity fund manager said the capital market was disappointed with Lu and had since become wary. “After the official regulation in the last two years, investors are more conservative and cautious about splurging money, so corporate financing is not as easy as it was a few years ago,” said the fund manager, who asked not to be named.

Without capital support, Lu and Qian can only expand the Cotti chain by attracting franchisees. According to its website, the company does not charge a franchise fee and a store can be opened with as little as 115,000 yuan. Under the self-management model, stores with monthly gross profit of less than 20,000 yuan do not pay service fees, but above that level charges of 10% to 25% of gross profit are levied.

The barrier to entry is much lower than for Luckin. As a result, Cotti attracts aspiring entrepreneurs on tighter budgets, especially among the younger generation. The lower start-up costs are the main driver of Cotti’s rapid growth.

In the run-up to Luckin’s New York listing, Qian maintained that coffee did not have to be marketed as a luxury drink in China, saying the company could heavily subsidize the price for up to five years without worrying about profitability.

A business that boosts sales through subsidies, without chasing profits, naturally invites questions about the sustainability of the business model. Within six months of its launch, Cotti has had to raise its prices per cup to slow down its rate of capital burn.

If it follows the Luckin playbook, Cotti would next be looking at an IPO. The private equity fund manager says a New York listing would be out of the question because of the Luckin scandal. “It will also have a hard time if it turns to Hong Kong for an IPO, as the regulators there will definitely scrutinize it harshly,” the fund manager said.

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