China’s scandal-tainted Starbucks challenger says liquidators handling its U.S. bankruptcy have filed a motion to formally close the case

Key Takeaways:

  • Luckin Coffee said the liquidators handling its U.S. bankruptcy have formally filed to close the case after a recent settlement with holders of $460 million of its convertible notes
  • Development could pave the way for company to relist on the Nasdaq, though the U.S. securities regulator could face pressure to veto such a move

By Doug Young  

This is one liquid that China’s largest coffee purveyor won’t miss.

That’s the sentiment coming from Luckin Coffee Inc. (LKNCY.US), which has announced it is on the cusp of emerging from a prolonged bankruptcy liquidation following a year-long reorganization to put it back on solid financial footing. This particular development isn’t all that earth-shattering, as the company has been keeping everyone updated quite regularly on its efforts to return to financial health.

Many believe the company’s ultimate goal is a return to the Nasdaq’s main board, where Luckin was briefly a favorite after it sold investors on its story of being a high-tech coffee purveyor that could challenge Starbucks (SBUX.US) in the U.S. coffee giant’s second-largest market. But such a return could be difficult due to Luckin’s checkered history that got it kicked off the Nasdaq in June 2020, several months after it admitted to massive accounting fraud. But more on that later.

First, we’ll take a look at the latest announcement saying a Cayman Islands court has formally ordered an end to an ongoing liquidation of the company. In this case “liquidation” is probably a bit misleading, as it appears that true liquidation was never the actual goal and instead the company was working on an agreement to restructure the terms of $460 million worth of convertible bonds it previously issued.

It announced a completion of that restructuring in late January, and this latest announcement notes the Cayman Islands court officially accepted the deal on Feb. 25. Luckin added a court overseeing the bankruptcy in the U.S. also recognized the deal, and last Saturday the liquidators handling that matter filed a formal provision to officially close the case.

There’s no word if the U.S. court has officially accepted the request, but such a move seems almost guaranteed in light of its previous recognition of the settlement and the Cayman Islands cessation of the liquidation. In December 2020, the company also reached a separate settlement with the U.S. securities regulator that included its payment of a $180 million fine related to the fraud.

After all of those settlements and restructuring, the company is looking surprisingly strong with about 5 billion yuan ($792 million) in cash and cash equivalents in its coffers at the end of last September, according to its latest financial report for last year’s third quarter.

“The successful completion of the provisional liquidation is yet another positive step for Luckin Coffee, and has allowed us to significantly reduce our debt burden and improve the company’s capital structure,” said Chairman and CEO Guo Jinyi. “Operating from a position of financial strength, we are focused on executing our growth strategy and continuing to deliver industry-leading services and products to our customers and long-term value for our shareholders.”

Investors weren’t too impressed by the latest development, with Luckin’s over-the-counter (OTC) traded shares falling about 16% in the two trading sessions since the announcement. That’s not extremely surprising, since the company has been issuing regular updates on its reorganization. Still, the actual imminent emergence from bankruptcy is a major symbolic milestone, showing the company no longer needs court protection to stand on its own feet.

New and improved brew

To understand what lies ahead for the company, and why it may face some headwinds in trying to return to big-board trading, we need to do a brief recount of its turbulent history.

Luckin was founded in 2017 and burst into the public eye not long afterwards through a savvy campaign saying it would take on Starbucks in China through its high-tech formula of app-only coffee-on-the-go sales from minimalist stores with little or no seating. The idea looked intriguing since it allowed Luckin to control costs through the use of technology and also lower rents due to the far smaller spaces required for its stores than Starbucks.

Luckin went on to open stores at a lightning pace, overtaking Starbucks at one point and going public in May 2019 – less than two years after its founding. It was always hamstrung by its heavy discounting to attract customers. But the far bigger blow came when an accounting scandal was uncovered in early 2020 that saw the company later admit to fabricating 2.2 billion yuan in sales.

Luckin quickly went from superstar to poster child for the lax accounting sometimes practiced by Chinese companies. Its case was a major factor behind a U.S. law enacted a year ago that now threatens to delist Chinese companies from New York unless Beijing agrees to share information on those companies when the U.S. securities regulator suspects financial irregularities.

While that threat could derail Luckin’s potential relisting, the bigger obstacle could simply be the company’s own history and association with the current U.S.-China frictions. That could make it difficult for the U.S. securities regulator to approve a Luckin relisting on the Nasdaq main board even if it wanted to, since it might not want to look too soft on a company that previously bilked investors of so much money.

After listing its shares at $17 in its 2019 IPO, Luckin’s stock briefly soared as high as $50 before crashing into penny-territory when the scandal was exposed. Its investors took a huge bath when that happened, and many could complain loudly if Luckin were suddenly allowed to relist.

Luckin has completely changed its top management since the scandal, and it is also moving to a franchise model that is far less capital intensive than its early model of self-operated stores. As a result, the company currently had 5,671 stores at the end of last September, more than Starbucks. Its revenue in last year’s third quarter also doubled to 2.35 billion yuan and it posted a modest 23.5 million yuan loss for the period – if you believe the latest numbers.

From a valuation standpoint, the company is currently the biggest in the OTC pink sheets with a market value of $2.7 billion. Its price-to-sales (P/S) ratio of 3 is lower than the 3.6 for Starbucks, which seems justified considering its checkered past but still quite respectable. That figure is also stronger than the P/S of 1.9 for premium Chinese tea seller Nayuki (2150.HK), and also ahead of the 2.3 for Yum China (YUMC.US; 9987.HK) operator of KFC restaurants and the Lavazza coffee chain in China.

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