Luckin’s fresh $1 billion infusion hints at M&A ahead

The coffee giant could try to purchase a domestic or international rival, following the big new investment by its controlling stakeholder Centurium and Mubadala Investment

Key Takeaways:

• Luckin looks likely to use a fresh $1 billion in new investment for M&A, since the company is already quite cash rich and strongly cash-flow positive
• Potential acquisition targets could include Blue Bottle, Costa or Massimo Zanetti Beverage globally, or a local coffee or bubble tea chain in China

By Doug Young

How do you bring some warmth back to a rapidly cooling cup of coffee?

If you’re Luckin Coffee Inc. (LKNCY.US), the world’s second largest coffee chain behind only Starbucks, the answer could well be to look for a major acquisition to bring back some excitement to your story. That’s our key takeaway following the Thursday announcement of a massive $1 billion new investment into Luckin, which is already quite cash-rich and hardly needs the money to fund its existing operations.

The companies behind the fresh investment, as well as the wording, also suggest some M&A could be brewing up for Luckin. The money is coming from private equity firm Centurium Capital, which is Luckin’s controlling shareholder, together with Mubadala Investment Co., a Middle Eastern sovereign wealth fund based in Abu Dhabi.

Centurium said the aggregate transaction was valued at $1 billion, but didn’t say how much specifically it or Mubadala was providing. Based on Luckin’s latest valuation of about $10 billion, the new investors would get about 10% of Luckin in exchange for their cash. Centurium is already Luckin’s single biggest shareholder with about 23% of its stock and 44% of its voting power. That means this latest deal will leave Centurium and Mubadala with a majority of Luckin’s shares combined, giving them absolute control of the company if they choose to act in tandem.

Investors weren’t too impressed with the deal, sending Luckin’s stock down 1.8% on Thursday after the announcement. The reality is that Luckin’s stock has been largely flat over the last year as investors rapidly lose interest in its growth story. A big part of that waning interest probably owes to the company’s complete reliance on opening new stores at lightning speed to keep its revenue growing. But as it does that, its overall operation is becoming less profitable.

Reflecting that, the company’s store count grew 39% year-on-year to 36,310 worldwide by the end of June this year. But its revenue grew by a slower 28.5% to 15.9 billion yuan ($2.37 billion) over that period. As new store openings outpaced revenue growth, same-store sales for Luckin’s self-operated stores fell 5.3% in the second quarter, accelerating from a 0.1% decline in the first quarter, ending four consecutive quarters of growth last year.

As its revenue per store fell, the company’s profit rose just 16.1% to 1.49 billion yuan in the second quarter, trailing the growth rate for both revenue and store count.

Cooling enthusiasm toward Luckin is also reflected in its price-to-earnings (P/E) ratio of 19, which is below the somewhat inflated 58 for Starbucks (SBUX.US). But we should point out it’s ahead of the even lower 11 for Mixue (2097.HK), China largest seller in the country’s overheated bubble tea market.

As we previously noted, Luckin is quite a cash-generating machine and clearly doesn’t need this fresh $1 billion to fund its current operations. The company recorded net cash inflow of 2.63 billion yuan in the second quarter, roughly the same as the 2.56 billion yuan it recorded a year ago, even as it spent nearly $200 million in the latest quarter to buy back its stock. Its strong cash flow allowed it to build up its cash reserves and short-term deposits to 10.9 billion yuan at the end of June, up from 9 billion yuan at the end of last year.

Who to acquire?

Having made our case that this new $1 billion investment is almost certainly earmarked for M&A, we’ll look at what potential acquisitions Luckin could make. One of the most obvious would be premium coffee chain Blue Bottle, which was acquired by Centurium earlier this year for $400 million from Nestle. At the time of that purchase, a source close to the deal told financial media Caixin that Centurium didn’t plan to integrate Blue Bottle with Luckin.

Blue Bottle is quite different from Luckin, both in terms of scale and also brand positioning. Based in California, Blue Bottle only has about 100 stores worldwide in Canada, Japan, South Korea and China. It’s also quite a premium brand, selling its coffee for nearly 50 yuan per cup, or roughly triple the 10 yuan to 20 yuan that Luckin charges.

Centurium and Luckin also reportedly bid jointly last year for the Costa Coffee, which has around 2,000 stores globally and was being shopped by owner Coca Cola. Coke ultimately scrapped the sale plan after the bids it received were all reportedly well below the 2 billion pounds ($2.7 billion) it was seeking. But the new cash infusion and more potential backing from Mubadala could potentially prompt Luckin to try again at a higher valuation.

Then there’s Italy’s Massimo Zanetti Beverage Group, which is reportedly being shopped by private equity owner QuattroR, which is seeking to sell the company at a valuation of up to 1.2 billion euros ($1.4 billion), according to a June report in Coffee Geography magazine. At least six private equity firms were interested in the company, according to the report, though Centurium wasn’t listed as one of those.

Significantly, the Italian company’s main business is coffee roasting, though it does own a chain of about 400 stores. It operates in more than 110 countries and controls around 40 coffee and tea brands, including Chock full o’Nuts and Hills Bros. in the U.S. and Boncafé in Asia.

Finally, there’s also the potential for a domestic acquisition, which is suggested by the wording in the Thursday announcement. In his comments on the move, Mohamed Albadr, Mubadala’s head of private equity for Asia, said: “We continue to see compelling long-term opportunities in China’s consumer sector.” That seems to suggest the Middle Eastern sovereign fund might like to see Luckin make an acquisition at home.

There’s certainly no shortage of potential acquisition targets in China, whose coffee market has become extremely overheated in the last decade. Some of the larger operators after Luckin and Starbucks include names like Manner Coffee, M Stand and Seesaw. Then there’s also Cotti Coffee, which was founded by Luckin’s original co-founders after they were forced to leave Luckin in the wake of a major accounting scandal in 2020. Some of China’s many bubble tea makers could also be attractive targets due to depressed valuations in that equally overheated market.

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