SINGAPORE (Apr 9): Ivar Krueger, dubbed the Match King, used to kiss women on the wrist when introduced, and not on the hand. He was afraid of germs.
A man of piercing intellect, he helped pioneer safety matches — then used for lighting everything from stoves to cigarettes. His companies produced almost three quarters of the world’s matches.
But Krueger was also a swindler. His empire was built on fictitious sales, which collapsed in the wake of the Great Depression, leading to his suicide in 1932. It was said that he burned through — in today’s money — US$1.5 billion ($2.14 billion) of financier’s funds.
Almost a century after his death, Krueger’s legacy lives on: Not because of his aversion to germs before the Covid-19 era, but due to his use of accounting tricks.
Luckin Coffee — China’s answer to global chain Starbucks — may be one of Krueger’s inheritors. It has been allegedly cooking the books instead of just brewing the coffee.
On April 2, the company revealed that its chief operating officer Liu Jian may have faked RMB2.2 billion ($445.04 million) of sales in FY2019. The amount represents almost half of the projected FY2019 revenue of US$732 million. Liu — who has been with the company since 2018 — was suspended pending an investigation.
The stock sank 81% on April 3 and has lost more than 90% of its value since its May 2019 IPO. Muddy Waters, a short seller led by Carson Block, had announced it was shorting the stock after an anonymous report in January. Luckin Coffee’s angry denial earlier has now come back to haunt it.
Chairman Charles Zhengyao Lu and CEO Jenny Zhiya Qian have defaulted on the US$518 million margin loan. Their shares have been handed over to the banks.
Luckin Coffee was founded in October 2017 in Xiamen. It rose in breakneck speed from a startup to a Nasdaq listing in just 18 months, backed by shareholders including GIC and Blackrock. It’s revenue was projected to grow six-fold y-o-y in FY2019. Its 4,500 outlets exceed that of Starbucks in China. It also raised US$645 million in its IPO.
In its listing, Luckin Coffee’s management — projecting a Krueger-esque confidence — presented itself as a rival to Starbucks, where the average cup of coffee was sold at about a third cheaper. But coffee was sold not through a transaction with a cashier who doubles up as a barista. Instead, the purchase would be through an app and delivered through cheap delivery platforms.
Luckin Coffee also avoided the fancy furniture and large floor space of its major rivals. In fact, its outlets were basically holes in the wall slightly larger than a teh tarek (pulled tea) shop. Customers were wooed by coupons and what was touted as premium Arabica coffee.
The chain’s rapid revenue growth drove a sea of red through its income statement and cash flow statement. In FY2018, its losses were 1.5 times more than its revenue. In a perverse twist, this cash burn actually increased its merits in the heady summer of 2019. Investors were willing to tolerate and fund the cash burn, as long as a path to profits was remotely discernible.
Apart from its extremely short operating history, there were glaring red flags. The management had sold 49% of their stock holdings through pledges. This eventually magnified the sell-off through margin calls.
The company announced store-level profitability in 3Q2019. This meant that it was profitable excluding operating expenses and other charges. However, the latest revelations seem that sales have been fabricated to satisfy this yardstick. Its net selling price was inflated, according to the anonymous short selling report.
The final source of suspicion could be the need to raise funds without a discernible purpose, except to bridge the cash burn. Just before the Covid-19 carnage, it raised another US$865 million via a convertible bond issue and share sale.
The combination of growth fuelled by a cash burn and a massive share pledge was an unpalatable brew. We may have entered a bear market, when the scandals are exposed. Cooking the books can be as destructive as any kind of disease. Caution would serve investors well, just like Krueger’s wariness of germs.
Nirgunan Tiruchelvam is head of consumer sector equity at Tellimer (Exotix Capital)
