Starbucks of China Stock Luckin Down 80% on Fraud Probe

If stock buybacks are toxic for wealth equality on the stock market, short sellers play an important role, I think. Take the example of Luckin (LK) which is a new-ish coffee chain based out of China.

An independent special committee was formed to oversee the internal probe on audit issues. Luckin Coffee disclosed that an internal investigation has found that its chief operating officer fabricated 2019 sales.

So what are we talking about here? Starbucks rival Luckin Coffee faked nearly half of its roughly $732 million in sales. That’s outrageous and shows how the bull market delivered a few companies that were literally too good to be true.

I typically like Chinese growth stocks, but this could only happen in China. In a filing with the SEC this morning, the company’s board announced that it has initiated an internal investigation into the activities of its former COO, Jian Liu, who may have inflated revenues by the company by an early estimate of more than $300 million (RMB2.2 billion).

I’ve never heard of anything like this, while rumors have surrounded this company for months. The company told investors in its filing that they shouldn’t rely on the company’s recent financial statements, which are now believed to be inaccurate, given the surfacing of this information.

Muddy Waters Research said in January that it bet against the stock in light of what it described as fraud and a “fundamentally broken business.” While I’m all for stopping corporate buybacks and even dividends, short sellers clearly play an important role as real-time stock market detectives.

There’s something heroic about pointing out fraudulent business models and sketchy management teams to keep the markets honest.

$310 million is the difference for Luckin being profitable or not. Shares cratered more than 80% in premarket trading after the release of the regulatory filing. The investigation found that Jian Liu, Luckin’s chief operating officer, and several employees who reported to him had engaged in misconduct, including fabricating sales.

When you go and do a flashy IPO in the U.S. please understand, China, that you cannot conduct fraudulent practices, even if Beijing wants you to.

The announcement of the investigation comes just days after the company appointed two new independent directors to its board. Last week, the company announced that Tianruo Pu, a seasoned accounting executive would be joining the company.

The coffee chain previously said net sales for the first nine months of 2019 were 2.9 billion yuan ($413 million). The supposed cult of coffee in China might not be as great as previously reported.

Stocks that take on a cult-like brand such as Uber, WeWork and even Tesla, are in a sense dangerous. A cult-like brand can warp consumer sentiment into over-bullish territory.

I think China. in its aggression to copy American brands, needs to understand the dangers of hyping cult-like growth narratives that may not in fact be true. The era of faking it till you make it may be over in the 2020s.

If Luckin Coffee fabricated hundreds of millions of dollars worth of coffee orders, what does that tell us about shiny Chinese startups? That they are willing to do nearly anything to get ahead? Worse yet if their HQ is in Beijing, they must be under incredible pressure. One wonders about ByteDance’s startling rise to power in view of how TikTok operates.

The company has since suspended the individuals involved in the misconduct and will pursue legal action against them. If China lies about coroanvirus infection cases, what else does it lie about? When you inflate statistics you tamper with the viability of your brand and reputation. In February, Luckin Coffee denied what it called “misleading and false allegations” that the chain had inflated sales. What happens in China, doesn’t stay in China.