Some may have forgotten all about Luckin Coffee (LKNC.Y -0.39%), and that's understandable. The once high-flying Chinese coffee retailer caught the imagination of growth investors in 2019, before prior management was caught fabricating hundreds of millions of dollars in sales in March of 2020.
After the subsequent stock crash and fallout, former management was ousted, but prior chairman and large shareholder Charles Lu both escaped scrutiny and retained some influence over the company -- influence that unfortunately continues to this day. Moreover, Luckin's stock fell recently after it filed a petition for recognition under Chapter 15 bankruptcy.
However, there may be some confusion as to the bankruptcy filing, which is different from Chapter 11 liquidation. Furthermore, Luckin just completed an investigation that could further distance the company from prior management, which is apparently trying to sabotage its new CEO. With a lower share price, is it time to buy?
Image source: Getty Images.
Investigation revealed no wrongdoing by current CEO
First, some recent history. In January, several mid-level and senior-level executives wrote a letter to the board of directors accusing new CEO Jinyi Guo of "corruption, abuse of power to eradicate dissidents, and low capability to run the company." Guo denied the allegations, and posited that the letter may have been the work of Charles Lu and other ousted senior managers.
It's perhaps not surprising that Guo has been absolved by an independent investigation into the matter, and that his inkling of Lu's complicity was correct.
The new board formed a panel, consisting of independent directors and joint provisional liquidators (JPLs) appointed by the Grand Court of the Cayman Islands. The panel also sought the help of outside lawyers and forensic accountants. After a monthlong investigation, which included 40 employee interviews and a review of 50,000 documents, the panel concluded that there was no evidence Guo acted improperly; it also concluded that "certain members of the Company's former management participated in the planning of the Petition Letter."
For those new to the story, former founder, chairman, and large shareholder Charles Lu has been an annoying continuing presence at Luckin, even though he himself was responsible for the widespread fraud that put the company in its current perilous condition.
Still, it's a promising sign that the board has Guo's back as he attempts to repair the company's financials and reputation. Lu could continue to be a presence, but it appears his grip over Luckin may be diminishing.
Chapter 15 isn't like Chapter 11
Interestingly, the refutation of Lu and support for Guo have coincided with a lower stock price, since Luckin's over-the-counter shares plunged following the release of its Chapter 15 filing on Feb. 5.
However, even though Luckin's stock price is now about half of what it was before that filing, Chapter 15 is quite different from Chapter 11. Chapter 11 occurs when a company cannot meet its debt or other liability obligations, and must restructure, usually by wiping out shareholders.
That's different from what Luckin Coffee is doing. While Luckin is attempting to restructure its $460 million in convertible notes due in 2025, according to an investigation by the court-appointed JPLs, the company still had over $740 million in cash on the balance sheet as of the end of November. It's unlikely all of that cash has been used up by now. While I'm not a bankruptcy expert, it appears the Chapter 15 filing is more procedural, and a step that may prevent additional lawsuits in the U.S., following the company's settlement with the Securities and Exchange Commission.
A statement from the JPLs stressed this fact for investors:
The primary purpose of the Chapter 15 filing is to invoke the automatic stay to prevent the commencement or continuation of claims against the Company or other parties in the United States while the Joint Provisional Liquidators continue their efforts to achieve a restructuring of the Company's indebtedness. The Chapter 15 filing also seeks to centralize administration of the restructuring through recognition and enforcement of schemes of arrangement, once approved and sanctioned by the Cayman Islands Court, providing certainty and finality for stakeholders in respect of their claims. ...
The Chapter 15 filing is a routine filing in the context of Cayman restructuring involving international jurisdictions and should not be confused with a terminal bankruptcy process involving the winding down, sale or liquidation of the company.
So is there an opportunity in Luckin shares now?
Luckin's current market cap is roughly $1.8 billion, or around 2.5 to 3 times estimated sales in 2020. That's pretty cheap and actually kind of tempting.
However, there are still huge risks to consider. First, we still don't know how much cash Luckin is burning each quarter, or how profitable the company is overall. While the JPLs noted that the company's store-level profit had reached breakeven in aggregate for the first time in August 2020, there are obviously overhead expenses, so that doesn't mean the company on the whole is profitable.
Second, we also don't know what kind of deal the JPLs may strike with the convertible bondholders. Since those bonds were sold under false pretenses, the bondholders could potentially receive a lot of shares in any sort of deal, severely diluting current shareholders. The outcome is uncertain, but considering these notes are already in restructuring even though they don't mature until 2025, more concessions to convertible holders could be on the way.
Finally, there's still a big risk from prior management, especially former chairman Charles Lu. While the independent panel thwarted the recent attack on current management, it's clear that the former senior executives, who fomented the false sales and ensuing scandal, are still trying to shape the direction of the company, even from their diminished status as passive shareholders. While it's good that Guo was absolved by the board, there's a high probability this may not be the last time Luckin must deal with the meddling of Lu and his group. Luckin shareholders should be prepared for more shenanigans from Lu, even if they don't stick.
All in all, Luckin still remains a hugely speculative stock only appropriate for investors with money they can afford to lose -- though the deep value investment case has admittedly gotten brighter over the past few days.
