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Luckin Coffee IPO - Luckin coffee cup on a counter

In Hot Coffee: Where the Luckin Coffee IPO Went Wrong

By | General

China’s great Starbucks rival, Luckin Coffee, hit on the nerves of a lot of investors last week – and the coffee wasn’t to blame. A precipitous share price drop of 39 percent from its previous peak seems to have dampened the market’s thirst for java. But it wasn’t always this way.

A few weeks ago, Luckin’s story was one of promise and potential: a young upstart brewing a revolution against multinational coffee overlord Starbucks.

With an oversubscribed public listing in the US, the company raised US$651 million. Its rapid growth continues, with Luckin aiming the top of the market by year’s end, opening 4,500 coffee shops across China.

So what went wrong?

Luckin built itself up using the formula of China’s hyper-growth tech startups: grab market share from a Western incumbent through aggressive growth, heavy subsidies, and a unique tech-focused approach.

Unfortunately, this playbook works better for perennially private tech firms than young upstarts with public market ambitions.

Smartkarma Insight Providers have tracked the company on the lead-up to its IPO, and their early concerns echo the market’s current misgivings pretty accurately.

A Nascent Coffee Culture

From the outset, LightStream analyst and Smartkarma Insight Provider Oshadhi Kumarasiri noted some of the challenges in a note published on 2 May. For one, coffee is just not that huge in China yet.

While the overall Chinese coffee market grew at a CAGR of around 30 percent from FY 2013 to 2018, it still makes up just about 2 percent of the global market.

“Even if this rapid growth continues, we expect it will take another 15-20 years minimum for the Chinese coffee market to reach the size of the US coffee market,” said Kumarasiri.

In that light, Luckin’s shop-opening spree doesn’t look promising. In less than two years, the company has opened 2,300 stores in China, and is looking to almost double that by the end of 2019.

To compare, Starbucks reached 3,800 stores in the country over a steady and measured approach over the past 20 years.

Luckin Coffee vs Starbucks stores in China

By splurging on rapid growth, Luckin has very little room to maneuver on costs like store rentals, operations, payroll, and more.

“Our base case assumptions forecast Luckin’s gross loss to reduce over time. However, even after the improvements, we expect the gross margin to remain negative in 4Q2021,” Kumarasiri pointed out.

Read Oshadhi Kumarasiri’s Insights: Spilling the Coffee: Rapid Expansion Without Much Due Diligence Could End in Disaster and Luckin Coffee: Top Line Growth May Not Be Enough to Generate Positive Operating Margins

Coupon Craze

Then there are those aggressive discounts and subsidies.

“Presently, Luckin’s average revenue per unit of a brewed drink is less than half of the listed retail price (starting at RMB 21), thanks to massive discounts and free coupons that are on offer,” said Investory analyst and Smartkarma Insight Provider Devi Subhakesan in a report.

Coffee delivery is also highly subsidised, with fee charges for delivery covering only one-fifth of delivery expenses.

Meanwhile, Insight Provider Zhen Zhou Toh of Aequitas Research found that, among other costs, 89 percent of Luckin’s revenue goes to “ads, free promotion, and delivery.”

Read Devi Subhakesan’s Insight: Luckin Coffee: Looking at the Good, the Bad, the Unsure, and the Future

A History of Cash Burning

In a different Insight, Toh explored Luckin’s pedigree, especially regarding Founder Jenny Qian’s connection with automotive startups UCAR and CAR. Both companies, founded by Qian’s mentor Charles Lu, followed the exact same cash-burning strategy to achieve growth against incumbents like Didi Chuxing and Uber.

As Toh noted, Lu is an active player within Luckin as well, attracting some of the same investors to the new venture. And looking at CAR and UCAR’s IPOs, which both fizzled after an initial high, it’s hardly surprising that Luckin’s listing went a similar way.

To further drive the point home, Aequitas compiled 30-day stock performances of recent Chinese IPOs in the US, including Pinduoduo, Tencent Music, and NIO. Most of them dropped off after a first-week high, and Luckin was not going to be an exception, Toh warned.

Luckin Coffee IPO

Chart by Aequitas Research

“We think that after the first week, the market will adopt a wait-and-see approach until the next quarter announcement to see whether management can deliver the growth that they have promised,” he wrote.

Read Zhen Zhou Toh’s Insights: Luckin Coffee (瑞幸咖啡) IPO Trading Strategies, Luckin Coffee (瑞幸咖啡) Vs. Starbucks (星巴克) – Still Has a Long Way to Go, Luckin Coffee (瑞幸咖啡) – The Art of Burning Cash for Market Share

Future Brew

It’s not all over for Luckin. The big bet will be achieving sustainability, or even profitability, before the cash runs out.

“A long-term sustainable coffee shop/chain business model cannot afford to run like a fashion brand,” said Subhakesan.

The analyst expects the company to phase out aggressive discounts, which will improve average realised revenue. If it manages to stabilise volumes as stores mature, offsetting the fall in discount-powered demand, net operating margins should improve to 20 percent, she calculated.

Luckin will still need to keep an eye on the competition, however. For example, Starbucks China now offers both online ordering and delivery – two of Luckin’s unique selling points.

“We feel the risk is too high with Luckin Coffee, especially when there’s a much safer investment option into the Chinese coffee boom by way of Starbucks,” Kumarasiri concluded, two days before the NASDAQ listing.

Read more IPO coverage on Smartkarma!

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Exchanges Redefine Their Role as More Than Just Listing Boards

Exchanges Redefine Their Role as More Than Just Listing Boards

By | Corporates

Choosing an exchange on which to list might be one of the most important decisions a company will ever make.

The reasons underpinning this may vary from one company to another but some common denominators remain. Among them, metrics like Average Daily Trading Volume, which serve as a reliable indicator of market liquidity.

Liquid boards make it easy to buy and sell securities. As such, they tend to carry greater investor appeal. This might explain, at least in part, why some companies choose to list on foreign exchanges instead of those in their home markets.

Exchanges Unite

Faced with this current reality, many exchanges are now embarking on a raft of initiatives to enhance their unique “listing” proposition.

One trend that’s catching on is the establishment of cross-border partnerships, such as the fairly recent multifaceted accord agreed between the Shenzhen Stock Exchange (SZSE) and the Indonesia Stock Exchange (IDX).

“Both parties reached consensus on jointly building a China-Indonesia small- to medium-sized enterprises capital market service plan to leverage the SZSE V-Next Platform [an initiative to facilitate innovative capital formation] and the IDX Incubator mechanism [to support digital-based startups],” the SZSE mentioned in a statement, citing one of several areas of cooperation.

As an added benefit, the agreement could also open new doors for SZSE to actively participate in the ASEAN+3 Bond Market.

Only time will tell how such partnerships will fare. Nonetheless, they set an encouraging precedent for more exchanges to follow.

Identifying and Supporting Future Listers

Exchanges used to be viewed mainly as a final destination of sorts for startups, with public listings seen as hallmarks of success.

While that perception still holds true to some extent, listing boards around the globe are making deliberate attempts to alter this perception. Some are doing so by inserting themselves into the heart of a still-private company’s business journey.

Germany’s Deutsche Börse, for instance, supports founders of startups from the financial sector via its Venture Network, which aims to improve their financing situations. Numerous fintech firms also base their headquarters at the Deutsche Börse FinTech Hub – 450 square metres of individual offices and co-working spaces.

But that’s not all.

Refusing to rest on its laurels, the German exchange announced in March 2019 further plans to develop the Hub and bring in new startups by tying up with fintech community platform TechQuartier.

This example clearly demonstrates how exchanges are proactively repositioning themselves as early-stage partners of prospective listers.

Going Above and Beyond

To the extent that some exchanges go the distance to attract new listings, a few others go further by maintaining that commitment even after companies list.

Here’s one: The Stock of Exchange of Thailand runs an investor relations professional development division to help IROs of listed firms build communication and engagement capabilities.

Upskiling IROs happens to fall under the domain of IR associations, too. Read more about what they do: Don’t Let Your IR Association Membership Go to Waste

And, here’s another: In Singapore, smaller-cap companies on the Singapore Exchange will benefit from a S$75 million (~US$54 million) funding programme launched earlier this year by the country’s central bank. Part of the grant aims “to groom a pipeline of equity research analysts and retain experienced research talent to initiate research coverage primarily of listed mid- and small-cap enterprises.”

Beyond Exchanges

The aforementioned initiatives can potentially inject an added measure of value into both prospective and existing listers.

Moreover, they evidence the renewed commitment of listing boards to be more than just market-making platforms, but as a partner that has the best interests of their listers at heart.

Even so, companies should still take initiative to make the most out of the value provided by exchanges. For starters, why not empower their IROs to engage investors more independently?

Sign up for a FREE account on Smartkarma’s Corporate Solutions, a brand-new range of services for C-Suite and Investor Relations personnel of listed companies that’s been designed to help IR professionals establish and maintain valuable connections to the investment and analyst communities.

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