The Anonymous Report that brought down Luckin Coffee with Rui Ma

In episode 324, Rui Ma, co-host of Tech Buzz China podcast and a trusted voice on China Tech joined us on a conversation to dive deeper on the anonymous report that unveiled Luckin Coffee’s recent debacle. We start with a quick history of Luckin Coffee with Rui Ma breaking down the backstory on how Luckin Coffee’s alleged fraud came to light and the impact after the fallout. Rui Ma dived deeper beyond the original story with an analysis of the anonymous report entitled “Luckin Coffee: Fraud + Fundamentally Broken Business”. Last but not least, she discussed the implications of Luckin Coffee’s debacle and how investigative reporting and corporate activism will impact the public listings of Chinese companies in the US.

Here are the interesting show notes and links to the discussion (with time-stamps included):

• Rui Ma, Creator & Host of Tech Buzz China podcast by Pandaily produced by SupChina (LinkedIn, @ruima) [0:26]
  • Since our last conversation, what have you been up to? [0:30]
• Luckin Coffee Debacle [1:36]
  • Disclaimer: The information provided here by our host and guest are not here to encourage buying or selling any equities mentioned here and investing is strictly our audience’s own responsibility. So, please do your homework. 
  • Origins of Luckin Coffee has been covered by Matthew Brennan in Episode 279 and it was starting to challenge Starbucks Cafe in China two years back.
  • Highly recommended: Rui Ma and Ying Ying Lu in Techbuzz China Episode 65 (Extra Buzz Special): Luckin’s luck ran out
  • To help our audience, Luckin Coffee (瑞幸咖啡) started off with the on demand delivery model and did not have physical stores similar to Starbucks. Then it started scaling up by burning investment cash and building physical stores. The investors came from a variety of sources (according to CB Insights): venture capital (JOY Capital), asset management fund (BlackRock), private equity (Centurium Capital), China International Capital Corporation or CICC (investment bank) and GIC (the sovereign wealth fund in Singapore).  
  • Let’s start from today and work backwards to what happened that led to alleged fraud of Luckin Coffee being announced by the company.
    • How was alleged fraud for Luckin Coffee come to public attention? (Source: Luckin Coffee’s filing of 6K) [3:04]
    • What was the alleged fraud about and how much has been uncovered? [4:23]
    • Who are the people behind the alleged fraud? [5:27]
    • What is the impact given the announcement of the alleged fraud by Luckin Coffee, from stock crashing to customers rushing to claim their coffee? (Source: SCMP) [7:08]
    • Luckin Coffee has been a strange story in China. What is the business model that led to them going public? [9:11]
  • The Anonymous Report titled “Luckin Coffee: Fraud + Fundamentally Broken Business” [11:40]
    • Citing the Extra Buzz Newsletter #7: “The report was very extensive 89 pages, utilized 92 full time, 1418 part time staff on the ground who recorded 11,000 hours of video, which is almost 3 years worth of store days covering 620 stores in 38 different cities.”
    • Basically, it is this report that fanned the flames for Luckin Coffee in their present state. However, there’s a lot of confusion of who did the report, for example, 燃财经 Rancaijing and Muddy Waters leeched off from the report (and somehow Western Media mistakenly attributed to them). So, the first question, what are the key facts behind the report? [12:24]
    • The report have two interesting parts titled “The Fraud” and “The Fundamentally Broken Business Model”. Let start from the first part “The Fraud”, what are the key smoking gun evidence and red flags cited that led to the alleged fraud claim in the report? 
    • What are the business model flaws cited in the report that claims that Luckin Coffee has the fundamentally business model? [15:16]
    • Let’s zero in to one key red flag from the “Fraud” section: “Number of items per store per day inflated by 69% in 2019 3Q and 88% in 2019 4Q, supported by 11,260 hours of store traffic video”, can you explain how the report presents its investigation and use the numbers to get to the conclusion? [18:44]
    • The anonymous report took a very strong look at the unit economics of Luckin Coffee (Business Flaw #3) at page 78: what are the key arguments from the report that establish that Luckin Coffee is not able to be profitable? [20:40]
    • With such a construction of an elaborate report and this entire episode can be turned into a “Billions” TV series episode (by Showtime), the $1m dollar question: who is behind the report and what is their motivation behind it? [24:06]
  • Aftermath 
    • Who benefits from the entire Luckin Coffee’s debacle? [25:44]
      • The hedge funds
      • Starbucks in China, given that 30% of their revenues came from China before Luckin’s entrance to challenge them. 
    • One interesting consequence of this Luckin Coffee episode, is the quality of investigative reporting for corporate fraud in China. The anonymous report took a lot of effort in constructing the actual picture by people going undercover to find out the actual numbers. We notice that this is getting better whenever each scandal pops up in the market. Does that mean that we will see more of these exposes? [27:16]
    • What are your first thoughts when the report was first released into the public? [30:00]
    • Do you think that how Chinese companies should do to dispel myths or being challenged about their businesses? [31:48]
    • What do you think that the US investor learn from this episode? [33:30]
    • Do you think that the English and US media have reported the Luckin Coffee narrative properly? [35:47]
  • Closing [37:52]
    • Rui Ma’s recommendation: Dan Grover “How Chinese Apps Handled COVID-19“
    • Carol’s video on how millennials cope with COVID-19 with the apps on their smart phone.

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The show is hosted and produced by Carol Yin (@CarolYujiaYin) and originally created by Bernard Leong (@bernardleong, Linkedin).  Sound credits for the intro music: Taro Iwashiro, “The Beginning” from Red Cliff Soundtrack.