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Luckin Coffee IPO: A Dangerous Brew for Investors?

Tom Taulli

Luckin Coffee, which operates a chain of coffee locations across China, has filed to go public in the U.S. (the company expects to list on the NASDAQ under the ticker of LK). The terms of the deal have not been set but the buzz is that the offering could raise about $800 million at a valuation of $5 billion. The lead underwriters for the Luckin Coffee IPO include Credit Suisse (NYSE:CS), Morgan Stanley (NYSE:MS), CICC and Haitong International.

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Luckin Coffee is the brainchild of 42-year old Jenny Zhiya Qian. Before founding the company, she was the chief operating officer of UCAR, which is a ride-hailing operator in China. While there, she saw how technology can scale at a staggering pace.

And she has applied the same strategy to Luckin. In fact, it seems that she only knows one speed: hyper fast!

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In about 18 months, Luckin has gone from one location to 2,370 across 28 cities. At the current pace, the expectation is that the company will be larger than Starbuck’s (NASDAQ:SBUX) — in terms of locations — by the end of the year.

Background on the Luckin Coffee IPO

Luckin has three types of storefronts: pick-up stores, relax stores and delivery kitchens. Of these, the primary focus is on pick-up stores, which account for over 90% of the total. They are located in office buildings, university campuses and commercial areas — allowing for access to higher traffic areas but also having the benefit of lower rental costs. The pick-up stores have also become important for establishing a delivery network — which includes a group of couriers — that accounts for over 60% of orders.

Another key strategy — which may be the most important for the Luckin Coffee IPO –– is the aggressive investment in technology. According to the S-1: “We leverage big data analytics and AI to analyze our customer behavior and transaction data, which enables us to continuously enhance our products and services, implement dynamic pricing and improve customer retention. We also leverage our proprietary technologies in store operations and supply chain to support our business, such as new store selection, inventory management and workforce management. Our focus on technologies has enabled us to operate efficiently, grow rapidly while maintaining quality control.”

The Luckin Coffee mobile app is also is critical. For example, customers can easily pay with services from Tencent’s (OTCMKTS:TCEHY) WeChat and Alibaba’s (NYSE:BABA) Alipay.

Bottom Line on the Luckin Coffee IPO

There are certainly glaring risk factors with the Luckin Coffee IPO. First of all, the losses are enormous, coming to $241.3 million last year on sales of only $125.3 million. Let’s face it, the costs of growth are far from cheap. It also does not help that Luckin has ginned up sales with heavy discounts and ubiquitous promotions.

Next, the company is counting on a change in consumer behavior in China, which will likely be challenging. Note that coffee consumption is fairly low as people prefer tea. A study from Frost & Sullivan indicates that the per capital coffee consumption is a mere 6.2 cups per year. By comparison, it’s 388 in the US.

And finally, the fast growth could wind up being a problem, as it can be extremely difficult to manage (a new location is launched every 15 hours). This is especially difficult in China since the government can be mercurial.

True, the IPO market is red-hot right now — but then again, investors are also discerning. Just look at the tepid response to the Lyft (NASDAQ:LYFT) offering, which is off 13% from its high. So given the issues with Luckin, the best plan may be to skip the deal for now.

Tom Taulli is the author of High-Profit IPO StrategiesAll About Commodities and All About Short SellingFollow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.

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