Luckin Coffee: Investors Lose Millions (2019-2020)
Abstract
Luckin Coffee, a Chinese company was recently delisted from the Nasdaq for fraudulent behavior. They were able to inflate their sales numbers totaling 2.12 billion yuan ($300 million) and get away with it before their shares even became available to investors on the New York Stock exchange. By taking advantage of grey areas in financial reporting and auditing standards in China in order to report these inflated sales, they established a tremendous amount of excitement amongst investors in the Western world. Luckin Coffee, which claimed to be the next Starbucks of China was able to lie their way into boosting the growth of their stock so quickly that it almost seemed too good to be true. Unfortunately, investors and professional firms found out it really was and were blindsided by the lies Luckin told them. Investors lost millions, and Luckin added to the distrust that the United States has with Chinese companies, which further damaged Chinese companies that are hard working and do the right thing when it comes down to business.
Using the ethical theories of Individualism, Utilitarianism, Kantianism, and Virtue theory the actions of Luckin Coffee can be further analyzed and reveal why they specifically went wrong. Individualism calls for profit within the law, Utilitarianism’s goal is to maximize happiness for all of those involved (stakeholders), Kantianism is meant to bring humanity into business, and virtue theory involves courage, honesty, self-control, and justice. According to each of these theories, the actions of Luckin Coffee were completely wrong. By incorporating these theories in their business, they could have prevented the downfall, and delisting of their shares, which led to damaging not only themselves, but many other parties as well.
(CEO Jenny Zhiya Qian at Luckin's IPO - (Forbes))
Ethics Case Controversy
In May of 2019, Luckin Coffee went through its IPO on the New York Stock Exchange. Investors were very excited about this company, seeing as how their stock price surged 18% on the day it was introduced to the Nasdaq, raising $561 million (Lucas). According to Bloomberg this excitement could be attributed to Luckin’s, “promises to defeat Starbucks.” It seems as though investors in the US saw this as a tremendous opportunity seeing how successful Starbucks has been over the years. Their plan seemed simple, “offering lower-priced coffee, primarily for takeout and delivery,” and providing an app as well which would allow them to be called a “tech company (Wang & Campbell).” This was a solid strategy because according to Bloomberg, “investors like apps and disruption.”
(Picture on day of Luckin’s IPO
(CNBC-Weizent))
Bloomberg stated that, “Starbucks had prospered in China by selling much more than just coffee and offering a comfortable place outside the home or office to meet friends or study. Luckin did the opposite: Most of its locations are more like kiosks, with little or no seating. Orders have to be placed and paid for with Luckin’s app.” Although Luckin’s plan was to do this to ultimately decrease rent, and labor costs, their approach would cost them (Wang & Campbell). In fact, in 2018, “Luckin disclosures show, its operating expenses were almost triple its sales (Wang & Campbell).”
Another important point is that Chinese consumers prefer tea over coffee. This proved to be a struggle for Starbucks when entering into Chinese markets, thus why their strategy was different as described in the previous paragraph. “In 2018 annual per capita coffee consumption in China had reached just about six cups, compared with more than 200 cups in Taiwan and 388 in the U.S. (Wang & Campbell).” If aware of this statistic the intense and rapid growth of Luckin may have seemed a little too good to be true, given that their strategy was to provide cheap coffee.
(COO Jian Liu celebrating Luckin's IPO - (Hope))
Eventually,
Luckin’s lies caught up with them when investigators looked further into
Luckin’s reports of stellar sales. It was found that Luckin’s, “2019 sales were
inflated by 2.12 billion yuan ($300 million) and it’s expenses by 1.34 billion
yuan ($190 million) that year. The fraud began in April 2019, a month before
Luckin made its public market debut in the United States (Lucas).” All the
investors were being lied to from the beginning and the reasons for Luckin’s
skyrocketing stock price were built on pure deceit and manipulation. “Evidence
shows that former CEO Jenny Zhiya Qian, former COO Jian Liu and other employees
who reported to them fabricated transactions and used third parties with ties
to company employees to funnel funds supporting the falsified transactions to
Luckin (Lucas).” CNBC told of a report from the Wallstreet Journal that employees were
able to fake these sales, “by purchasing tens of millions of vouchers that
could be exchanged for cups of coffee through fake buyers and obscure
companies. Many of the companies had ties to [co-founder and chairman Charles
Zhengyao] Lu.”
Since the company first came on the Nasdaq it’s shares went from around $17, to as high as $50. After the fraudulent behavior came out, the share price dropped to as low as $1.50, which can be seen in the chart from CNBC.
(Chart of Luckin Coffee Stock Price (CNBC-Weizent))
After this story shocked the market, other Chinese stocks were adversely affected as well. Luckin’s actions spread fear in the market for investors in Chinese stocks, along with other Chinese companies who were similarly accused.
“Shares of China’s version of Netflix, iQIYI IQ, 3.22%, are up only 12%, even though it would seem to be one of the biggest beneficiaries of COVID-19 lockdowns. Last month, short seller Wolfpack Research issued a report saying that the company has inflated revenue since before its 2018 IPO… Shares of another potential beneficiary of a global lockdown, Douyu DOYU, -2.52%, a developer of a videogame streaming service, are down about 28% since that company’s IPO in July 2019. The company is now the target of shareholder litigation in the U.S., alleging that it made false or misleading statements in its IPO regulatory filings (Poletti).”
Although it would seem discriminatory to think that all Chinese companies are fraudulent, they are certainly capable of it. This is because of the difference in financial reporting policies in the U.S. and in China. The problem lies in the accounting standards because, “accountants who sign off on company financial statements in China don’t have access to those company’s actual books and records, only what they are allowed to see (Poletti).” This loophole is what adds to the distrust between the U.S. and China, and policy makers are pushing to change this. The rule of thumb being that if companies from China want to put their stocks on exchanges in the U.S, they should have to abide by the same standards. Senator Marco Rubio of Florida and Senator Robert Mendez of New Jersey are trying to pass the “Equitable Act Bill,” which would result in the delisting of companies on U.S. exchanges who, “fail to comply with auditing regulations.”
Ultimately, if this bill were to be passed it would help to weed out the bad companies from the Chinese companies who are doing the right thing. If we look at Luckin and these other malicious companies, they are only making the problem of distrust worse. Zhang Yifan, a private investor at Commando Capital had a good point that dishonest Chinese companies, “will have an impact on Chinese companies who do things properly when they try to raise capital in U.S. stocks… it will indeed lead to a very serious crisis of trust. It will take years to ease (Stevenson & Wong).” A stock that I personally invest in (NIO) was even temporarily affected and dropped 9.4% on April 2nd due to the Luckin scandal even though they had no reports of fraud (Seeking Alpha). The actions of Luckin not only affected their own investors, but other innocent and hardworking Chinese companies as well.
(Timeline
of events)Looking at the issues regarding Luckin Coffee, ethical theory can prove useful in analysis. Individualism, Utilitarianism, Kantian Theory, and Virtue Theory in particular can all show how Luckin’s actions were unnaceptable, and lead to the conclusion of what they should have done differently. The stakeholders(those affected by the scandal) involved in the analysis are investors, CEO Jenny Zhiya Qian, former COO Jian Liu, co-founder and chairman Charles Zhengyao, and Chinese companies in general.
Individualism
Individualism theory’s main idea is that one should try to maximize profit, but do so within the law. Under Indivualism the actions of Luckin are not ethical, this is because they failed to maximize profit and they broke the law.
When they were reporting inflated sales numbers they were proffiting and providing profit to their shareholders, but this didn’t last for long. By tricking their investors they made profit but at the cost of breaking the law. By going against China’s “SOX,” which could be compared to the Sarbanes Oxley Act in the United States, they failed in respect to being ethical. Yu Lu and Diandian Ma explain in their journal, ““China SOX” What Is It and Why Was It Introduced?,” that SOX was established to promote internal control. This, “internal control is to reasonably assure that management and operations are legal, the assets are safe, financial report and relative information are true and complete, the effectiveness and efficiency of operation are improved and development strategy is realized.” By reporting inflated numbers they violated SOX, because the numbers were untrue and incomplete which made it illegal.
The profit that they made was short-lived and after the scandal went public they lost a massive amount of money when their stock dropped, along with their investors. When this happened they destroyed their reputation through their own actions which set them up for their own finacnial demise. They failed to maximize profit, and they failed to do so within the law.
Utilitarianism
When it comes to Utilitarianism, in order to be ethical the goal of a company’s actions must aim to maximize happiness for all stakeholders. When breaking down all of the stakeholders, Luckin fails being ethical under Utilitarianism.
Starting with the investors, it can be argued that the investors who rode the stock up and sold for a profit were happy and saw tremendous returns. However, we need to look at the group as a whole. Some may have profited, but as a whole, millions of dollars were lost from holding Luckin’s stock. After the scandal broke out and the price dropped, those who held the stock lost basically all of their money. Just before the announcement the price was around $25 and dropped to around $1.50, so if one owned 100 shares at an average of $25 a share during this time, the drop would have cost them -$2,350 (1566.67% loss), with their initial investment being $2,500. This example puts the sheer loss into perspective, and shows how those who invested well over $2,500 lost a lot more if you input a larger number. For example, if one had invested $1 million at the same price, their 40,000 shares would be worth $60,000 at $1.50 leaving them with a loss of $940,000.
The COO, CEO, and co-founder would have all been happy while profiting off lies, but after the scandal was publicized, they were not happy. They not only lost money, but their stock was delisted off the Nasdaq. Amongst the associated firms there were also $9 million in fines, which they definitely were not happy about (France-Presse).
Lastly, as mentioned before, Chinese companies were affected in general by the stigma of all Chinese companies being fraudulent. This is an even larger problem, because it affects the relationship between investors in the U.S. and the hardworking companies in China who are honest about their operations. Although there are multiple companies who take advantage of differences in reporting standards, this issue still needs to be addressed. The bill that I had mentioned may help separate the bad companies from the good. For now, the other companies affected would be unhappy as a result of Luckin’s actions too.
Kantianism
The third theory is Kantianism, which is based on the Formula of Humanity. This means that to be ethical under Kantianism the company must treat others as both a means and an end, instead of as a mere means. An example of failure would be to treat people as though they don’t matter, and only use them to achieve a goal. Also, in Kantianism it is important to not manipulate, or deceive others in pursuit of a goal. Lastly it is important to allow others to make their own decision, and have a say, without manipulation.
Luckin fails again under this third theory because they are treating their investors as a mere means. By lying to them and manipulating them to believe that their sales were much higher than they actually were, they were in pursuit of profit without thinking of how it would affect their investors. They also took away the investors ability to make a well-rounded and smart decision to purchase the stock because they were fed inaccurate financial information. The investors were clearly manipulated and used as a mere means to an end in this case.
Additionally, Luckin took advantage of the loophole within the financial reporting standards in China and the United States. By doing this they used their own country as a means and not an end. By doing this they not only made themselves look bad, but made China look bad and added to the distrust that already exists between our countries. They deceived everyone by twisting the rules in their favor to profit off investors.
Virtue Theory
The last theory, Virtue theory consists of four key virtues. These virtues are courage, honesty, self-control, and justice. To be ethical, a company must follow each of these key virtues as guidelines to improve their image and relationships within the business world. By doing this they can become successful financially, as well as make a positive difference on society. Unfortunately, Luckin has done the opposite in this case, but before I get into the analysis, I’ll explain each key virtue in more detail.
Courage is about setting hard goals, that require hard work, and always following them through to the end. Honesty is about not lying, even if it is easier to lie. Self-control is about being in control of our actions and doing the right thing even when its harder to do it. Lastly, justice is about doing what is fair for everyone.
They failed to act courageous by being the opposite; cowardly. They reported fake numbers in order to look better, when in reality they were struggling. They started with a courageous goal to compete with Starbucks, a company that is well-known and respected, but did not follow through with courageous actions in their business plan. Secondly, they failed by being dishonest. By fabricating their sales, they lied to the world about who they were as a company, which ultimately showed their true self. Additionally, Luckin did not demonstrate self-control because they could have done the right thing. Even though doing the right thing (being honest about their struggle in sales) would have been the harder thing to do, it would have been better for them in the long term. Virtue theory is about doing the right thing even in these circumstances. Lastly, they failed the key virtue of justice. It was unjust for them to lie because it was not fair to the investors, and other Chinese companies affected.
Justified Ethics Evaluation
Personally, I feel that the actions of Luckin coffee were unacceptable and completely unethical. Looking further into their business model, and simply the amount of people who actually drink coffee in China, they set themselves up to fail. They compared themselves to Starbucks, who was successful in China for reasons other than just selling coffee, and put themselves out there as a “tech company” by making an app that users had to order their coffee on.
Seeing as how they were lying about their sales, even before they listed on the Nasdaq, listing their shares in the United States almost seemed like a ploy to manipulate investors in the Western world and scam them of their money. The fact that they were dishonest before even listing their shares goes to show they knew exactly what they were doing was wrong, and their decision was made out of pure greed.
Although I could find no information about higher ups profiting off selling shares when they were boosted so high, their net worth still increased as the price went up and their ownership in the company was worth more. Whether or not they cashed out at the right time simply does not even matter. They still deceived so many people into thinking that Luckin Coffee was something it was not, which further damaged themselves and others.
Action Plan
Luckin’s problem boils down to their lies at the end of the day. The first thing that they need to do in order to overcome the situation is to admit to them and to apologize. By doing this they can start to rebuild the trust that they initially broke amongst investors and firms. Additionally, it would be wise for them to agree to Western auditing and financial reporting standards. Although they are not required to do this as a Chinese company, if they ever want to gain the trust of investors, they are going to have to make a change. Also, they should make a promise to not lie and be completely up front, even if they are not performing as well as they would like to be. By doing this, they will not blindside anyone again. It is easy to make a promise, but on top of this they should take the promise very seriously. Instead of simply telling people what they want to hear, they need to follow through with the promise as well.
Luckin Coffee’s new mission statement should be, “our mission is to provide affordable coffee by people you can trust. Through the change in technology and our app, we will provide a positive experience in addition to what’s in your cup.” Their current mission statement is, “our mission is to be part of everyone's everyday life, starting with coffee. We are China's second largest and fastest-growing coffee network, in terms of number of stores and cups of coffee sold,” which can be found on public document F-1 from the SEC for Luckin Coffee. I feel as though their mission statement is too directly shoving growth in the face of the investors. Instead of basing the company on pure growth to make it an attractive investment, Luckin needs to focus more on the consumer. By doing this they will grow in a more steady and organic manner and establish their brand with the consumer, which will eventually attract investors.
They should also establish some new core values to integrate in their business plan. The first should be borrowed from virtue theory being honesty. This is because they have lost a lot of trust and need to earn it back. In order to do this, they must be completely transparent and answer every question with complete honesty. Secondly, they should value hard work. I think this would be beneficial, instead of cheating their way to the top like they did before. By promising to work hard to strategize and achieve their goals they will go much further. Additionally, Luckin must value customer relationships. Like I mentioned before, if Luckin focuses on the consumer they will be able to establish their brand to promote growth. Lastly, they should focus on app functionality. To make their business model work for them they should work on making their app the best it can be. By doing this, consumers will enjoy using the app’s features and it will make ordering their coffee easy and free of frustration.
Luckin should also establish a zero-tolerance policy involving any sort of corruption like they saw before. In addition, there should be regular investigations into processes within the business, and all red flags should be looked into. By doing this they can efficiently solve any problems, and fire anyone who is involved in fraudulent behavior.
This new plan will help repair the trust problem between investors and Luckin, boost profitability, and prevent more fraud from happening within the company. By marketing their brand in a more consumer friendly manner, they will sacrifice their aggressive marketing approach towards investors, which will make the company’s growth safer and steadier.
Conclusion
Ultimately, Luckin made some big mistakes and at the end of the day every company isn’t perfect. We are all human and can make mistakes, learn from them, and try to make things right. Whether the world of investors decide to trust Luckin again is their own decision, but Luckin will have to put fourth the effort if they want to continue growing as a company. By keeping the ethical theories Individualism, Utilitarianism, Kantianism, and Virtue Theory in mind, they may be able to pull it off. They could also benefit from a new action plan which may give them hope in achieving the dream the founders originally had for Luckin Coffee.
-Jacob Neal
Works Cited
· France-Presse, Agence. “Luckin Coffee, Associated Firms Fined $9M Over Scandal.” CNS, 22 Sept. 2020, www.courthousenews.com/luckin-coffee-associated-firms-fined-9m-over-scandal/.
Hope, Blaise. “Lu Zhengyao, the Billionaire behind Luckin Coffee's 'Burning Money' Strategy.” South China Morning Post, 23 Apr. 2020, www.scmp.com/magazines/style/news-trends/article/3081256/luckin-coffee-mastermind-lu-zhengyao-how-chinese.
· La Monica, Paul R. “Chinese Coffee Company Luckin Will Be Delisted after Defrauding Investors.” CNN, Cable News Network, 26 June 2020, www.cnn.com/2020/06/26/investing/luckin-coffee-delisted/index.html.
· Lu, Yu, and Ma, Diandian. “‘China SOX’: What Is It and Why Was It Introduced?” Wseas Transactions On Business And Economics, World Scientific and Engineering Academy and Society, 2017, www.wseas.org/multimedia/journals/economics/2017/a925907-035.php.
· Lucas, Amelia. “Luckin Coffee Says Independent Probe into Sales Fraud Is 'Substantially' Complete.” CNBC, CNBC, 1 July 2020, www.cnbc.com/2020/07/01/luckin-coffee-says-probe-into-sales-fraud-is-substantially-complete.html.
· Poletti, Therese. “Luckin Coffee Shows How Risky Chinese IPOs Can Be, but Investors Are Just Not Listening.” MarketWatch, MarketWatch, 20 May 2020, www.marketwatch.com/story/chinese-ipos-are-risky-but-theyre-not-going-away-anytime-soon-2020-05-12.
· Stevenson, Alexandra, and Wong, Edward. “Chinese Coffee Chain's Scandal Renews U.S. Calls for Oversight.” The New York Times, The New York Times, 30 Apr. 2020, www.nytimes.com/2020/04/30/business/luckin-coffee-china-fraud-wall-street.html.
“Stock Picks, Stock Market Investing.” SeekingAlpha, seekingalpha.com/news/3557916-nio-lower-after-luckin-coffee-flameout.
Wang, Jennifer. “Chinese Starbucks Competitor's IPO Briefly Makes Its Female Founder A Billionaire.” Forbes, Forbes Magazine, 17 May 2019, www.forbes.com/sites/jenniferwang/2019/05/17/chinese-starbucks-competitors-ipo-briefly-makes-its-female-founder-a-billionaire/?sh=689e64a6137e.
· Wang, Selina, and Campbell, Matthew. “Luckin Scandal Is Bad Timing for U.S.-Listed Chinese Companies.” Bloomberg.com, Bloomberg, 29 July 2020, www.bloomberg.com/news/features/2020-07-29/luckin-coffee-fraud-behind-starbucks-competitor-s-scandal.
· Weizent. “Fraud at China's Luckin Is a 'Great Morality Tale' for Investors, Says Analyst.” CNBC, CNBC, 7 July 2020, www.cnbc.com/2020/07/06/investing-fraud-at-china-luckin-coffee-fraud-case-warning-for-investors.html.
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