Luckin Coffee IPO: BlackRock Financed The Chinese Starbucks

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About: Luckin Coffee Inc. (LK), Includes: BLK, DENN, DNKN, MCD, SBUX
by: Wilsonville Capital
Summary

Luckin Coffee commenced its operations in October 2017. The company runs a chain of coffee shops in China.

Frost & Sullivan reports that LK is the second largest coffee network in terms of the number of shops.

As of December 31, 2017, the company had nine stores, and one year later, this figure was equal to 2,073 stores.

The company offers 100% cashier-less environment. Customers can use mobile apps to acquire products. Additionally, they can connect to the store anywhere.

The company expects to use the money from the IPO to finance its store network expansion, the acquisition of customers, R&D, sales and marketing, and other purposes.

Reporting magnificent growth and having well-known investors behind, Luckin Coffee (LK) is a name to be followed carefully. While most investors will not appreciate that LK is very young, the company already runs a significant amount of stores. Besides, if the sales continue to grow at the same pace, the total enterprise value should approximate $1-1.4 billion.

Source: Prospectus

Source: Prospectus

Business

Luckin Coffee commenced its operations in October 2017. The company runs a chain of coffee shops in China.

The company is quite young. However, it has already acquired a massive size. Keep in mind that Frost & Sullivan reports that LK is the second largest coffee network in terms of the number of shops. As of March 31, 2019, it owns a total of 2,370 stores and reported a total of 90 million items sold in 2018. The image below offers further details on this matter:

Source: Prospectus

Many analysts claim that LK could become a serious competitor of Starbucks (NASDAQ:SBUX) in China. LK cannot yet be compared with Starbucks, as the company does not have that many stores. With that, let's tell it this way. The revenue growth is substantial, which should enable LK to become a large company soon. Besides, the company's stores look very much like that of Starbucks. See below for further details on the matter:

Source: QZ

Source: Pandaily

LK's business model has some differences as compared to that of Starbucks. Firstly, the company offers 100% cashier-less environment. Customers can use mobile apps to acquire products. Additionally, they can connect to the store anywhere. Finally, the company has several types of stores. However, pick-up stores represent more than 90% of the total stores. They don't offer a lot of space but are located close to business environments, universities, and other areas where individuals demand a lot of coffee. The lines below provide further details on this matter:

Source: Prospectus

The key performance indicators show that LK is growing at a high pace. Keep in mind that as of December 31, 2017, the company had nine stores, and one year later, this figure was equal to 2,073 stores. Additionally, in December 2017, the number of customers was equal to 11k, and in March 2019, it approximated to more than 16.8 million. See the table below for more details on this matter:

Source: Prospectus

LK appears to be learning how to attract new customers. Check the image below and note how LK assess the behavior of customers using big data analytics.

Source: Prospectus

Source: Prospectus

The company does not own any store. Instead, LK decided to lease its stores and its office space in Xiamen, China. This strategy offers a lot of flexibility to LK. It will permit to close stores where the business model does not perform.

Assets

With an asset/liability ratio of 3x, the company's financial situation appears very stable. Besides, the fact that cash comprises of 46% of the total amount of assets is very favorable.

The recent increase in the number of assets is very remarkable. It should impress most value investors. Bear in mind that the total number of assets increased by 937% amounting to $519 million in 2018. Additionally, cash in hand increased by 644% in 2018. Many investors are giving money to the company at a rapid rate. The image below offers a list of assets:

Source: Prospectus

Liabilities And Contractual Obligations

The list of liabilities should not worry investors. LK only reports a total of $169 million in total liabilities with $52 million in financial debt. The amount of cash is more significant than the company's debt. A list of liabilities is shown below:

Source: Prospectus

Besides, the table of contractual obligations does not reveal any worrying obligation. The largest obligation is operating lease commitments worth RMB1.280 billion or $186 million with RMB475 million payable in less than a year.

As of December 31, 2018, with $243 million in cash, the company reports sufficient financing to pay these obligations. It is very beneficial. IPO investors are usually reluctant to give money to companies needing to pay for contractual obligations. The table below offers further information on the matter:

Source: Prospectus

Income Statement

The revenue growth of LK is quite impressive. For the year ended December 31, 2018, the company reported $125 million. For the period from June 16 through December 31, 2017, the company reported only RMB0.25 million or $0.036 million. Investors should understand that the entity commenced operations in 2017.

With that, the company is still far from reaching its break-even point. In 2018, total operating expenses were equal to $363 million. The image below offers the top of the P&L:

Source: Prospectus

In the year ended December 31, 2018, LK reported net losses of $241 million, which is massive. The net losses are as significant as the total amount of cash in hand, which is worrying. It means that the company needs a large amount of financing to function in the future. The net losses are reported in the image below:

Source: Prospectus

Use of Proceeds

The company expects to use the money from the IPO to finance its store network expansion, the acquisition of customers, R&D, sales and marketing, and other purposes. It is favorable that the company does not expect to pay the debt or acquire shares from existing shareholders. The lines below offer further details on this matter:

Source: Prospectus

Expected Equity Structure

As the IPO goes live, the company expects to convert its convertible preferred stock and the shares held by angel investors. It is very favorable. Bear in mind that shareholders will not have to worry about the potential stock dilution created by the convertible preferred stock. The image below offers further information on the matter:

Source: Prospectus

Competitors

The prospectus does not provide a list of competitors. So, let's use the list offered by Owler:

Source: Owler

Among the competitors mentioned by Owler, only Dunkin' Brands Group, Inc. (DNKN) and Denny's (DENN) report revenue that can be compared with that of LK. Starbucks and McDonald's (MCD) have revenue of more than $21 billion, which is much more than LK's revenue line. The chart below offers further details on this matter:

Source: YCharts

DENN and DNKN trade at 2.5-6.3x forward sales. However, their revenue growth is minimal. Their revenue grows between -2% and 5%. LK's revenue growth is much larger than the figure reported by DENN and DNKN. The images below offer further information on this matter:

Source: YCharts

With that, DENN and DNKN report more considerable gross profit margin than LK. Investors should take into account this fact to assess the valuation of LK. For instance, DNKN notes a gross profit margin of more than 89%. The chart below offers further information on the matter:

Source: YCharts

Taking into account the cited figures, LK could easily trade at 5-7x forward sales. The company needs a large amount of capital to finance its operations, and its gross profit margin is negative. As a result, more than 7x forward revenue appears to be expensive.

For the year ended December 31, 2018, the company reported $125 million. Taking into account this figure, assuming forward revenue of $200 million appears reasonable. At 5-7x, the total enterprise value should approximate $1-1.4 billion.

List of Shareholders

While LK is a very young company, it has many institutional investors behind. There are Lu's Family, Summer Fame Limited, Mayer Investments, Centurium, and Joy Capital. LK was very successful in selling stakes to institutions, which should help the company sell more shares. The image below offers the list of institutional investors:

Source: Prospectus

The list of financing institutions is extensive. It is impossible to note all the companies that acquired shares or convertible securities. However, investors should notice some of the following shareholders. Check the table below and note that BlackRock (BLK) invested more than $50 million in LK:

Source: Prospectus:

The Company Was Incorporated In Cayman

Luckin Coffee Inc. was incorporated in Cayman. It owns an entity in the British Virgin Islands, which owns several subsidiaries in Hong Kong. Finally, the group of companies owns more than six operating entities in China. The business structure is shown below:

Source: Prospectus

The fact that LK was established in Cayman is worrying. It means that minority shareholders will not be as protected as in the United States. Bear in mind that the securities law in the Cayman Islands is not as developed as in the United States. The lines below offer further information on this matter:

The rights of our shareholders and the fiduciary duties of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedent in some jurisdictions in the United States." Source: Prospectus

Besides, minority shareholders can't initiate actions against the management or directors leading the company. Finally, judges in the United States may not be able to act against the LK as the assets are located in China. Read the lines below for further details on this matter:

In addition, Cayman Islands companies may not have standings to initiate a shareholder derivative action in a federal court of the United States." Source: Prospectus

Related Party Transactions And Dual-Class Shares

The company also reports related party transactions with directors and several affiliates of directors. The list of related parties is shown below:

Source: Prospectus

While Chinese companies usually disclose such type of transactions, investors should get to know about them. Bear in mind that there exist conflicts of interests. Directors may be making transactions that don't benefit the company but are favorable for themselves.

Additionally, the dual-class shares structure is also not favorable. The company expects to have class B shares, which will provide ten times more votes than class A shares. It means that some shareholders may have a significant amount of voting power, which could permit them to block takeover attempts. The lines below offer further details on this matter:

Each Class A ordinary share is entitled to one vote; and each Class B ordinary share is entitled to ten votes and is convertible into one Class A ordinary share at any time by the holder thereof. Class A ordinary shares are not convertible into Class B ordinary shares under any circumstances." Source: Prospectus

Conclusion And Risks

With impressive sales growth, LK will most likely have an enterprise value close to $1-1.4 billion. The fact that Blackrock and many institutional investors decided to invest in the company is very favorable. It means that powerful money managers are behind the company.

With that, there are several risks. Firstly, the company is very young, which some investors may not appreciate. Most conservative investors may wait and see if the revenue growth can continue in 2019. Also, the fact that it was established in the Cayman Islands is not ideal. Keep in mind that the protection of shareholders is not as extensive in Cayman as in the United States.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.