Luckin Coffee Is A Ticking Time Bomb That Might Explode Later This Month

Summary

• The market performance of Luckin Coffee since May 20 has baffled many investors and there's optimism regarding the future of the company.
• The worst, however, is yet to come and many negative developments can be expected toward the end of this month.
• Investors are in for an unpleasant surprise when the stock begins trading on the OTC market.
• If an investor wants to bet on the future of the company even after all this, the best course of action is to wait until the company is delisted.

Source

Last time I wrote about Luckin Coffee Inc. (LK), I attracted a lot of criticism for suggesting investors who bought the stock at recent highs of around $50 should wait it out and see what happens. At the time of publishing the first article, Luckin Coffee stock had already plummeted to around $4, and I thought shares would bounce back because of its liquidity position and the revival of the Chinese economy. The store count of around 4,500, I noted, is not fictitious. The trading ban on the stock was lifted on May 20, and after falling dramatically, shares are now trading above $6 in the pre-market session on June 8 at the time of writing this article. Shares, indeed, have recovered faster than many investors thought it would, if at all. My first piece on Luckin Coffee was targeted at investors who bought the stock at recent highs. On the contrary, this article focuses on investors who are considering investing in this troubled company and the ones who picked up shares from the historic lows seen during the last week of May. Even though the momentum is very strong, I consider Luckin as a ticking time bomb that will explode toward the end of this month. The prudent decision, therefore, would be to distance from Luckin Coffee by booking the gains and never looking back.

The timeline of the delisting process

The company, in a press release dated May 19, announced receiving written notice from Nasdaq confirming the decision the index committee has reached to delist its shares. A quick glance at the list of noncompliant companies published every day by Nasdaq on its website reveals two reasons behind this decision.

1. Failure to disclose material information in a timely manner.
2. Public interest concerns (as a result of the accounting fraud).

Luckin has reportedly received the notice from Nasdaq on May 15, and the company has requested a hearing before a panel to appeal this decision. According to Nasdaq listing rules, a company has 7 days to challenge a decision taken by its committee. Luckin Coffee, therefore, would have requested this hearing on or before May 22. As per standard procedure, the hearing will take place 30 to 45 days after the request, which means Luckin Coffee could go in front of the hearing panel as early as the third week of June.

There is no guarantee, but chances are that Nasdaq will execute its decision to delist Luckin Coffee. The next step, therefore, is to determine what might happen afterward.

The outlook is not encouraging

Once delisted from Nasdaq, Luckin Coffee will be traded on the OTC market. This, according to many recent investors, is a guarantee that the stock will start from where it left off. However, the reality is much more different from that.

First, Luckin Coffee stock is likely to decline drastically once the delisting is confirmed. The remarks of the Nasdaq panel will renew the unpleasant memories of how company executives reported fictitious revenue in 2019, and this will lead to a deterioration of the investor sentiment as well. The bad news, as I believe, is only a few weeks away but Mr. Market seems to be oblivious.

Second, many investors will soon find out that the liquidity in the OTC market is considerably low in comparison to major indexes such as Nasdaq and the S&P 500. The results of a study conducted by Yale University and Cornell University confirm this.

Source: ResearchGate

This expected drop in volume will first make it difficult for investors to liquidate their investments and will then make Luckin Coffee a less attractive option for any investor in the future. These are not encouraging signs.

Third, all Chinese companies listed on U.S. stock exchanges are in the firing line from the U.S. government. The new bill approved by the senate poses a risk to every Chinese company alike, and the geopolitical environment will only aggravate the situation. Trade tensions between the United States and China are once again escalating, which makes it difficult for regulators in these two nations to reach some middle ground regarding the supervision of auditors who work with Chinese companies. Amid the rising tensions, China reported a record trade surplus thanks to a jump in medical equipment exports.

Source: Bloomberg

Trade tensions first emerged in 2018 as the Trump administration initiated a move to reduce its deficit with China, and I believe the recently reported numbers won't be taken any lightly by U.S. policymakers. The rising tensions, in return, paint a bleak outlook for Chinese companies listed on American markets for now. Luckin Coffee that is already struggling with other negative developments is not ready for another blow of this magnitude. But, surprisingly, investors seem to brush-off this risk.

For more on the new bill and its implications, please read this article I published a couple of weeks ago.

Takeaway

To sum it up in a few words, the risks of investing in Luckin Coffee far outweigh the potential rewards. From now on, I expect the company to be entangled in a web of bad news through the end of this month, and geopolitical developments won't be supportive for Chinese companies as well. I do not plan to invest in Luckin at any time in the future but an investor who wants to go long on Luckin Coffee should ideally wait until the stock is delisted and buy in the OTC market afterward.

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Analyst’s 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.