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A Cautionary Tale of Luckin Coffee

Luckin Coffee shares were halted for pending news earlier this month, but that news has yet to appear. It’s unclear whether the stock will ever trade again, which means those who haven’t dumped it since the fabricated sales were reported are stuck with it for now. Luckin Coffee (NASDAQ:LK) should be a wake-up call for investors because it indicates that virtually any company could be guilty of faking its numbers.

In a post for Nikkei Asian Review, GMT Research reports that Nasdaq has requested information from Luckin Coffee, but shares have been halted until that information is provided. Given that it’s been over a week since the information was requested, it seems the company is either unwilling to provide it or having a difficult time doing so.

Daniel M Ernst/Shutterstock.com

How Luckin Coffee is different from other Chinese frauds

The company announced early this month that its chief operating officer and other employees had overstated its revenue by 40%. The revelation decimated Luckin Coffee shares, which plunged nearly 90% into penny stock territory.

Unlike most Chinese companies that have been discovered to be frauds, Luckin Coffee was a massive company. It had more than 4,500 stores in China and a $13 billion market capitalization. It was growing rapidly as the Chinese discovered a newfound love for coffee. Luckin was declared the “Starbucks of China,” and it seemed like nothing but blue skies ahead.

However, Muddy Waters revealed earlier this year that it was shorting the company after receiving a tip that it was fabricating sales. Then Luckin Coffee confirmed that allegation on April 2, and investors started to dump its shares.

Andrew Left had been backing Luckin Coffee

Citron Research founder Andrew Left is usually very suspicious of Chinese companies, and even he was taken in by Luckin Coffee. He told the Financial Times earlier this week that Luckin Coffee’s announcement causes investors to question most Chinese companies listed on U.S. stock exchanges. He said the situation shows “the lack of controls” because the fraud obviously wasn’t perpetrated by just one person.

Left even faced off with Muddy Waters founder Carson Block over it on Twitter earlier this year. The Chinese coffee shop chain even attracted reputable backers in the form of Blackrock and Singapore’s sovereign wealth fund, Benzinga noted.

In a report on GSX Techedu, Citron’s latest Chinese target, Left wrote that he was “startled at the brazen fraud” of Luckin Coffee. He also called attention to four big lessons that should be learned from what happened to Luckin Coffee shares.

The first is that no matter how “front facing” a company is, some Chinese companies’ “willingness to commit fraud cannot be ignored or understated.” He also pointed out that Chinese people have taken an interest in exposing fraud, as evidenced by the fact that much of the investigative work into Luckin was carried out by Chinese citizens.

He also said, “If a company presents financials that cannot be relied upon, the stock should be immediately halted even if there is ‘some revenue.'”

Finally, he said the one common denominator of all Chinese frauds is that “if it seems to be too good to be true, it is.”

Calling into question Chinese companies’ accounting practices

The issue investors should now think about is the fact that even well-known companies that are growing rapidly and have the backing of smart money can sometimes be guilty of fraudulent practices. Even retail giant, Alibaba has been accused of questionable numbers by Muddy Waters and Jim Chanos. The reality is that no companies are safe, and now it’s only natural to start wondering about the accounting practices of all Chinese companies.

Disclosure: No positions

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