Shares of Luckin Coffee (LK) were halted before the open on Tuesday pending news, and have yet to resume trading. The company has been in the spotlight after announcing last week that it was probing "fabricated transactions" that make its prior guidance unreliable and prompt an investigation of its financial reports. Meanwhile, Muddy Waters announced a new short position, this time in eHealth (EHTH). Earlier this year the short seller had shared a report that accused Luckin Coffee of both fraud and having a "fundamentally broken business."
PROBING 'FABRICATION' OF TRANSACTIONS: Luckin Coffee said in a statement last week that its COO Jian Liu and several employees engaged in misconduct and that the company has formed an independent special committee to oversee the investigation. Further, Luckin warned investors should no longer rely upon prior guidance.
"The Special Committee brought to the attention of the Board information indicating that, beginning in the second quarter of 2019, Jian Liu, the chief operating officer and a director of the company, and several employees reporting to him, had engaged in certain misconduct, including fabricating certain transactions. The Special Committee recommended certain interim remedial measures, including the suspension of Jian Liu and such employees implicated in the misconduct and the suspension and termination of contracts and dealings with the parties involved in the identified fabricated transactions," Luckin Coffee said.
"The company will take all appropriate actions, including legal actions, against the individuals responsible for the misconduct. The information identified at this preliminary stage of the Internal Investigation indicates that the aggregate sales amount associated with the fabricated transactions from the second quarter of 2019 to the fourth quarter of 2019 amount to around RMB2.2B. Certain costs and expenses were also substantially inflated by fabricated transactions during this period. […] As a result, investors should no longer rely upon the company's previous financial statements and earning releases for the nine months ended September 30, 2019 and the two quarters starting April 1, 2019 and ended September 30, 2019, including the prior guidance on net revenues from products for the fourth quarter of 2019, and other communications relating to these consolidated financial statements."
According to a report by Reuters over the weekend, Luckin Coffee said it will maintain normal operations at its stores and apologized to the public, days after it announced an internal investigation had shown its chief operating officer and other employees fabricated sales deals.
MOVING TO THE SIDELINES: On Thursday, KeyBanc analyst Eric Gonzalez downgraded Luckin Coffee to Sector Weight from Overweight after the company announced an investigation into misconduct including fabricating certain transactions and their associated expenses. Following his talks with the company, Gonzalez sees earnings visibility being "limited for the foreseeable future" and thinks it will take several years for management to repair credibility. He also believes the announcement that guidance can no longer be relied upon calls into question the company's overall liquidity.
LENDERS SELLING UP TO 76.35M SHARES: On Monday, Luckin Coffee was again under pressure after Goldman Sacks (GS) said lenders were selling up to 76.35M shares. Following the occurrence of a default by Haode Investment, a shareholder of Luckin Coffee under a $518M margin loan facility, a syndicate of lenders, as secured parties under the facility, has instructed Credit Suisse (CS) to exercise the lenders' rights with respect to the collateral securing the borrower's repayment obligations under the facility.
A total of 515,355,752 Class B ordinary shares and 95,445,000 Class A ordinary shares of Luckin Coffee have been pledged to secure the facility, including shares additionally pledged by an entity controlled by the family trust of Jenny Zhiya Qian, the company's CEO. In connection with the exercise of their rights under the facility, the lenders have commenced the process of enforcement against the collateral in order to satisfy the borrower's obligations under the facility, Goldman Sachs said in a statement. This includes the conversion of Class B ordinary shares of the company into American Depositary Shares. The enforcement action equals up to 76.35M American Depositary Shares of Luckin Coffee.
WHAT'S NOTABLE: Earlier this year, shares of China's Luckin Coffee were under pressure after short-seller Muddy Waters shared a report that accused the company of both fraud and having a "fundamentally broken business." "Luckin knows exactly what investors are looking for, how to position itself as a growth stock with a fantastic story, and what key metrics to manipulate to maximize investor confidence," according to the report that was shared by Carson Block's firm. The anonymous report, which claims to demonstrate "how Luckin faked its numbers and why its business model is inherently flawed," was not written by Muddy Waters but in a tweet the firm said it is short Luckin shares and views "the work as credible."
On Wednesday, Carson Block's Muddy Waters announced a new short position, this time in eHealth. The company's "highly aggressive accounting masks what we believe is a significantly unprofitable business," Muddy Waters said in a report posted on its website. Based on variable costs alone, the firm best known for short-selling estimates eHealth will lose approximately $135 from each Medicare Advantage member it enrolled in 2019. When including fixed costs, the firm estimates the company's per Medicare Advantage member loss is $402.
During an interview on CNBC, Block estimated that shares of eHealth are worth around $20. eHealth operates a private online health insurance exchange where individuals, families and small businesses can compare health insurance products from insurers and purchase and enroll in coverage online and over the phone. At the time of publication, eHealth had not replied to The Fly's request for comment.
PRICE ACTION: Luckin Coffee's stock was halted before the open on Tuesday, after closing at $4.39 on Monday. Shares of the company, which competes in China with Starbucks (SBUX), sank as much as 81% on April 2 after it said the investigation had found that fabricated sales from the second quarter of 2019 to the fourth were about $310M. Meanwhile, shares of eHealth have dropped over 13% this morning to $101.59.
