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Luckin Coffee Inc., a China-based company that has quickly become a key competitor to Starbucks Corp. in that country, has filed the paperwork for an initial public offering.
The company will offer 30,000,000 American Depositary Shares. Expected to price between $15 and $17, the company could raise up to $510 million. Luckin has applied to trade on Nasdaq under the ticker symbol “LK.”
Credit Suisse, Morgan Stanley, CICC and Haitong International are lead underwriters on the deal.
Luckin Coffee, which is based in Fujian, China, was incorporated just two years ago in June 2017 and began operations in October of that year. In the 18 months since then, it has grown from a single trial store in Beijing to 2,370 wholly-owned stores in 28 cities. Its customer base totaled 16.8 million “transacting” consumers as of March 31, according to its prospectus.
“Our mission is to be part of everyone’s everyday life, starting with coffee,” says the prospectus.
The company’s director and chief executive officer, Jenny Zhiya Quan, and an employee, Min Chen, hold 83.33% of the equity interest in the company.
Luckin is an emerging growth company with $125.3 million in revenue for the year ending Dec. 31, 2018. Its net loss for the year came to $241.3 million. It is the second largest coffee chain in China, says the prospectus, citing data from consulting firm Frost & Sullivan.
Though it has three kinds of stores, 91.3% of them are “pick-up stores” that offer limited seating and are located in places like office buildings and university campuses that have built-in demand. The remainder are “relax stores” and delivery kitchens.
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Technology is key for the company, which Luckin says it uses to standardize its operations and, through the use of AI, to analyze customer behavior to better select products and services. It’s mobile app is also a big part of the company’s operations.
“China’s coffee market is highly underpenetrated,” the company says in its prospectus. “Inconsistent quality, high prices, and inconvenience have hampered the growth of the freshly-brewed coffee market in China. We believe that our model has successfully driven the mass market coffee consumption in China by addressing these pain points.”
In April 2019, Luckin announced plans to enter into a joint venture with an affiliate of Louis Dreyfus Company B.V. and Louis Dreyfus Company Asia Pte. Ltd., a processor of agricultural goods, to construct and operate a coffee roasting plant in China. Louis Dreyfus will also purchase “a number” of class A Luckin shares.
Here are five things to know about Luckin Coffee ahead of its IPO:
It has a risky corporate structure
Like other Chinese companies with listings outside of China, such as Alibaba Group Holding Ltd. BABA, -2.99% , Luckin Coffee is a variable-interest entity, or VIE, a structure created in the 1990s as a workaround for Chinese companies not allowed to have direct foreign ownership.
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Under the VIE structure, the Chinese company creates two entities, one in China that holds the permits and licenses needed to do business there and the other an offshore entity, in this case in the Cayman Islands, in which foreign investors can buy shares. The Chinese entity, which is usually owned by top executives, pays fees and royalties to the offshore company in contractual arrangements. The risk is that foreign investors don’t actually own stock in the company, and local management or even the Chinese government could force a split with the listed company, leaving U.S. investors high and dry.
Among the risk factors Luckin Coffee lists are the limits to protecting shareholders under the laws of the Cayman Islands, which the company said “are not as clearly established” as those in some U.S. jurisdictions.
Luckin has incurred ‘significant losses’ since its founding
Like many startups, Luckin has incurred heavy losses mostly because of its rapid expansion. The company cautions that as it is so new, its past performance doesn’t guarantee future growth rates.
Luckin Coffee plans to use most or all of its funds for operations and expansions and is not planning to pay a dividend any time soon. That means shareholders will have to rely on stock price appreciation for returns.
It is operating in a highly competitive market
Luckin Coffee is facing fast growing competition in its marketplace, including from global powerhouse Starbucks Corp. SBUX, +0.45% which has set its sights on China. Starbucks has stated its goal of adding 600 net new stores annually to reach 6,000 locations by fiscal 2022. Starbucks has partnered with Alibaba for delivery service in 2,100 stores in 35 cities. And it has launched its popular loyalty program, which has accumulated 8.3 million members.
Unlike Luckin, Starbucks is focused on creating retail locations where customers will have the “third place experience,” meaning diners can stick around after making a purchase. Luckin’s focus on takeaway is a differentiator.
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“[W]e are seeing accelerated competitive environment in China and discounting as part of that,” said John Culver, international group president at Starbucks, who participated in the company’s earnings call last week. “And I would just say that we continue to take the long-term view and belief in our strategy in executing in a way that continues to elevate the experience for our customers.”
Luckin says it also expects to compete against convenience stores and other businesses, which could hurt its market share.
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Business could be disrupted by some unusual red tape
Under Chinese law, lease agreements have to be registered with a local land and real estate administration bureau. Failure to do so could invalidate the lease or lead to fines.
Luckin says that most of its lease agreements have not been registered with the proper authorities.
“In the event that any fine is imposed on us for our failure to register our lease agreements, we may not be able to recover such losses from lessors,” the prospectus said.
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Penalties can range from RMB1,000 (about $148.53) to RMB10,000 (about $1,485.33).
Luckin also hasn’t received all of the valid property ownership authorizations from purported owners.
“There is a risk that such lessors may not have the relevant property ownership certificates or the right to lease or sublease such properties to us, in which case the relevant lease agreements may be deemed invalid and we may be forced to vacate these properties, which could interrupt our business operations and incur relocation costs,” the prospectus said.
Business in China means government involvement
Luckin Coffee notes the unique nature of doing business in China, which involves a high level of government involvement, including the imposition of policies. As a result, some companies can get preferential treatment over others and growth has been uneven across different sectors and geographies.
“Although the Chinese government has implemented measures emphasizing the utilization of market forces for economic reform, the reduction of state ownership of productive assets, and the establishment of improved corporate governance in business enterprises, a substantial portion of productive assets in China is still owned by the government,” the prospectus said.
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In addition, there are uncertainties within the legal system that could impact the company’s ability to determine which protections Luckin Coffee has.
Ciara Linnane contributed to this report
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