Urban Trade Breakdowns - Luckin

For Qin Kang, The summer after graduation sucked ass.  With a newly minted degree in marketing from a mid-tier university near Beijing, Qin moved in with his Aunt in a small apartment on the third ring and begin his search for an entry-level internship with a tech firm.  But after three months of chasing down leads and scrolling through job postings and submitting applications, he got all of 5 interviews and no offers.  By mid-August he stopped looking and basically spent his days playing Honor of Kings and checking out the chicks on Tantan.  

And like every competitive job market for new graduates, there is always one shit post that seems to pop up everywhere.  This is because the algos know desperation when they see it and for Qin and thousands like him in the summer of 2019, one shit-post ad stalked their digital lives: a link to apply for an entry-level paid internship as a “Cafe Statistician” for a boutique staffing firm doing field market research in the “hospitality industry”.  

After a few weeks of avoiding it, Qin did a quick WeChat search and found a group of over 1000 people in over 40 cities across China who had clicked the ad and accepted their fate.  So one Tuesday night, he applied for the job and was offered a position without an interview.

As expected, the job sucked, but it was pretty chill.  It worked like this: Qin Kang would spend the first half of the day in various Luckin coffee locations throughout Beijing discreetly watching and counting the customers, employees and quantity/type of drinks and shit sold at Luckin coffee shops.  They said it was “market research”.  Mid-day he was replaced by another intern and then move to another location for his afternoon shift.  A couple time he was asked to do some wired shit, like hide a video device on a shelf in the Luckin store, or collect Luckin’s trash from the dumpster on the ground floor.  But mostly he just stood around counting shit.  Which at first he did on paper but then the company gave him an app which was way easier.  A lot of people made mistakes and quit but the “leader”, a real prick with three phones, only cared that the counts were perfect.  There was always another loser intern to fill a spot and even Qin had to admit that it was a pretty well coordinated operation.  In the evening, Qins totals, and the totals collected from nearly 1400 interns doing the same thing throughout China, were uploaded to an Alibaba cloud server and forwarded to an office in the financial district of Hong Kong where the data was analyzed and compiled and correlated against 11,260 hours of store video, detailed 3rd party media tracking data of Luckin advertising activity, the social feeds of Luckin “influencer’s” (its a thing), and the spot price of Luckin discount coupons online, all of which was analyzed and collated and then compared the data on a day-by-day basis with Luckin’s quarterly sales figures.  

A few months later, sometime in late January of 2019, Sean Ma, the 30-something founder and CEO of Snowlake Capital, a small hedge fund based in that very same office in Hong Kong, (allegedly, according to reports, etc), put the finishing touches on an 89-page report summarizing the findings of all that “market research” and emailed copies to several prominent short sellers around the world (allegedly, according to reports), one of whom was Carson Block, founder of Muddy Waters Research, LLC in California, who, on January 31st, 2020, tweeted the following:

“MW is short ‪$LK‬. We received unattributed 89-page report alleging ‪$LK‬ is a fraud: "number of items per store per day was inflated by at least 69% in 2019 3Q and 88% in 2019 4Q, supported by 11,260 hours of store traffic video" We view the work as credible.”

And included a hyperlink to the report.  And then all hell broke loose.  But hold that thought for a moment, because first, allow me to riddle you this: what the fuck is Luckin Coffee?

Well, Luckin sells coffee and gum and shit in China.  Which is cool and all, but as a business model, selling coffee and gum and shit in China is kinda meh.  Yet, a few weeks after pitching the idea (January, 2019), Luckin raised roughly $550m from huge-money investors (private equity, sovereign wealth funds, big institutional investors).  Then, months later, in May of 2019, Luckin went public in a highly successful IPO and their stock rose 160% in the following two months.  And in January of 2020, Luckin raised another ~$1.1B in a private placement as the stock reached a record high, valuing the company at $12B, and they had over 4,500 stores (more than Starbucks) and a valuations multiple of over 20x trailing revenue.  All that in about a year.  

Wait, the fuck?  How?

Well, a cup of Starbucks coffee in China costs roughly 20 yuan.  The same Luckin cup sells for about 9.1 yuan, which is not how much it costs, it’s how much it sells for.  Because if you download their app, you get a free coffee.  And if you share the app with friends you get a free coffee and your friends get free coffee.  Invite more friends on WeChat, more free coffee.  Register your relatives and co-workers and your parents villiage, free coffee all around.  Launch a coffee wallet using their phone app and buy 2 coffee credits, get one free.  But 5, get 5 free.  And to keep the customers coming, Luckin sent countless SMS coupons to app users offering discounts up to 50% off, and the coupons are widely traded digitally on line and you can easily buy a coupon while waiting in line.  So multiply cheap or free coffee times zillions of Chinese consumers and you’ve got one fuck of a huge market.  And throw in investor pixie-dust words like “platform” and “disruption” and “unicorn” in the pitch-decks or S1 and that, motherfuckers, is a winning formula.

Which was fucking awesome except for one thing: Luckin’s stock traded in America, land of both participation trophies and the everything bubble.  And in America, it’s not whether you win or lose (Americans don’t make investment decisions on stupid shit like loses and profits), it’s how you play the game. Americans will invest big in loss-making businesses but they expect those losses to be audited and guaranteed.  Americans love honest losers.

Enter Muddy Waters.  Actually, enter Snowlake Capital.  Apparently (allegedly), Snow Lake was an early investor in Luckin, but by May 2019, they became skeptical and hired two boutique staffing and research firms to check shit out, employing a staff of 92 full time, and roughly 1,418 part time interns like Qin Kang to report on the activity of 981 Lukin store days across China.  According to the report, Luckin inflated the items sold per store by 69%-88% in Q3 and Q4 of 2019.  Additionally, they inflated the selling price by 12.3% and reported profits when, in reality, store level losses were between 24.7% and 28%.  Meanwhile, according to a WSJ article, the vast majority of stock gains post IPO were driven by Luckin claims to store-level profitability.  Fuck.  We all know what happened next (denials, accounting scandal, fall guy exec terminations, delisting...).  But wait, what about the trade?

Well. This is a tough one.  Rumors are that the Snowlake short begin in August, 2019 (by way of reminder, the report came out in January, 2020), and if indeed Snowlake was an early investor, they may have profited both long and short.  According to some reports, Snow Lake manages roughly 2.4B, most of which was made on Luckin trades, which, based on their SEC filings, doesn’t seem far fetched.  Additionally, MW likely made shitloads, but how much is anyone’s guess.  Block says he knows the identity of “anonymous” and given MW’s history banking millions shorting Chinese businesses trading in the US, they probably bet big.  But this only scratches the surface.  The Luckin S1 founder equity disclosures  reads like a Panama Paper leak and given the amount of founder stock sold in the Jan 2020 private placement or post-IPO (or as part of the Luckin dry run that was the CAR (XHKG: 699) listing in Hong Kong), my guess is the winners, long and short, banked over $5B (allegedly, as reported, etc).

But fuck, why did this happen?  I mean, It’s confusing as fuck (for me, anyhow).  There are restrictions on Chinese markets that limit loss-making companies from listing their shares, and in February 2020, China placed big restrictions on short-selling to reign in volatility.  But in America, we love that shit.  For example, to calm nervous investors prior to their IPO, Uber executives did their best to provide assurances of a bright future, emphasizing that Uber is well positioned to penetrate a $12 trillion addressable market and their platform is poised to become the Amazon of transportation and even companies like Amazon and Facebook had rocky IPOs.  Meanwhile the company would continue to double-down on rider discount programs to capture market share.  In the first quarter following the IPO, they lost over $1B.

Yo, that’s how the game is played.  No need to fake profits, profits aren’t even part of the game. Why fuck up a good thing?

In commenting on the $100M plus payout of his Wildcard short (same shit, different country), Jim Chanos, master caller of financial bullshit, stated “It’s bittersweet, because short sellers put up with weeks and months of misery, and you feel good for hours or days.”  I’m guessing Qin Kang probably felt the same way after his summer of misery when the Luckin scandal was exposed.  Except maybe more like a minimum wage kinda “good”.  Same shit, different country.

Huge shout out to [this site ](https://feng.ifeng.com/c/7vLbcNHQCW9)and [this site ](https://t.qianzhan.com/daka/detail/191120-33be9bb8.html) for the best reporting I could find on Luckin.  Good shit, fellas.  

Peace!