Breakingviews - China's wannabe Starbucks brews a muddy IPO

HONG KONG (Reuters Breakingviews) - China's Starbucks wannabe is in an unseemly rush to deliver a New York listing. Luckin Coffee's draft prospectus argues, unconvincingly, that its fair value doubled in three months; an April funding round puts the company’s worth even higher, at a frothy near-$3 billion. Even with a rapidly-expanding chain of cheap outlets, it is still losing more than it rings up in cappuccinos. Add an unnecessarily complex corporate structure, and founder Qian Zhiya’s offer will leave investors worrying about a bitter aftertaste.

    Luckin, established in 2017, has proven excellent at two things: opening new stores as rapidly as possible in a race to overtake Starbuck's China footprint, and convincing backers like BlackRock that this is a financially meaningful achievement.

   The speed comes at a cost: Luckin subsidises its offerings. The strategy delivered some $125 million in net revenue in 2018, and a $475 million net loss attributable to shareholders.

   Frantically adding users at all costs is a common ploy among Chinese tech startups, but there other alarm bells too. In the prospectus filed on Monday, the company argues that its fair value roughly doubled to $530 per share between December and the end of March. It then raised funds a month later at nearly $866. To explain the sharp rise, it points to the pending initial public offering, and the ensuing conversion of preferred shares to ordinary shares, which hardly justifies the jump. It also notes rising customer numbers and an anticipated acceleration in revenue growth, which would come naturally from opening new stores.   

    In terms of governance, investors were given cause to worry in March, when Chairman Lu Zhengyao demanded banks loan him $200 million personally in exchange for a role in the IPO, Reuters reported. The prospectus does not reassure on this point either. Luckin has offshore holding companies and a China unit has 49 subsidiaries. It also has a variable interest entity owned by founder Qian and an employee, which will house permits and licenses.

    Chinese startups are often tempted to race to market before models are fully tested. Luckin may be a case in point.