By Jing Yang
China's upstart Luckin Coffee Inc. grew at a blinding pace. It opened stores faster than Starbucks Corp., doubled its valuation to $12 billion eight months after going public and pleased its big-name investors in the U.S.
Then, on April 2, Luckin said many of its sales had been faked.
The shock brought a screeching stop to the three-year-old juggernaut, sending its stock plunging 75% overnight. Since then, investigators have delved into the books, executives have lost jobs and a stock exchange has moved to delist Luckin, but no one has explained just what went on inside the onetime corporate rocket ship.
Now, some light can be shed.
It turns out that Luckin sold vouchers redeemable for tens of millions of cups of coffee to companies that had ties to Luckin's chairman and controlling shareholder, Charles Lu, according to internal documents and public records reviewed by The Wall Street Journal. Their purchases helped the company book sharply higher revenue than its coffee shops produced.
Meanwhile, other internal documents showed a procurement employee called Lynn Liang processing more than $140 million of payments for raw materials such as juice, delivery and human-resources services. Ms. Liang was fictitious, according to people familiar with Luckin's business.
The scale and audacity of deception, which the Journal found traced back to before Luckin's initial public offering on the Nasdaq Stock Market just a year ago, has stunned international investors and confounded regulators. This was a company that went from founding to public listing in less than two years. Its sudden fall saddled pension, mutual and hedge funds, not to mention individual investors, with heavy losses both in Asia and the West.
Luckin on May 11 ousted its chief executive, Jenny Qian, and chief operating officer, Jian Liu, but provided little detail. It suspended or put on leave six others.
Ms. Qian couldn't be reached for comment. Mr. Liu hung up when reached by phone. The only one of the other six who provided a comment said he was just following orders.
Mr. Lu didn't respond to questions from the Journal. On May 20, he said in a public statement: "My style may have been too aggressive and the company may have grown too fast, which has led to many problems. But I by no means set out to deceive investors."
He also apologized and restated his faith in the company in the statement, issued after Nasdaq moved to delist Luckin's shares, a decision Luckin said it would appeal.
Luckin said in response to questions from the Journal that a committee of its board is continuing an internal investigation and responding to inquiries from regulatory agencies in the U.S. and China. It said it couldn't comment on specific details relating to the probe at this time.
"The Company continues to take appropriate measures to improve its internal controls and remains focused on growing the business under the leadership of its Board and current senior management team," Luckin said.
Nasdaq, although seeking to delist Luckin, last week permitted its American Depositary Shares to resume trading after a six-week suspension. They promptly resumed their drop. The shares closed Wednesday at $2.59, versus a brief high above $50 in January.
Luckin's fall has rekindled long-running tensions over the U.S. Securities and Exchange Commission's inability to inspect financial records of Chinese firms to protect American investors.
The SEC is among the agencies investigating Luckin, according to people familiar with the matter. In April it issued a renewed warning about the risks of investing in companies in China and other emerging markets. China's top business and commerce regulator has raided Luckin's headquarters in Xiamen, China, and taken records.
Luckin Coffee was born with a silver spoon in mid-2017, during China's recent technology funding boom. While private it raised more than half a billion dollars from investors including BlackRock Inc., Singapore sovereign-wealth fund GIC and a bevy of Chinese and American investment funds. Credit Suisse and Morgan Stanley courted its executives and later won leading roles underwriting its public offering.
Luckin's controlling shareholder, who goes by Lu Zhengyao in addition to Charles Lu, is an entrepreneur who previously started auto-rental firm CAR Inc. and a Chinese ride-hailing firm called Ucar Inc.
Ms. Qian, an executive at those earlier ventures, co-founded Luckin with Mr. Lu and became its CEO. They fashioned it as a tech company that could disrupt the expanding business of coffee sales in China, dominated by Starbucks.
Luckin built its strategy around a mobile app, with which it sent vouchers for free coffee to tens of millions of people, and coupons for deep discounts on later purchases. The discounts brought the price of a latte down to 12 yuan, or $1.67, about a third the cost of a similar drink at Starbucks.
Customers ordered and paid electronically, eliminating cashiers. Luckin promised to deliver coffee within 30 minutes. It told investors its model helped it collect data to optimize sales and supply-chain efficiency.
By May 2018, just seven months after opening its first cafe, Luckin had more than 500 of them, in over a dozen cities. It said it obtained premium arabica coffee beans from Latin America and Africa, syrup from Italy and milk from New Zealand. It boasted of using high-end Swiss coffee machines and hiring award-winning baristas to help design recipes and cafes.
At a glitzy launch party that included hordes of business partners and journalists, Ms. Qian, standing in front of a giant LED screen, said the goal was to provide affordable premium coffee that people could access at any moment.
Days later, Luckin fired a salvo at Starbucks, which over two decades had helped lure a tea-drinking population to coffee. Luckin accused Starbucks of discouraging suppliers from doing business with rivals and filed an antimonopoly lawsuit. Starbucks said it welcomed competition. Luckin later dropped the suit.
A fundraising in June 2018 gave Luckin a billion-dollar valuation just a year after its founding. The cash supercharged its opening of cafes, many close to a Starbucks. The Seattle-based giant, too, began delivering coffee to Chinese customers.
Luckin's IPO in May 2019 was a big success, raising $651 million and valuing the company at around $5 billion on its first trading day. Mr. Lu high-fived colleagues as the stock jumped.
Back in Xiamen, Luckin held a banquet for hundreds of business partners, investors, bankers and lawyers. Guests posed for photos at a booth mimicking the Nasdaq listing ceremony, and Ms. Qian presented the next goal: 10,000 stores in China by the end of 2021. Starbucks had fewer than 4,000 at the time.
"It was just explosive, humongous growth, and those numbers were very seductive to a lot of investors," said John Zolidis, a restaurant-industry analyst and president of Quo Vadis Capital, which said it has never bought or sold Luckin stock.
A group of Luckin employees had already begun helping sales along by engineering fake transactions, starting the month before the IPO, according to people familiar with the operation. The employees used individual accounts registered with cellphone numbers to purchase vouchers for numerous cups of coffee. Between 200 million and 300 million yuan of sales ($28 million to $42 million) were fabricated in this manner, according to a person familiar with the matter.
The undertaking became more complex. In late May 2019, orders began flooding in under a fledgling line of business that involved selling coffee vouchers in bulk to corporate customers, according to internal records reviewed by the Journal.
Alongside bona fide voucher sales, to a few regular clients such as airlines and banks, the records show numerous purchases by dozens of little-known companies in cities across China. These companies repeatedly bought bundles of vouchers, often in large amounts. Rafts of orders sometimes came in during overnight hours.
Qingdao Zhixuan Business Consulting Co. Ltd., situated in China's northern Shandong province, bought 960,000 yuan ($134,000) worth of Luckin vouchers in a single order, according to the documents. They show it made more than a hundred similar purchases from May to November of 2019.
Mainland China and Hong Kong corporate-registry records link this company to a relative of Mr. Lu, to an executive of Mr. Lu's previously founded Ucar Inc. and to a Luckin executive, via a complex web of other companies and their directors and shareholders. Qingdao Zhixuan also has the same telephone number as a branch of CAR Inc. and is registered with a Ucar email address.
Luckin booked more than 1.5 billion yuan ($210 million) of corporate sales in this manner in 2019, dwarfing genuine purchases during the period, according to a Journal analysis of the records.
As money flowed in from the bulk sales, Luckin also made payments to more than a dozen companies listed in its records as providers of raw materials, delivery or human-resources services. Many didn't exist until April and May of 2019, corporate registration records show.
Chinese regulators who recently went through Luckin's systems found more than 1 billion yuan (about $140 million) in questionable supplier payments, according to the company's internal documents and people familiar with the matter. The documents showed payments were processed by Ms. Liang, the woman described as fictitious by people familiar with Luckin.
According to internal records and a person familiar with the matter, Luckin CEO Ms. Qian approved the payments and, in some instances, actively saw to the progress of the payment processes. The payments bypassed the chief financial officer, who then didn't oversee Luckin's finance and treasury department, the person said. The CFO, Reinout Schakel, declined to comment.
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