Investors who bought into the initial public offering of Luckin Coffee (LK) have made out great. The shares of the largest Chinese stock offering so far this year rose as much as 52.7% as they listed last Friday. They closed up 19.9% from the listing price of US$17.
But subsequent investors should not buy into the company's growth story. Those that are counting their winnings in Luckin's IPO lottery should collect them.
Luckin Coffee's growth trajectory will see it go from no stores in November 2017, when it was founded, to 2,370 outlets now. It intends to open another 2,500 stores this year.
That pace would take it past Starbucks (SBUX) , which has 3,600 stores in China, a market it entered in 1999. It is also not sustainable, or wise, in the slightest.
Starbucks took 20 years to reach its current scale in the mainland, and you can bet its stores were growing more like mushrooms than coffee beans. Its pace means it has still averaged opening a new one virtually every two days it has been in China.
There is no way whatsoever that Luckin Coffee is identifying almost seven good locations, negotiating seven good leases, renovating seven properties correctly, hiring the staff to manage seven stores correctly - every single day. I don't care how big China is, that's just not possible.
If you thought Silicon Valley was bad, there's nowhere better to burn cash than China. It has a history of producing a successful company, and then an unsustainable number of copycats, who then undercut each other to death.
Just look at the bike-sharking business. Ofo grew out of a Peking University school project in 2014. It experienced early success, its yellow bikes popping up on urban streets in the biggest cities. Soon, it was joined by Mobike, with its red bikes.
Then they were joined by around 60 other bike-sharing startups. There are now piles of bikes of a rainbow of colors piled in heaps and stacked in scrapyards. The town of Wangqingtuo, which has specialized in churning out bikes since the 1970s, experienced a massive boom in which it couldn't meet demand. Now of course, it's going bust.
Luckin Coffee generated revenue of US$125.3 million last year. And it turned a net loss to shareholders of US$475.4 million. That's just under half a billion dollars, almost four times its cash coming in.
Don't expect it to turn coffee black, in bookkeeping terms, anytime soon. It has warned that it may incur future losses and is more focused on expansion than making money for now. It is relying on discounts, with a large Americano around 25% lower than Starbucks, and cheap delivery to win business. It averages delivery time of 18 minutes.
Also worrying is the way that the company is couching itself. It has an app, which you must use to order. Stores are cashless. You pay either using the ubiquitous WeChat messaging service or a Luckin e-wallet. The app allows people to order coffee in advance - and watch it being prepared. That's a cool spin that will get old in, well, one coffee blender's time.
"People think we're just coffee, but actually we're more than coffee," Chief Financial Officer Reinout Schakel told Reuters at Nasdaq headquarters during the IPO. He says the company wants to use coffee as a "connection," and then "cross-sell different types of products."
Luckin told Xinhua that its rapid expansion would come thanks to a technology-driven, differentiated retail model built on mobile apps. But it's still selling coffee (and noodles).
The company's co-founder, Qian Zhiya, earned her chops as chief operating officer of Car Inc. That's a car-rental business that expanded with the ride-hailing business UCar.
Ride hailing? I think we are also familiar with that particular craze. It's another business with basic barriers to entry, an industry that relies more on brand name than differentiation of the actual product to win business.
Luckin is undercutting Starbucks by opening smaller stores, and trying to cut costs. If it is successful, expect other competitors to undercut it. The barriers to entry to opening a coffee shop are coming up with the rent, and buying a bit of coffee. There will be a chase to the bottom. I'm looking forward to my budget cups of Joe, subsidized by shareholders.
Let's also not get distracted by China's size. That 1.38 billion population exists. But let's slice and dice it. The urban population is 59%, and no peasants in the countryside working the fields are popping out their smartphone (which they probably do have) and downloading the app to order an extra-large cappuccino.
Another 17% of the population is under 14, while 23% are over the age of 55. The first demographic can't afford a fancy coffee or frozen drink, the second don't want one - they'll stick with one of China's many traditional teas.
So we're left with a population of 488 million urban Chinese aged 15-55. Let's assume Luckin is targeting the 102 cities in China that have populations of more than 100 million. It intends to have almost 50 (to be precise, 47.7) stores in each and every one of them.
Luckin Coffee raised US$561 million in its IPO, which gives it a valuation of US$4.7 billion. Starbucks has a market cap of US$95.6 billion. So there is size to grow if it is to match its competitors.
But Chinese people drink around six cups of coffee per year, on average. Americans drink 388. Little wonder Starbucks is highly profitable. Luckin is trying its luck with blind faith that Chinese consumption habits will change - and that its own competition won't now undercut it, just as it is attempting to do with Starbucks.
