Starbucks in Crisis – Part 2
(Feat. Luckin Coffee, China Market, NASDAQ Scandal, IPO Listing, Muddy Waters, Window Dressing Accounting, Short Selling, Portfolio Risks, Franchise Cafe Brands)
Continuing from Part 1
56. As of September 2024, Starbucks operates 40,199 stores globally.
57. Out of these, 7,596 are located in China, making China a significant market for the company.
58. However, a strong competitor has emerged in China.
59. This competitor is Luckin Coffee.
60. Luckin Coffee opened its first store in Beijing in October 2017.
61. Luckin’s business strategy involves offering coffee similar in quality to Starbucks but at a lower price, with a focus on online orders and delivery.
62. The company handles all payments through its dedicated mobile app and attracts customers with heavily discounted prices and free latte coupons.
63. While Starbucks charges around 33 yuan (about $4.50) for a cup of coffee, Luckin sells theirs for about 11 yuan ($1.50), positioning itself as an affordable alternative.
64. Within less than two years, Luckin expanded to over 2,000 stores across China and went public on Nasdaq in May 2019.
65. This rapid expansion caught the attention of Muddy Waters Research.
66. Muddy Waters is a prominent short-selling firm that profits by uncovering companies engaged in questionable practices and betting against them.
67. Muddy Waters launched an in-depth investigation into Luckin, closely monitoring 980 of its key stores and deploying over 1,000 investigators to verify Luckin’s reported sales.
68. They observed store sales via CCTV, recorded transactions, and even joined managers’ group chats to gather detailed information.
69. Through this investigation, Muddy Waters noticed inconsistencies in Luckin’s order numbers.
70. Specifically, they found that Luckin’s order numbers were not sequential.
71. For instance, rather than moving from Order #280 to #281, the sequence would skip to #284 or #286.
72. Despite these skipped numbers, Luckin was calculating daily sales totals by simply multiplying the final order number by the price per coffee.
73. Muddy Waters verified 25,843 receipts, ultimately uncovering that Luckin was inflating its reported revenue by more than double.
74. In traditional finance, this type of financial fraud is often referred to as “window dressing” or “makeup accounting.”
75. In Chinese, the characters for “powder” and “decorate” combine to mean “window dressing” or making accounts appear better than they are.
76. Financial “window dressing” refers to the practice of “applying makeup” to accounting records to misrepresent a company’s financial position.
77. Companies use this practice for various reasons, including boosting their stock value or reducing tax obligations.
78. In Luckin’s case, it was done to inflate revenue figures and make the business look more successful than it actually was.
79. If the first instance of “makeup” was on revenue, the second was on profit.
80. In the third quarter of 2019, Luckin claimed that most of its stores had reached profitability.
81. The company distributed fake sales worth approximately 3.8 billion yuan across its stores, funneling this fabricated income back to headquarters as advertisement expenses.
82. Muddy Waters compiled all this evidence and released it publicly.
83. As a result, Luckin Coffee was delisted from Nasdaq on June 26, 2020, and subsequently declared bankruptcy.
84. With its Nasdaq delisting, American investors lost their investments in Luckin, yet the company itself did not go bankrupt.
85. Luckin quickly pivoted to patriotic marketing within China.
86. Following the stock collapse and Nasdaq delisting, Luckin framed the situation as a problem that affected only U.S. investors.
87. The company positioned itself as a “victim” of the U.S.-China trade conflict, allowing it to continue operating in China.
88. Rather than downsizing, Luckin increased its store count in China to 6,024, surpassing Starbucks’ 5,557 stores.
89. Later, a government-linked fund in China, invested $240 million to acquire a controlling stake in Luckin.
90. With this patriotic marketing strategy and support from state-backed funds, Luckin continued to thrive on its China-based sales.
91. As of 2024, Starbucks operates 7,596 stores in China, but Luckin now boasts 21,343 stores, significantly outpacing Starbucks.
92. Meanwhile, Starbucks in the U.S. recently appointed a new CEO in September 2024, marking a shift in strategy.
93. Starbucks has also sold some of its stores in other parts of Asia to local licensees, allowing it to refocus on its original mission and brand philosophy.
94. Under the slogan “Back to Starbucks,” the company is now working to lower prices for additional options and bring back the relaxed, welcoming atmosphere that encourages customers to stay longer.
Alphazen Insights
Starbucks is facing a two-sided challenge: high prices and loitering issues in the U.S., and fierce competition from budget-friendly rivals like Luckin Coffee in China. To tackle this, Starbucks is leaning into its roots—lowering prices a bit and revamping its stores to bring back that warm, inviting atmosphere that encourages customers to stay and relax. It’s a bold bet on experience over speed and price, but time will tell if this approach can help Starbucks regain its edge globally.
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