Luckin Coffee is a typical Chinese initial public offering: the group's prospectus, obedient stockbrokers and a largely friendly media all paint a picture of vast growth potential that glosses over current losses and a heavy cash drain.
The business in question hardly matters. It could be technology, it could be manufacturing. In this case it is coffee. Luckin wants to become China's Starbucks and, in fact, to beat Starbucks at its own game on the mainland. This, it claims, is a virtually untapped market. The company touts the fact that the Chinese drink an average of just 6 cups of coffee a year compared to 209 cups in Taiwan.
Luckin plans to change that by applying its "technology-driven new retail model" to increase consumption -- though the new model seems to mainly involve opening (expensive) stores, very rapidly. Only 18 months old, it plans to have 10,000 in operation by 2021 even though it has taken Starbucks 20 years to reach 3,700 in China.
While the shares have not exactly soared, they are trading almost a fifth above their $17 May launch price and most analysts are bullish. Media coverage too is overwhelmingly positive, reporting the management's expansion plans rather uncritically.
By contrast, our scoutAsia research team has written a much more sceptical analysis, based on our own surveys of Chinese consumers. These reveal two simple truths that seem, at least to me, to undermine Luckin's entire business model. The first is that the Chinese are -- and appear happy to remain -- a nation of tea drinkers. While consumption of tea, including fruit and bubble teas, has soared since 2015 (just ask food delivery service Meituan Dianping), consumption of coffee in first-, second- and third-tier cities has remained minimal -- and is obviously lower still in the countryside.
Second, Luckin is essentially buying itself revenue growth. Consumers report that their main attraction to the brand is the plethora of coupons and discounts that are on offer, which means they get every third or fourth cup of coffee for free, cutting Luckin's net price to below that of inferior coffee from convenience stores. When the company reduced this marketing "investment" in early 2019 to prepare for flotation, new customer numbers fell dramatically.
It could all work out, if Luckin can raise enough money to keep expanding until it generates sufficient scale economies to offset its ruinous pricing policy. Or it may at some point be able to reduce discounts if it can build a much stronger brand or reputation for quality. But this assumes flawless execution and no response from competitors or any new entrants. And, of course, that the Chinese will suddenly become a nation of coffee addicts.
The odds are against Luckin succeeding and investors need more objective analysis that is willing to point out the risks.