Will Luckin Coffee prove a good IPO bet?

January 16, 2019 16:20
Luckin Coffee, which has emerged as a strong challenger to Starbucks in China, is said to have begun preparations for a Hong Kong listing. Photo: Reuters

Chinese startup Luckin Coffee is reportedly seeking an IPO in Hong Kong this year, even as global coffee chain giant Starbucks has warned of a slowdown in the China market.

Targeting a similar customer group, Luckin's stores are located in downtown streets or big shopping malls in China, competing with the American coffee chain head to head.

Luckin started as a smartphone-based on-demand coffee business, quickly gaining popularity among the mainland Chinese who basically order everything from their smartphones nowadays.

More importantly, Luckin typically prices its products at over 30 percent cheaper than Starbucks, and the Chinese coffee chain often also launches promotional campaigns that further widen the price gap.

Barely a year in business, Luckin now has 2,000 stores in China. It plans to have 4,500 outlets by the end of 2019, which would likely beat Starbucks, which has about 3,600 stores now.

The speed of expansion is staggering. It means Luckin needs to open around 5.5 shops every day. Finding the right location, negotiating rental contracts, hiring employees all involve a lot of work.

Unlike founders of coffee giants such as Starbucks, Blue Bottle and Lavazza, Luckin’s founder Qian Zhiya is a former tech executive. He had been the chief operating officer at Chinese car rental giant CAR Inc. Therefore, technology is at the heart of Luckin’s business model, from introduction of digital management to user experience design.

The company raised US$400 million in B-series fund-raising, helping it to stick to its frenetic expansion pace.

Meanwhile, the top global chain Starbucks projects its China market sales to slow down. Goldman Sachs downgraded the firm's shares, citing "a number of points of caution on China.”

Starbucks already caved in to intense competition in China, and decided to offer delivery service by teaming up with Alibaba’s food delivery platform Ele.me in a move to shore up sales.

Luckin is said to be targeting an IPO valuation of HK$30 billion. The firm has reported a loss of 860 million yuan for the first three quarters of last year. A company spokesperson has said that s“full-year loss will be much greater,” adding that “customer subsidy is our set strategy. Therefore, the loss is in line with our expectations.”

It’s hard to say whether a business model with such a high cash burn rate makes sense or not. But at least, a high cash burn rate does not preclude Luckin IPO from being a good bet.

After all, coffee shops can be a highly profitable business, Starbucks gross profit margin is close to 70 percent for example. Luckin might be the winner eventually if its cash-burning strategy and delivery model work.

Meanwhile, its vast coffee outlets and food delivery app have built a huge customer base, which would also make it a potential acquisition target for big technology firms.

This article appeared in the Hong Kong Economic Journal on Jan 16

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal columnist