Shares of Luckin Coffee have already fallen well below their initial public offering price just days after the company’s debut on the Nasdaq, as analysts question whether the Starbucks rival has a solid plan to reach profitability and support future growth.
The Xiamen-based company saw its shares open at $25 on Friday, an almost 50% jump from its IPO price of $17. But the stock has since fallen back to $14.75 at the close on Wednesday, giving the company a market cap of $3.4 billion. Analysts are questioning whether Luckin, which was founded only two years ago, can eventually deliver meaningful profits, especially as it's still burning cash to hand out generous discounts in the face of rising competition.
“Right now investors look at the company and they see growth, and that looks exciting,” says Ben Cavender, director of Shanghai-based consultancy China Market Research Group (CMR). The thing is, if your only continuous path to growth is spending at this rate, it is very difficult to make a profit.”
A big chunk of Luckin’s aggressive spending comes from heavy discounts. To win customers from Starbucks, the company subsidizes its coffee products through promotions like "buy one and get two for free." It also caters to consumer’s demand for a quick coffee fix by offering 18-minute deliveries. Couriers deliver the drinks ordered on the company's smartphone app that have been prepared at Luckin’s so-called pick-up stores, which are small outlets that don’t have seating areas. So far, the chain has attracted 16.8 million paying customers, and has opened 2,163 outlets across China. By comparison, Starbucks' network of stores in China has grown to 3,600 locations, where consumers are encouraged to lounge instead of grabbing coffee fixes on the go.
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But Luckin has been paying a high price for its rapid expansion. The coffee chain’s selling and marketing expenses --- which includes product subsidies --- accounted for one-third of the company’s total operating costs of $363.4 million in 2018, according to its prospectus. Meanwhile, Luckin earned $125.3 million from sales of its coffee beverages and other products, an amount that was just enough to cover the discounts and vouchers it was handling out.
Luckin’s future outlook remains challenging. Analysts don’t see the subsidies going away any time soon because a substantial number of its current customers have been attracted by its cheaper prices, meaning the cash burn would have to continue to keep them from going elsewhere.
“It is undeniable that in this market, a lot of consumers are buying Luckin because of the discounts,” says Jason Yu, a China-based general manager at consultancy Kantar Worldpanel. “There is a big question mark over whether they’d stay in the future.”
What’s more, competitors are also closing the gap in coffee deliveries. To entice China’s digital-savvy consumers, McDonald’s launched last year a delivery service for its McCafe in China, while Starbucks is partnering with Alibaba’s food-delivery platform Ele.me to offer a similar service.
Its less advantageous position in the delivery market, combined with the deep losses, makes the IPO expensive, says Brock Silvers, managing director at investment firm Kaiyuan Capital. “Even at the bottom of its indicated range, Luckin’s IPO still seems problematic,” he says. “Luckin hasn’t indicated any clear pathway to profitability, and the current model loses money on each cup of coffee.”
Luckin declined to comment. Liu Erhai, founder of Joy Capital and an investor, told Forbes in a previous interview that Luckin was focusing on building scale rather than achieving profitability.
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To be sure, the company does have a number of factors working in its favor. According to consultancy Mintel, China’s coffee market is projected to grow at an annual rate of 12.3% and reach 29.2 billion yuan ($4.3 billion) by 2023, suggesting ample future opportunities. To generate additional revenue lines, Luckin has recently started to expand its offerings with more food items as well as tea-based beverages.
“They do have a lot of opportunities to break even,” Yu says. “But they have to first build up a product barrier and a scale that others can’t compete with, and doing these certainly requires fast action as well as a lot of money.”
