Why Bankruptcy Should Finally End the Case for Luckin Coffee Stock

Stocks to sell

Let’s be clear up front. Just because Luckin Coffee (OTCMKTS:LKNCY) has declared bankruptcy doesn’t mean Luckin stock is going to zero.

Luckin (LKNCY) logo on the wall of a coffee shop with a customer sitting at a table below it.

Source: abolukbas / Shutterstock.com

Of course, it does at least create that possibility. More importantly, at this point, it’s hard to imagine exactly why investors are sticking with this name.

This is a company that executed one of the biggest frauds of the past decade, which it finally admitted not long after a vigorous denial. After that caused a trading halt, the company then delisted Luckin stock from its U.S. exchange almost immediately. That led to a wave of forced selling, which crushed the stock price and reduced the value that fleeing shareholders could salvage.

Now, Luckin is filing for Chapter 15 bankruptcy in the U.S. And while it’s largely a technical move, it still matters.

Luckin stock initially fell on the news. But investors, once again, are bidding up LKNCY, which rallied 10% on Monday. It’s hard to see why. At this point, it’s long past time to move on.

Why Is Luckin Declaring Bankruptcy?

It’s possible that, to at least some extent, the Chapter 15 filing is much ado about nothing. Luckin Coffee’s statement about the filing claimed that it was to “protect the interests of stakeholders,” which presumably includes shareholders.

And part of the point of the filing (again, per Luckin), is to gain U.S. recognition of a process already underway. In July, a court in the Cayman Islands, where Luckin is domiciled, approved a request to appoint provisional liquidators in that jurisdiction.

That provisional liquidation is required because the fraud has left Luckin unable to provide audited financial statements. That, in turn, has meant the company has defaulted on its bonds. Bankruptcy is required to restructure those bonds.

As is usually the case, bankruptcy doesn’t mean the end of the business. Chapter 15 in the U.S. is analogous to the well-known Chapter 11, except for foreign companies like Luckin. Most notably, the operations in China will continue through and likely after this process.

So this is mostly a technical maneuver. But it still puts shareholders at risk.

Bondholders may wind up with a good chunk of the company. The fact that Luckin bonds haven’t fallen much on the bankruptcy news shows that the U.S. filing perhaps doesn’t change the story all that much. The fact that those bonds still trade at only 76 cents on the dollar highlights the risk to shareholders, who are in line behind creditors.

This can go south in a hurry. And while shareholders may not get wiped out, they may see substantial dilution. Luckin’s market capitalization, still close to $2 billion, doesn’t seem to price in that risk.

A Broader Look at Luckin Stock

We’ve seen elsewhere in the market that bankruptcy doesn’t make a stock worthless. One of last year’s more well-covered stories shows that fact.

Of course, another stock that briefly roared in bankruptcy has come close to wiping out shareholders. At the least, recent history shows that these kinds of names are high-risk, high-reward propositions.

But the risk to Luckin stock of the bankruptcy can’t be seen in a vacuum. Again, this is a company that has shown zero regard for shareholders since it went public in 2019.

The Luckin growth story admittedly still exists. But as the report from the Cayman liquidators showed, the company remains unprofitable. Positive free cash flow isn’t expected until at least 2023.

So investors need to think about everything that has to go right to support the current Luckin stock price, and the current market capitalization near $2 billion.

First, growth needs to continue, even against entrenched and well-managed competition. Second, Luckin needs to prove that it can drive profitability at the store level, let alone after corporate expenses. Those two risks alone would be meaningful, even if the fraud had never occurred.

Third, the bankruptcy process needs to play out favorably. And, fourth, shareholders need Luckin to stand up for them during that process, even though the company has shown no interest in doing so at any point in its history on the public markets.

That’s an awful lot that needs to go right. And it all rests on investors trusting a company that hasn’t merited that trust. Bankruptcy perhaps doesn’t change the story all that much — but this story has been rotten for a long time.

On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.

Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. Click here to see what Matt has up his sleeve now. As of this writing, Matt did not hold a position in any of the aforementioned securities. 

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