By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
Santa Claus came early this year for me though Rudolf was a Chinese white nosed reindeer. I had recommended Luckin Coffee (symbol LK), popularly (but inaccurately) known as the Chinese Starbucks, at its IPO in New York in a column published on this media platform on 21 May 2019. There were three major reasons for my bullish call.
One, Luckin Coffee was financed as a venture capital investment by two of the world’s ultimate smart money investors BlackRock and Singapore’s Temasek. Two, Luckin’s business model was not to compete with Starbucks in the high end urban yuppie market but to focus on cheap, technology enabled, ATM like (no baristas) pickup stores that would focus on the mass markets in networked Chinese cities with aspirational (but income constrained) kids bought up on millennia of a tea drinking culture and ready for something edgy, Western, hip, neurologically addictive – beverage. Three, superb execution and the potential for rising margins. The company has increased sales by 540% and quadrupled its stores to 3800 in the past 12 months – now this is exponential growth. This is the viral curve, the ultimate holy grail of investment, the hyper growth that is rarer than “unicorns” and Herodotus’s griffins that guarded mythic mountains of gold (Uber down 35% is a unicorn that has lost its horn!).
Luckin Coffee’s performance has been as spectacular as I had expected. The shares are up an incredible 54% in the last three weeks though I had doubled my money on this IPO since May just by selling puts at implied volatility as high as 120 – obviously the cognoscenti on Wall Street grossly mispriced this deal to our financial benefit and all we had to do was ahlan wa sahlan on the Chicago Board Option Exchange! What next?
I have even contacted fund managers and private equity friends in Shanghai to get the latest scoop/dirt (this is China, things fall apart, the disclosure cannot hold, anarchy is loosened on NASDAQ). I wish I had asked all my friends in town over a Starbucks Frappuccino and laid my investment thesis out on Luckin since I was so sure this IPO was a winner, but… life is short.
Lone Pine Capital and other New York hedge funds have been accumulating Luckin Coffee shares in October and November – a tad late since a Dubai fund (moi!) was long in June. I remember trading Luckin while in Nairobi and the Côte d’Azur in the summer – for 120 implied vols, I would gladly turn cartwheels in my polka dotted jammies if physics and my wife only permitted.
Lone Pine owns 14.5% Luckin Class A ADR’s in New York, all the shares acquired in a frenzy of buying since the end of the second quarter but its SEC disclosure suggest Steve Mandal, one of history’s legendary stock pickers, agreed with me on my investment theses on this puppy – tea bags and triple baggers, duckies. God save our gracious Queen and make her Empress of China as Vicky was once of Empress of India!
The third quarter earnings results were literally a blowout. This is the reason the shares are up 50% since the company reported in early November 2019 after my return from a short but eventful trip to Sri Lanka to seek post – Gotayaba investment ideas in this frontier market. Luckin’s operating metrics are truly spectacular. Revenue growth is 90% and store profit margins are 38%, above Wall Street consensus. Revenues were $300 million in the 3Q, way above the whisper number. Average monthly clients grew at 40%. True, Luckin’s ad budget jumped six fold to 246 million renminbi (RMB) but Rome (ok, Forbidden City?) was not built in a day and definitely not built without marble either, as Imperator Octavian proved.
Luckin’s ad/promotion budget has led to a gangbuster acceleration in customer growth/retention. So sales/marketing expenses per new client have begun declining this early in the game. Will this coffee retailing superstar, like Starbucks in the 1990’s, achieve hypergrowth with rising profit margins – the Valhalla of Wall Street’s fabled gorilla game? Yes. Will the Hong Kong/Chinese trade woes give us another chance to buy the shares below 30? Yes, how low? No clue but selling puts for yummy 75 implied vols is my idea of investment Shangri-la, lotusland, Elysium and Xanadu. Is the expanded menu of herbal tea, juice and French pastries (ooh la la, les Chinois sont trop Francophiles – billionaires snap up vineyards and chateaux in Bordeaux) goose the franchise? Absolutely, yes.
China’s freshly brewed coffee per capital rate is a dismal 6 cups versus 200 in America. So the coffee market’s CAGR is 20%. So Luckin has won the gorilla game with its tech/mobile wallet/takeaway/millennial and Gen Z focus/central and Western Tier 2, 3 and 4 cities footprint. I would like to accumulate Luckin Coffee on any setback in the stock market related to “macro” factors like Wall Street risk aversion, Hong Kong politics, Trump’s trade threats/tweets, ideally at 25 – 26. Despite the spectacular profit Luckin gave to us in November (better learn to increase my Mandarin vocabulary beyond chow mein, dim sum), my knowledge of the Chinese language and culture is monumentally ignorant. This is a potential quintuple bagger in my admittedly biased Dragon Empire cosmic crystal glass though the ride will be more rollercoaster than linear.