Complex Made Simple

Is the Luckin Coffee IPO a potential yummy four bagger?

Luckin Coffee, the Xiamin based Chinese Starbucks, priced its IPO at the higher end of its $15 – $17 range. Luckin was founded a mere two years ago with a single store in Beijing but now boasts a network of 2400 stores, an amazing achievement that spells hypergrowth and technology disruption to me. Luckin’s coffee is priced at a 50% discount to Starbucks in the world’s largest under-penetrated, coffee mass market. If space is the final frontier for Star Trek, China is the final frontier for coffee vendors. I witnessed the fabulous “viral curve” of Chipotle Mexican Grill in the past decade. Chipotle proved that it is possible to quintuple money in an empire of burritos, tacos, enchiladas and tobasco salsa. Will the Luckin IPO be another Chipotle? Creo que si!

I am culturally illiterate about the Dragon Empire. My Chinese vocabulary does not extend beyond “chow mein” and “moo goo gai pan”. I have only visited and done business in Hong Kong, where “one country, two systems” is under stress. So my opinions of Luckin IPO should be taken with a grain of salt – or soya sauce, to be more culturally politically correct. My analysis is amorphic now and based on the regulatory S-1 filed with the SEC. What attracts me to the Luckin IPO?

One, the company has raised $560 million from private equity investors that include Wall Street fund manager Blackrock and the Singapore sovereign wealth fund GIC. This is smart money.

Two, Luckin is already China’s second largest coffee chain and unlike Starbucks, benefits from an anti-American consumer backlash in the Middle Kingdom.

Three, Luckin, unlike Uber, disclosed its unit economics and has a break-even price of coffee far below its sales price.

Four, The average American drinks 388 cups of coffee per annum, against 6 cups in China. Coffee is addictive. Yet China population is 1.3 billion, four times the United States. From one store in Beijing in 2017, Luckin has built the mother of all coffee chain networks.

Five, Luckin stores have no human cashiers. Clients must pay for their coffee via the mobile app, which captures all their locations, credit card, product preference data. The stores are really small pickup and self-service joints in China’s fastest growing cities.

Six, the founders have an E-commerce/Big Data background and can well create a high tech Asian Starbucks.

Seven, the $586 million IPO on NASDAQ will enable Luckin to scale up its systems to accelerate its growth to at least 5000 stores in the next twelve to eighteen months.

Eight, Luckin’s technology backbone enables it to serve clients with smaller stores, saving rental/furnishing costs.

Nine, Luckin will have a bigger store network than Starbucks in the next two years. The company will win both the Gorilla and Godzilla game in global coffee. Size matters! For a business founded in 2017, Luckin has already changed the world.

Ten, Luckin addresses all the pain points in the Chinese coffee market – uneven quality, high prices, inconvenient access. Luckin was valued at $2 billion in its last funding round in April but is $4.2 billion at its IPO offer price. This takes the juice out of a first day blowout pop but does not negate my broader investment thesis as I roam the world, tilting like Don Quixote, at windmills in the quest for El Dorado with four bagger winner stocks!.

Eleven, Luckin provides a basic mass market product at an attractive price point, a product correlated with higher incomes, urbanization, mobile penetration and Westernized social status millennials. This is coffee with Chinese characteristics – unlike Starbucks!

Luckin’s track record as a public company is all of two sessions old on NASDAQ as I write. The shares soared 50% above the $17 IPO offer price, but then slumped to $18.6 on Monday’s close due to the bloodbath in the Chinese stock market. The world’s fastest growing coffee retailer is valued at $4.3 billion in a Chinese coffee market set for hyper-growth.

Sure, I can imagine Luckin trade down to $14 or a $3 billion market cap if the current ugly mood in Chinese equities persists. I expect the Politburo to let the Chinese yuan depreciate to 7.30, a scenario that will trigger contagion for Chinese companies listed in New York (or Shanghai/Shenzhen). This is the point I will use option strategies to accumulate my position in Luckin. Will a trade war inflict pain on a Chinese economy with a 280% debt/GDP ratio? Unquestionably yes. Chinese GDP growth could well tank below 5%. Yet the mass market for coffee in China’s cities will continue to expand in the next decade.

China is a $12 trillion economic colossus and not all of Trump’s horses and all of Trump’s men/tariffs can keep this consumer Humpty Dumpty down. Expect Luckin EPS to grow by 20 – 25% per annum as China becomes more cost-conscious, more affluent, more nationalistic, more mobile tech enabled – and more coffeeholic. Unlike the Opium War the British Empire imposed on the Manchus, we can all make money from the coming coffee wars with Starbucks. The alchemy of finance, the magic and mathematics of exponential/viral demand curves tells me that this puppy will be a potential $12 billion market cap firm in a decade. This means the shares rise to $52 on NASDAQ for a potential yummy four bagger.