A view of Luckin Coffe in Guangzhou, capital of South China's Guangdong Province in December. Photo: VCG

Starbucks’ China rival Luckin Coffee confessed to fabricating transactions, following Muddy Waters’ short thesis from February. 

The company has been embroiled in litigation over fraud-induced investor losses since the famed US short-selling firm placed a short bet on the coffee chain, and is likely to face a steep bill over investor compensation claims, according to a Beijing law firm that represents global investors in securities class action. 

Luckin’s NASDAQ-listed stock toppled over 80 percent in pre-market trading on Thursday as the company revealed transaction fabrications involving 2.2 billion yuan ($310.55 million) from Q2 2019 to Q4 2019.

The company’s chief operating officer, Liu Jian, and his subordinates, “had engaged in certain misconduct, including fabricating certain transactions,” Luckin said in a statement, citing an ongoing internal investigation.

“Certain costs and expenses were also substantially inflated by fabricated transactions” during the aforementioned period, according to the statement.

Luckin said it would “take all appropriate actions, including legal actions, against the individuals responsible for the misconduct.”

Many investors have reached out to us regarding litigation claims on a class action basis to recoup damages from the company, Hao Junbo, a lawyer with HAO Law Firm in Beijing, told the Global Times. 

Plaintiffs winning securities class actions in the US are about 50 percent, and how much investors would be compensated depends on the losses incurred by the company’s fraudulent statements, the securities class action lawyer explained.

“The company’s statement that confessed to fabricating transactions is a rarity among listed firms, raising the odds of a compensation settlement,” Hao believes. 

The company did not immediately respond to request for comments. 

The coffee chain was founded in 2017 and quickly rose to prominence with its ambitious expansion across China and pulled off an IPO debut in May 2019. Luckin stock soared nearly 50 percent above its IPO price of $17 in its debut and hit as high as $51.38 in mid-January. 

Its shares opened at $4.92 on Thursday following the free fall in pre-market trading and hovered around $6.5 by press time. All three major US stock indices held up in positive territory despite spiraling coronavirus woes.

Investors with damages in excess of $100,000 are encouraged to contact Hao’s law firm. He said the deadline for participation is April 13.

The Beijing law firm is not the only one intent on representing investor plaintiffs. Bronstein, Gewirtz & Grossman, LLC, a US business litigation boutique, has notified investors of a class-action lawsuit filed against Luckin, on behalf of investors who purchased the company’s stock from November to January.  

The complaint alleges that Luckin’s public statements were “materially false and misleading.”

Chinese stocks-focused Muddy Waters published an anonymous report in January alleging the upstart Chinese coffee chain had faked some of its financial performance metrics beginning in Q3 2019.

The 89-page report listed five fraud examples that suggested the company had inflated the items per store, exaggerating selling prices, and overstating expenses. It also revealed six red flags, including management cashed out their stock holdings and the co-founder’s questionable background in illegal business operations.

The report also discussed flaws in the ambitious coffee brewer’s business model, questioning whether a company should have a high-risk franchise and flawed unit economics, attracting customers that are highly price sensitive without brand loyalty could survive in the Chinese coffee market, which has almost saturated. The “Starbucks of China” denied the allegations as of press time. 

After the Muddy Waters’ announcement, Luckin stock dropped nearly 27 percent on January 31. Founded by the short seller Carson Block, Muddy Waters is an investment research company named after a Chinese proverb - catching fish in muddy waters. 

Since the company was founded in 2007, it has been betting against many Chinese companies, including Focus Media, which shifted from NASDAQ to listing in China in 2015, and was involved in Luckin’s fishy advertising spending, according to the report.

KeyBanc Capital which used to take a bullish stand on Luckin has downgraded it to sector weight from overweight and Needham has suspended its ratings on it.