China’s upstart Luckin Coffee Inc. grew at a blinding pace. It opened stores faster than Starbucks Corp., doubled its valuation to $12 billion eight months after going public and pleased its big-name investors in the U.S.
Then, on April 2, Luckin said many of its sales had been faked.
The shock brought a screeching stop to the three-year-old juggernaut, sending its stock plunging 75% overnight. Since then, investigators have delved into the books, executives have lost jobs and a stock exchange has moved to delist Luckin, but no one has explained just what went on inside the onetime corporate rocket ship.
Now, some light can be shed.
It turns out that Luckin sold vouchers redeemable for tens of millions of cups of coffee to companies that had ties to Luckin’s chairman and controlling shareholder, Charles Lu, according to internal documents and public records reviewed by The Wall Street Journal. Their purchases helped the company book sharply higher revenue than its coffee shops produced.
Meanwhile, other internal documents showed a procurement employee called Lynn Liang processing more than $140 million of payments for raw materials such as juice, delivery and human-resources services. Ms. Liang was fictitious, according to people familiar with Luckin’s business.
The scale and audacity of deception, which the Journal found traced back to before Luckin’s initial public offering on the Nasdaq Stock Market just a year ago, have stunned international investors and confounded regulators. This was a company that went from founding to public listing in less than two years. Its sudden fall saddled pension, mutual and hedge funds, not to mention individual investors, with heavy losses both in Asia and the West.

Barista Dong Huan packed Luckin coffee in bags for delivery at a Beijing cafe in February 2019.

Luckin on May 11 ousted its chief executive, Jenny Qian, and chief operating officer, Jian Liu, but provided little detail. It suspended or put on leave six others.
Ms. Qian couldn’t be reached for comment. Mr. Liu hung up when reached by phone. The only one of the other six who provided a comment said he was just following orders.
Mr. Lu didn’t respond to questions from the Journal. On May 20, he said in a public statement: “My style may have been too aggressive and the company may have grown too fast, which has led to many problems. But I by no means set out to deceive investors.”
He also apologized and restated his faith in the company in the statement, issued after Nasdaq moved to delist Luckin’s shares, a decision Luckin said it would appeal.
Luckin said in response to questions from the Journal that a committee of its board is continuing an internal investigation and responding to inquiries from regulatory agencies in the U.S. and China. It said it couldn’t comment on specific details relating to the probe at this time.
“The Company continues to take appropriate measures to improve its internal controls and remains focused on growing the business under the leadership of its Board and current senior management team,” Luckin said.
Nasdaq, although seeking to delist Luckin, last week permitted its American depositary shares to resume trading after a six-week suspension. They promptly resumed their drop. The shares closed Wednesday at $2.59, versus a brief high above $50 in January.

Rise and Fall

Luckin Coffee went from founding to IPO in less than two years. Its crash was even more swift.

Valuation in billions of dollars

Firm admits
some sales from
2nd to 4th
quarters were
June 2018: A year after its founding,
Luckin raises $200 million, becomes a
private company worth $1 billion.
November: Valuation more than doubles
following another $200 million capital
April 2019: Third investmentround raises
additional $150 million.
May: IPO raises $651 million.
November: Luckin says third-quarter product sales surged 558%.
January 2020: Shares hit a high after an $865 million sale of stock and debt.
February: Firm denies report circulated by short seller alleging it inflated sales.
April: Shares plunge after Luckin says some $310 million of sales were fabricated.
May: After a six-week trading suspension, shares fall further.
Sources: FactSet (market cap); the company
Luckin’s fall has rekindled long-running tensions over the U.S. Securities and Exchange Commission’s inability to inspect financial records of Chinese firms to protect American investors.
The SEC is among the agencies investigating Luckin, according to people familiar with the matter. In April it issued a renewed warning about the risks of investing in companies in China and other emerging markets. China’s top business and commerce regulator has raided Luckin’s headquarters in Xiamen, China, and taken records.
Luckin Coffee was born with a silver spoon in mid-2017, during China’s recent technology funding boom. While private it raised more than half a billion dollars from investors including BlackRock Inc., Singapore sovereign-wealth fund GIC and a bevy of Chinese and American investment funds. Credit Suisse and Morgan Stanley courted its executives and later won leading roles underwriting its public offering.
Dark BrewLuckin Coffee reported big jumps in quarterly revenuebefore revealing 2.2 billion yuan in fabricated sales fromthe second to the fourth quarter of 2019.Net revenue from productsSource: The companyNote: 1 billion yuan=$139.4 million; 4Q 2019 number is a forecastrepresenting the middle of the range provided by Luckin inNovember.
.billion yuan1Q20182Q3Q4Q1Q’192Q3Q4Q0.
Luckin’s controlling shareholder, who goes by Lu Zhengyao in addition to Charles Lu, is an entrepreneur who previously started auto-rental firm CAR Inc. and a Chinese ride-hailing firm called Ucar Inc.
Ms. Qian, an executive at those earlier ventures, co-founded Luckin with Mr. Lu and became its CEO. They fashioned it as a tech company that could disrupt the expanding business of coffee sales in China, dominated by Starbucks.
Luckin built its strategy around a mobile app, with which it sent vouchers for free coffee to tens of millions of people, and coupons for deep discounts on later purchases. The discounts brought the price of a latte down to 12 yuan, or $1.67, about a third the cost of a similar drink at Starbucks.
Customers ordered and paid electronically, eliminating cashiers. Luckin promised to deliver coffee within 30 minutes. It told investors its model helped it collect data to optimize sales and supply-chain efficiency.

Charles Lu, chairman and co-founder of Luckin Coffee, at the company’s trading debut on Nasdaq on May 17, 2019

By May 2018, just seven months after opening its first cafe, Luckin had more than 500 of them, in over a dozen cities. It said it obtained premium arabica coffee beans from Latin America and Africa, syrup from Italy and milk from New Zealand. It boasted of using high-end Swiss coffee machines and hiring award-winning baristas to help design recipes and cafes.
At a glitzy launch party that included hordes of business partners and journalists, Ms. Qian, standing in front of a giant LED screen, said the goal was to provide affordable premium coffee that people could access at any moment.
Days later, Luckin fired a salvo at Starbucks, which over two decades had helped lure a tea-drinking population to coffee. Luckin accused Starbucks of discouraging suppliers from doing business with rivals and filed an antimonopoly lawsuit. Starbucks said it welcomed competition. Luckin later dropped the suit.
Store BoughtLuckin Coffee opened new stores at a blistering pace,exceeding Starbucks's China network by the end of 2019.Number of stores across ChinaSource: The company
A fundraising in June 2018 gave Luckin a billion-dollar valuation just a year after its founding. The cash supercharged its opening of cafes, many close to a Starbucks. The Seattle-based giant, too, began delivering coffee to Chinese customers.
Luckin’s IPO in May 2019 was a big success, raising $651 million and valuing the company at around $5 billion on its first trading day. Mr. Lu high-fived colleagues as the stock jumped.
Back in Xiamen, Luckin held a banquet for hundreds of business partners, investors, bankers and lawyers. Guests posed for photos at a booth mimicking the Nasdaq listing ceremony, and Ms. Qian presented the next goal: 10,000 stores in China by the end of 2021. Starbucks had fewer than 4,000 at the time.
“It was just explosive, humongous growth, and those numbers were very seductive to a lot of investors,” said John Zolidis, a restaurant-industry analyst and president of Quo Vadis Capital, which said it has never bought or sold Luckin stock.
A group of Luckin employees had already begun helping sales along by engineering fake transactions, starting the month before the IPO, according to people familiar with the operation. The employees used individual accounts registered with cellphone numbers to purchase vouchers for numerous cups of coffee. Between 200 million and 300 million yuan of sales ($28 million to $42 million) were fabricated in this manner, according to a person familiar with the matter.

Inside a Luckin Coffee shop in Beijing in February 2019.

The undertaking became more complex. In late May 2019, orders began flooding in under a fledgling line of business that involved selling coffee vouchers in bulk to corporate customers, according to internal records reviewed by the Journal.
Alongside bona fide voucher sales, to a few regular clients such as airlines and banks, the records show numerous purchases by dozens of little-known companies in cities across China. These companies repeatedly bought bundles of vouchers, often in large amounts. Rafts of orders sometimes came in during overnight hours.
Qingdao Zhixuan Business Consulting Co. Ltd., situated in China’s northern Shandong province, bought 960,000 yuan ($134,000) worth of Luckin vouchers in a single order, according to the documents. They show it made more than a hundred similar purchases from May to November of 2019.
Mainland China and Hong Kong corporate-registry records link this company to a relative of Mr. Lu, to an executive of Mr. Lu’s previously founded Ucar Inc. and to a Luckin executive, via a complex web of other companies and their directors and shareholders. Qingdao Zhixuan also has the same telephone number as a branch of CAR Inc. and is registered with a Ucar email address.
Luckin booked more than 1.5 billion yuan ($210 million) of corporate sales in this manner in 2019, dwarfing genuine purchases during the period, according to a Journal analysis of the records.
Losing ItLuckin Coffee burned through cash by expanding rapidlyand doling out discounts to customers. It has yet to turn aprofit.Net loss, quarterlySource: The companyNote: 100 million yuan=$13.94 million
.million yuan1Q20182Q3Q4Q1Q’192Q3Q-800-600-400-2000
As money flowed in from the bulk sales, Luckin also made payments to more than a dozen companies listed in its records as providers of raw materials, delivery or human-resources services. Many didn’t exist until April and May of 2019, corporate registration records show.
Chinese regulators who recently went through Luckin’s systems found more than 1 billion yuan (about $140 million) in questionable supplier payments, according to the company’s internal documents and people familiar with the matter. The documents showed payments were processed by Ms. Liang, the woman described as fictitious by people familiar with Luckin.
According to internal records and a person familiar with the matter, Luckin CEO Ms. Qian approved the payments and, in some instances, actively saw to the progress of the payment processes. The payments bypassed the chief financial officer, who then didn’t oversee Luckin’s finance and treasury department, the person said. The CFO, Reinout Schakel, declined to comment.
A look at registration records of companies that bought vouchers and others that received repeated supplier payments shows that many had links to Luckin, Mr. Lu or Mr. Lu’s two previous ventures. Some listed the same office addresses and contact numbers as branches of CAR Inc. or Ucar. Several were registered with email addresses of employees of those companies. One was registered with a Luckin email address.
A few of the companies had links to a relative or a friend of Mr. Lu. One regular bulk buyer of coffee vouchers, Date Yingfei (Beijing) Data Technology Development Co. Ltd., has the same phone number as a branch of CAR Inc. and a predecessor of Ucar.

Jenny Qian, right, then CEO of Luckin Coffee, at the company’s May 2019 listing ceremony on Nasdaq.

Zhengzhe International Trade (Xiamen) Co. shows up in the documents as a supplier of raw materials to Luckin.
Date Yingfei and Zhengzhe have the same legal representative, Wang Baiyin, a former classmate of Mr. Lu. Mr. Wang owns 60% of Date and 95% of Zhengzhe, according to corporate registration records. Mr. Wang couldn’t be reached for comment.
Not all details of the operations could be learned. People familiar with these transactions surmised that, over time, the rafts of purchases and payments formed a loop of transactions that allowed the company to inflate sales and expenses with a relatively small amount of capital that circulated in and out of the company’s accounts. It remains unclear what was the original source of funds to kick-start the transactions.
In November 2019, Luckin reported a 558% year-over-year jump in third-quarter product sales, and projected around a 400% rise for the fourth quarter. Average net revenue from products per store soared 80%, its financial report showed.
About two months later, after the stock price had roughly doubled, Luckin raised $865 million in a follow-on sale of shares and convertible notes. Its stock climbed further when Luckin said it had overtaken Starbucks by number of cafes in China and it would roll out numerous vending machines selling its drinks.


Is it safe for Americans to invest in individual companies in China and other developing markets? Join the conversation below.
Then, on Jan. 31, Muddy Waters LLC, a U.S. short seller with a record of exposing misbehavior at Chinese companies, circulated an 89-page unattributed report on Luckin. The report said an examination of more than 11,000 hours of video footage of customer comings and goings, of more than 25,000 customer receipts and of observation by 1,500 individuals who visited Luckin outlets showed that much of the company’s revenue must be fabricated.
Luckin’s stock took a dive but started rising again after the company denied the allegations. The report was released around the time Luckin’s auditor was set to review 2019 results.
Two months later, on April 2, came Luckin’s explosive disclosure. Luckin said that as much as 2.2 billion yuan (about $310 million) of its 2019 revenue had been fabricated. That represented nearly half of its reported and projected sales from April to December.

Workers made coffee at a Beijing branch of Luckin Coffee in May 2018.

Auditor Ernst & Young Hua Ming LLP indicated the following day it had sparked an internal investigation by finding that some management personnel at Luckin fabricated transactions leading to inflation of income, costs and expenses.
Luckin’s once $12 billion valuation was around $650 million after Wednesday’s trading.