Betting on Luckin Coffee IPO former investors need to know five things

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Lucky coffee has filed initial public offering (IPO) documents. The China-based company has quickly become Starbucks Co., SBUX) is a major competitor in the country.

The company has not yet determined how many shares to issue, but has set a $100 million retention fee in its regulatory filing. Luckin Coffee has applied for listing on NASDAQ under the ticker symbol LK. Credit Suisse, Morgan Stanley, CICC and Haitong International are the lead underwriters for the deal.

Luckin Coffee is an emerging growth company with revenue of $125.3 million and a net loss of $241.3 million for the fiscal year ended December 31, 2018. Its prospectus cited Frost & Sullivan as saying the company was China's second-largest coffee chain.

Here are five things investors should know before Luckin Coffee IPO:

High-risk corporate structure

Like chinese companies listed outside china, such as alibaba group (BABA), luckin coffee is a variable interest entity (VIE), a corporate structure dating back to the 1990s that is used as an alternative to chinese companies that do not allow direct foreign ownership.

Under the VIE structure, the Chinese company established two entities, one in China, which holds the necessary licenses and permits to operate in China, and the other an offshore entity incorporated in the Cayman Islands, in which overseas investors can take a stake. The Chinese entity, which is usually owned by the company's top management, makes contractual arrangements to pay fees and royalties to offshore companies. The risk with this model is that overseas investors don't actually own shares in the company, and local management or even the Chinese government could force a breakup of the listed company, which could put U.S. investors in trouble.

Luckin also listed risk factors that limit shareholder protection under Cayman Islands laws, which the company said are not as clear as some U.S. jurisdictions.

Ruixing Coffee has been facing huge losses since its inception

Like many start-ups, Lucky suffered massive losses as a result of rapid expansion. Ruixing Coffee points out that because the company is very young, past performance does not represent future growth rates. Ruixing Coffee plans to use most or all of its financing proceeds to operate and expand its business and does not intend to pay dividends in the short term, meaning shareholders will have to rely on rising share prices for returns.

The coffee market is very competitive.

Luckin Coffee faces a rapidly intensifying coffee market with competitors including global coffee chain Starbucks Corp., SBUX), which is already planning to launch the Chinese market. Starbucks has announced plans to add a net 600 stores a year to reach 6,000 stores by fiscal year 2022. Starbucks has also partnered with Alibaba to launch coffee delivery services in 2,100 stores in 35 cities. Starbucks has also launched a popular customer loyalty program, which currently has 8.3 million members.

Business can be disrupted by some very cumbersome procedures

According to PRC law, lease agreements must be registered with the local land and real estate administration. If not registered, the lease agreement may be void or result in fines for the parties. Ruixing Coffee said most of its lease agreements were not registered with relevant departments.

According to the prospectus, Ruixing Coffee may not be able to obtain compensation from the lessor if it is fined for failing to register the lease agreement. Fines ranged from 1, 000 yuan ($148.53) to 10, 000 yuan ($1,485.33).

Doing business in China means government involvement

Luckin Coffee points out that doing business in China is unique in that there is a high degree of government involvement, including policy enforcement. As a result, some companies can get preferential treatment than others, and growth has been uneven across industries and regions.

Although the Chinese government has taken steps to emphasize economic reforms that use market forces to reduce government ownership of productive assets and establish sound corporate governance systems in enterprises, a large part of productive assets in China remain owned by the government, the prospectus revealed. In addition, uncertainty in the legal system may affect Luckin Coffee's ability to determine what protections it enjoys.

(Translated from MarketWatch)

(This article is copyrighted by Dow Jones)

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