Luckin Coffee Inc. (LKNCY, Financial) got lucky this week. It managed to raise the funds it needs to fulfill its obligations under a recent settlement with the Securities and Exchange Commission as well as the funds required to survive until 2023, when cash flow could turn positive.
The ailing Chinese coffee chain managed to secure $250 million from two existing investors at $6.50 per share.
Quo Vadis President John Zolidis believes that raising outside funds is undoubtedly a positive development for the company.
"The equity issuance is positive news from the perspective that it provides incremental protection against as-yet unresolved shareholder lawsuits and ongoing DOJ investigations," he said.
However, it will be dilutive to existing shareholders, as it raises the number of outstanding shares. Zolidis estimates that the new shares will dilute the existing shareholder equity by 14%, on top of the estimated dilution of about 7% of the equity holders related to the recent convertible debt restructuring.
Meanwhile, raising additional funds won't fix Luckin's strategy and business model, which appear to be driven by the mission to beat Starbucks (SBUX, Financial) in regard to store count and the number of cups of coffee sold.
To realize this mission, Luckin has been opening small "pick-up" shops in buildings and college campuses at a rapid pace, using an app to streamline its operations and analyze consumer preferences, and giving many cups of coffee away to win customers.
But there's an essential ingredient missing from Luckin's strategy, a business model, a "third place," that stands between home and the workplace that rivals Starbucks.
Simply put, Luckin's business model isn't a "third place." It's the fast delivery of coffee everywhere, making it a commodity—a product that the competition can easily replicate.
Economists know very well what that means: price destruction and earnings erosion. Zolidis estimates Luckin will generate a negative Ebitda of $100 million to $130 million in 2021. He further estimates an enterprise value to Ebitda multiple of 27 using 2023 figures, which makes Luckin overvalued at this point.
"Given remaining balance sheet risk, cash burn and minimal visibility on operations, this valuation appears wholly unjustified," Zolidis said.
Disclosure: I own shares of Starbucks.
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