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All the Coffee in China — April 10, 2020

All the Coffee in China


The story behind Luckin Coffee’s $310m fraud

Photo by Jakub Dziubak on Unsplash

The world’s attention is fixed on coronavirus. That’s why you might have missed the news that a Chinese start-up admitted to an over $300m fraud. It’s a good time to bury bad news, but not so for Luckin Coffee. The markets took notice and hammered China’s largest coffee shop chain. Its share price has plummeted, from over $50 in mid-January to less than $5 today. That 95% drop wasn’t the end though. Its chairman was forced to default on a $500m loan and shareholders have organised and are suing the company. It is a fall from grace for a darling of the Chinese start-up scene akin to that of WeWork’s. What happened?

Tea reigns in China.

It has the beverage of choice for thousands of years. From the lowliest peasant to the highest-ranking bureaucrats and rulers, everyone in China drinks tea. Chinese cities are studded with teahouses. Patrons gossip, smoke cigarettes and play board games, often spending hours sitting sipping tea. Starbucks wanted to change that and launched in China in 1999. Beforehand coffee had only been served in hotels and other places foreigners congregated. With the launch of its first outlet, Starbucks tried to change the palette of regular Chinese consumers, unaccustomed to the taste of coffee. Sugary and milk-laden drinks were the way to get people drinking coffee.

But as important was presenting the drink as western, youthful and cosmopolitan. Young, urban professionals, working in China’s booming tech hubs, began to take to the new drink. A nascent coffee culture was appearing. Serving social media-friendly beverages and contrasting with the sedate pace of teahouses, coffee took on a glamour similar to the people it served. Its ambitious image struck a chord with the tech industry where late nights were fuelled by coffee. Enter Luckin.


Founded in October 2017, Luckin Coffee grew from its base in Xiamen quickly. By May 2019 it was already running 2,370 locations, a growth trajectory that fit in with the booming tech start-ups. It managed this by eschewing the type of stores favoured by its competitors. Starbucks was by now the largest coffeehouse chain in China with Costa in second. Their Chinese stores are familiar to anyone who knows the laptop strewn tables and young creatives nursing cups of frappuccinos, iced coffees or macchiatos in any western city. Luckin’s locations were a little different.

If you wander into any of Luckin’s outlets you won’t be able to order a coffee at the counter. A little strange for a business which makes money by selling coffee. Instead, you must place and pay for your order through its app. Customers collect their coffee at kiosks smaller and without the comforts of a Starbucks or Costa. This tech-first approach appealed to Luckin’s target consumer. It also helped keep costs low as the firm expanded.

Customers are served quickly, and the turnaround time is low. This low-cost ethos helped Luckin undercut Starbucks on price and appealed to price-sensitive Chinese consumers who could get tea for cheap. Luckin also offered free and discounted cups of coffee to new customers. This aggressive and targeted discounting could only have been done through an app which tracked customer orders, tastes and signups. Another feature of Luckin’s model that appealed to its chosen demographic was delivery. Customers could get their coffee delivered straight to their offices or studies within half an hour. It was a feature Starbucks eventually copied, though it took them a while to do so.


Luckin grew. It grew fast. But it needed money — and lots of it. Less than a year after it was founded, in July 2018, it secured $200m of funding in an early series round. A year after it had launched, it had 1,300 locations. It was on its way to achieving its goal of eclipsing Starbucks as the largest coffee chain in China. In May 2019, it launched an IPO in the US. It raised $561m to help its ambitious growth strategy and was valued at $4bn. It needed the money as it was burning through cash at around three times the rate it was bringing it in. From its cashless stores and data mining app to its clientele and areas where it opened, Luckin positioned itself like a tech start-up. It produced the growth required to stay in that company too. But much like WeWork, Luckin was a traditional business masquerading as a tech start-up. WeWork was essentially a landlord. Luckin sold coffee. The bubble was ready to burst.


In January 2020 Luckin continued its expansion by launching vending machines that served coffee. They achieved the long-term goal of having more locations than Starbucks. Though the people behind Luckin didn’t know it, it was to be the company’s high point.

Photo by Szymon12455 on Unsplash

That same month, on 31 January, Muddy Waters, an investment firm that backs up its positions with investigative research, tweeted out a report that claimed Luckin was fabricating its sales. By watching thousands of hours of CCTV, examining customer receipts and monitoring app metrics, the report claimed that Luckin had been overreporting revenue since the third quarter of 2019. Founded by Carson Block, Muddy Waters was a firm that investigated Chinese businesses and took a short position if they smelled something fishy. Block had dealt with tech entrepreneurs early in his career and had come away from the experience with a sour taste in his mouth. The lying and obfuscation had motivated him to start his investment firm. Seeing the numbers Luckin released, Block and Muddy Waters thought that not everything at the firm was kosher.

To grow as bigger than Starbucks in less than three years Luckin had to launch a lot of new locations. Over 4,000 of them. Often these were near existing Luckin outlets. They targeted tech quarters and university districts. When a firm opens new stores in such a manner, it is expected that sales per store will fall. The new shops cannibalise some of the existing customer base of the older ones. Despite how aggressive Luckin was expanding, this was not happening. Instead comparable store sales were going up by around two-and-a-half times. Those were unbelievable numbers — and for good reason.


After the Muddy Waters tweet, Luckin took a small hit to its share price. But it wasn’t until early April when things got bad. An internal investigation backed up the allegations. The Chief Operating Officer was fired after over $300m of sales were found to be faked. Luckin’s cofounder, Lu Zhengyao, may have to step down from his other companies as the stink spreads.

Luckin may survive, but it will tough. Analysis from Seeking Alpha shows that each Luckin store is averaging a turnover of only $350 per day. Even in China, with low labour and other costs, that is hardly enough for a viable business. And it’s hard to believe any numbers coming out of the company right now, so the situation could be a lot worse. One redeeming quality is that China’s coffee culture has a lot of room to grow. The average Chinese person only drinks around 5 cups of coffee per year. Americans drink over 400. The entire Chinese coffee market was worth only $8.2bn in 2019 but is growing at a rate close to 10%. Its economy is reigniting after the coronavirus lockdown. It may just be enough to keep Luckin limping on.

Where are all the European unicorns? — September 1, 2019

Where are all the European unicorns?

And does it matter there aren’t that many?

“The problem with the French is that they don’t have a word for entrepreneur.” — President George W. Bush

Smartphones make our lives easier. The whole world is shown to us and mediate through the shiny screens that nearly all of us carry around. Ordering a taxi, discovering new music, staying in touch with friends or colleagues, and booking your next holiday is done quickly with a few taps. And a lot of money has been made making life easier.

The companies behind these technologies have become massive. They have grown from small start-up teams with only a good idea to private firms worth over $1bn. These are the unicorns. Some have become public and are now worth tens, if not hundreds, of billions of dollars.

Uber, Facebook, and Amazon all emerged in the age of the internet and are now worth over $1.5trn together. The smallest of that trio, Uber, alone is worth $55bn.

One thing, though, stands out. In the unicorn stable, only a few were bred in Europe.


Companies founded in the US since 2000 are now worth $1.37trn; in China, they’re worth $675bn. In Europe, that figure is only $240bn.

Europe is as large a market as both the US and China. There are more people in Europe than in the US and nearly as much money. It is not as simple as size. The true causes are historic and cultural as well as prosaic and regulatory.

One theory for the lack of European unicorns is that Europeans are just not as entrepreneurial as Americans or Chinese. They don’t have the ambition to create massive companies. That viewpoint is summed up by that famous (though probably fake) quote of President Bush. And it is a viewpoint that is wrong.


There are plenty of ambitious and talented people in Europe. It has traditionally been the birthplace of many big companies. On the Fortune 500, the list of the largest companies in the world, 160 were founded in Europe. Only 132 were American born. Traditionally, then, Europe hasn’t had a problem with producing ambitious individuals.

University campuses across the continent are full of students dreaming of founding great companies, shaping the world, making a difference. From Israel to Ireland there are entrepreneurs-in-waiting, fantasising of making it big, becoming the next Bill Gates or Elon Musk.

Musk himself isn’t even American. Many unicorn founders aren’t. Adam Neumann, the founder of WeWork, was born in Tel Aviv, Israel. Patrick and Joe Collison of Stripe came from Tipperary in Ireland. That’s only three. There is Russian Sergey Brin of Google, Ukrainian Jan Koum who set up WhatsApp, France’s Renaud Laplanche founded Lending Club, Mikkel Svane moved Zendesk from Denmark to the US after early funding gave it the money to do so. Zendesk is now an American unicorn, despite its start in Europe.


Silicon Valley attracts startups, whether they’re European or American. It has the conditions that founders are looking for. These founders don’t leave their countries to make it big somewhere else just because. They are coming to Silicon Valley for something.

Part of that is that many startups have found success there. It is where people with the skills that founders need gravitate to. It is a black hole, sucking in all those of building a unicorn. The talent pool is massive and it makes sense to start there. Success breeds success.

There are other reasons Silicon Valley provides a good environment for start-ups beyond the plentiful talent. There is a support structure for when things get tough, with lots of mentorship and advice from those that have gone through it before. That type of knowledge, concentrated in one area, is powerful.


London is the most successful startup hub in Europe. Of the roughly 70 European unicorns, 17 can be found in London, more than in any other one place. Many of the big ones, such as Monzo, Revolut, and TrasferWise, specialise in financial technology.

They are disrupting how money is stored, used, and moved around the globe. The talent they need to do this could only be found in London, one of the biggest financial centres in the world. Talent attracts talent.

Talent also attracts money. An investor looking at two different companies, everything else being equal, would lean to the one better placed to use its money. Unicorns chase growth, they burn money to grab a large part of the market and depend on scale for profitability. With the talent pool already in place in Silicon Valley, then they are better placed to burn that cash to reach a profit-making scale in Silicon Valley.

Investors want to be close to their investments. It makes more sense to base yourself in Silicon Valley or America than in Europe. The constant gossip of the Valley helps them find new startups to back. Flying to Europe all the time to hunt for new opportunities, to keep an eye or offer advice to a startup isn’t feasible. The money stays in Silicon Valley and is worked hard.

There is more money looking to invest in American startups as well. The success of previous unicorns has made some investors bolder, wanting to get on the next big thing before it takes off. Compared to a more conservative investing market in Europe, the US has around 14x the capital looking for a tech startup to invest in, according to Siraj Khaliq of Atomico, a European venture capital fund set up by Niklas Zennstrom, one of the co-founders of Skype.


With a much tighter financing market, European companies must focus on earning revenue quicker than their American counterparts. There isn’t as much money going around, and they have to make the most of what they have. Growth and potential are behind much of the valuation of US companies, but it can’t be such a focus for European ones.

This allows US competitors to snap up European companies before they can make it to the truly big time. Shazam was acquired by Apple in 2017 for $400m and has incorporated it as a key part of Apple Music.

Alphabet has gobbled up Belarussian AIMatter, which built a product that allowed users to transform images and videos in real-time. Booking.com, a Dutch startup, might have been worth around $50bn today, but it was acquired by Priceline, another American company, for $113m before it had the chance.

Supercell, the Finnish games company behind Clash of Clans, is owned by Chinese giant Tencent. Supercell was first acquired by SoftBank, the Japanese venture fund, for $1.5bn. After only three years, in 2016, it was sold to Tencent for $10.2bn.


European startups can make it big. Just it isn’t often throughout Europe. While the European Union has done a lot to bring the continent together, such as harmonise banking regulations that have made it easier for fintech firms like Revolut to access a large market, there are still national divides.

Zalando is a German online shopping platform worth more than $14bn. It is mainly active in the German-speaking part of Europe, Germany (of course), Switzerland and Austria. It has hardly made a mark outside its home territory.

A US company is just American, a Chinese firm is only Chinese, but a European one can be British, French, German or dozens of other nationalities. All countries that have historically not got along. National pride still acts as a barrier after regulations have been torn down.


There is one more factor to consider. What if American unicorns are being valued far higher than they should? That would mean that the sober European investors are better at pricing a company and not getting overhyped about a good idea that might not pan out.

There is some evidence for this. The recent IPOs of Uber and Lyft show that some valuations are overly optimistic. Uber went public in May with a share price of $45. It has slid to $32. It is a similar story with Lyft. It debuted at $72 and has declined to $50. The public markets are valuing these companies below what private investors were.

Even Slack, which had a well-received IPO, has taken a hit. Shares are trading at around $30, instead of the $38.50 they started at. Investors want to back the next Facebook or Google. They can fool themselves into thinking that the hyped private tech firm could be it. Each of these unicorns is unique — they are often the only big company with a similar idea (except for Lyft and Uber). If an investor thinks it is a good one, can work at scale and earn massive amounts of money, they are more likely to get involved. A look at the numbers behind a brand may dim that initial enthusiasm though. That’s could be what’s happening in a more risk-averse European market.


Europe has plenty of problems, though building unicorns isn’t one of them. There are plenty of exciting tech companies in the Old World, but the unbridled enthusiasm of the States is not present. There may be less eye-catching headlines, but it makes for a more stable market. There are as many European unicorns as there should be.

Should Amazon spin-off AWS? — August 26, 2019

Should Amazon spin-off AWS?

A breakdown of why some people think Amazon should spin-off AWS — and why some say it shouldn’t.

Amazon is two companies. The first is the one we all know about. It is the marketplace, the place to go to buy and sell on the internet. Buying a Prime membership gives you access to a lot; free shipping, exclusive savings, deals, and streaming video and music services.

The last of these, the streaming services, gives us a glimpse at the other business that makes up Amazon. It takes advantage of Amazon’s logistics expertise. This is one of Amazon’s main competitive advantages, as noted even by its leadership.

Amazon uses a lot of bandwidth. But it doesn’t use it all the time. It was better and cheaper for Amazon to build data centres. So, what could it do with that infrastructure when it was not being used?

The answer was simple; make money by renting it out. This was the beginning of Amazon Web Services (AWS). It began in 2006, and since then it has exploded. It is now the largest cloud computing provider in the world.

AWS provides the backbone for some of the biggest online firms in the world. It lets you binge-watch terrible movies and engrossing series on Netflix. It enables you to watch as streamers play games on Twitch. AWS helps you book your next holiday on Airbnb. That focus on selling to enterprises, rather than consumers, is one of the significant differences between AWS and Amazon.

Another came in 2015. It began reporting its financial results separately from the rest of Amazon. That gave us a glimpse at how much Amazon relies on AWS.

During the second quarter of 2019, AWS took in $8.38bn. That only represents an eighth of Amazon’s revenue of $62.4bn during the same period. But its operating income of $2.1bn was over two-thirds of Amazon’s $3.1bn.

Amazon without AWS wouldn’t be as big or valuable as it is today. That has led many to ask: shouldn’t AWS be its own company?

Some influential people in the industry think that Amazon should spin off AWS into its own firm. Number one among them is Scott Galloway, a professor at NYU and a tech industry analyst. Another is Mark May at Citi Research.

There are plenty of good reasons why it is a good idea.


Regulators are looking at Amazon. Right now, there are three significant investigations in the US looking at the tech industry giants. One was launched by the Federal Trade Commission, another by the Department of Justice and a final one by attorneys-general of around twenty US states.

Spinning off AWS might take the heat off Amazon. It wouldn’t have as much power in the market. It wouldn’t be the dominant player in two massive sectors, e-commerce and cloud computing. It could save Amazon billions of dollars in fines or restructuring costs. It might be forced to do it anyway, so why not do it now?

AWS dominates cloud computing. The other two big players in the industry are Microsoft’s Azure platform and Google Cloud. None are separate companies. Investors have nowhere to put their money if they want to bet on only cloud computing.

If you don’t think digital advertising, e-commerce or operating systems will grow as much as cloud computing, tough luck; you’re saddled to an investment you only half believe it.

If AWS goes its own way, it will hoover up all those investors who believe in cloud computing above everything else. This would boost the value of AWS beyond the hit Amazon would take by losing it. An AWS unshackled from Amazon could focus on cloud computing and dominate the market to an even greater extent.

AWS, right now, subsidises the rest of Amazon. It could use that money instead to invest in itself or pay dividends to shareholders. AWS’s operating margins, how much money is leftover from a sale after the costs of goods sold and operating expenses, since 2013 is 23%. For the rest of Amazon it’s 1.5%.

Amazon uses that reliable money sitting in the bank to fund research. Between 2001 and 2009, covering a period when AWS wasn’t even a thing, Amazon’s research budget grew by around 19% each year. From 2010 to 2018, that figure was 42%.

New products, some of them failures, are continually emerging. The Kindle, Fire phone, Alexa and others are, in effect, paid for by AWS. If they fail, it is no big deal. Unlock that money and AWS would be one of the ten biggest companies in the world.

That’s what Scott Galloway believes. He has form when it comes to predicting what Amazon will do. He called them buying Whole Foods, and he predicted where their new headquarters would be. Scott knows Amazon.

But others aren’t as convinced.


All those subsidises leaving Amazon would hit it hard. Those small margins from its retail business would stop Amazon doing what it wants to do: investing cash flow into growth rather than giving back money to investors as dividends.

A recession will hit Amazon, as a consumer-facing business, hard. If people have less money, then they have less money to buy on non-essentials which they shop on Amazon. Enterprise customers, which rely on AWS as the backbone of its product, can’t stop buying from AWS. Their costs are for essentials. Keeping AWS will limit Amazon’s exposure to any volatility in the market.

AWS also enjoys the cheap money Amazon can generate. Setting up a modern server farm is expensive. In the second quarter of 2019, AWS had a capital expenditure of $3.31bn. Amazon issued a 3-year bond in 2017, which yields 2.53%. China’s 3-year government bond has a yield of 2.8%.

When you can borrow money cheaper than China, you’re a business in a good place. AWS wouldn’t be able to raise capital at such a cheap rate. That would make its large capital expenditures a lot more expensive. This handbrake on growth would limit its chances at dominating the sector.


There are good arguments on both sides. But what will happen? What is the hot take?

The answer lies in Jeff Bezos’s philosophy.

He has set up Amazon to chase long-term growth rather than short term profitability. If he wanted a quick buck, then AWS might well be spun off. But that isn’t the case. For the foreseeable future, AWS will remain part of Amazon.

When Bezos wants to cash out and rake in the piles of dollars that are waiting for him, AWS will become its own firm. It won’t happen before that. When it does happen, buying things on Amazon, then, will become a lot more expensive.

Why WeWork’s IPO will be a failure — August 19, 2019

Why WeWork’s IPO will be a failure

WeWork’s recently released IPO prospectus should have sent investors running. The office and hot desk rental company, after SoftBank pulled out of a $16bn investment, is looking to raise up to $3bn from the public market. It won’t be getting a dollar from me.
Photo by Shridhar Gupta on Unsplash

WeWork’s business model is simple. It leases property from landlords, does them up, and sells spaces to self-employed workers, start-ups and larger enterprises. It typically leases a location for 15 years and sells desk space on a monthly basis. It thinks that it should be worth $47bn.

It is, instead, likely to join the other big unicorns who launched their IPOs this year in stumbling to a much lower valuation. Think of Uber and Lyft.

Why won’t WeWorks model work?

They take on long-term obligations and only require short commitments from their members. They have $47bn in lease obligations, and that figure will only grow as they open more locations. They pump loads of money into their sites, making them fit for a hip, millennial freelancer or start-up. That’s where a lot of their losses come from, but that high up-front cost must be recouped over more than a decade. It would be risky in a stable, growing economy. Right now, we’re headed into the first recession for over a decade.

Will the coming recession hit WeWork hard?

The UK and Germany both announced that their economies were shrinking last week. The stock market took a considerable hit from the news. All around the globe, people are expecting a recession sooner rather than later. Trade wars, Brexit, and a mature business cycle all contribute to that feeling. Yield curves have inverted. Such an inversion has preceded every recession for the past fifty years. Only once have yields inverted without a recession happening.

The S&P 500 peaks within 3 to 22 months of a yield curve inversion. We could have two years before a downturn hits, but it may happen a lot quicker than that.

What is a yield curve inversion?

Government’s sell bonds to finance their running costs. These are very secure, not many countries default on their debt. But things are always more secure in the short term when we know more of the risks an economy might run into. This means that usually long-term bonds give better returns than short term ones as there is more risk involved. When a yield curve inverts, markets believe that short term risks are greater than the long-term ones and want to protect their money. In other words, bad times are coming sooner rather than later.

Recessions are bad for all parts of the economy, so why should you be more concerned about the effect one will have on WeWork in particular?

WeWork’s customers are mostly small teams, freelancers and the self-employed. Renting a hot desk in a WeWork location in London costs around £600 per month. When a recession hits, it hits those small businesses and freelancers hardest. An easy cost to cut is that hot desk. Someone is £600 richer and can just work from the kitchen table. Not as lovely as the kombucha, microbrew offerings of a WeWork, but you’ve got to save money. And it is a natural expense to get rid of. These memberships are done on a monthly rolling basis.

Photo by Dan Gold on Unsplash

WeWork recognises this problem and has been trying to attract more enterprise customers. In their IPO prospectus, however, they have redefined what enterprise customers are, from businesses with 1,000 employees down to those with 500. Even then, they only make up 29% of WeWork’s business.

When the next recession hits, there will be a lot of space in WeWork locations.

Is WeWork overvalued?

The company’s sky-high valuation, around twenty-six times revenue, is based on its reputation. It brands itself as a tech company, in the same field as Facebook, Google or Amazon. ‘Technology’ is mentioned 93 times in their prospectus. But it isn’t a tech company. It rents office space. It might rent the most beautiful office space on the market, but it is still renting office space.

The brand of WeWork is doing a lot of heavy lifting. It calls customers ‘members’, its mission is to ‘elevate the world’s consciousness’, and it opens its IPO prospectus with the lofty declaration that ‘[w]e dedicate this to the energy of we — greater than any one of us but inside each of us’. That is a whole lot of bullshit. It rents office space.

IWG, which rents office space out, has revenues of over $3.25bn, much more than WeWork’s. Yet it is only valued less than $5bn. It doesn’t have the explosive growth of WeWork, but that growth is risky in risky economic circumstances.

Are there any signs of optimism?

In 2018 WeWork brought in $1.54bn. That’s nearly double the $764m it did in 2017. That’s stupendous growth and would auger well for a lot of companies. The losses, though, are on a similar trajectory. In 2017 it lost $900m, in 2018 that was $1.9bn. It costs WeWork $2 to make $1.

That could change in the future. High up-front costs recouped over decades unless a recession hits, can be sustainable. But even WeWork doesn’t think this is likely:

“We have a history of losses and, especially if we continue to grow at an accelerated rate, we may be unable to achieve profitability at a company level… for the foreseeable future.”

Adam Neuman, CEO and founder of WeWork, doesn’t even believe in the company. He has sold $700m of his stock already, and the prospectus even says ‘there can be no assurance that Adam will continue to work for us or serve our interests in any capacity’.


WeWork is a lousy bet. Its fundamentals are lacking, it’s facing a tight market, and it will be found out. Can a successful business be built of its model? Yes, but IWG has already done it. It’s not sexy or hip. But it works. The problem is that it has a value less than a tenth of WeWork’s.

When WeWork IPOs, it will be the early investors and backers who make money. The rest of us will soon be held WeWork shares that are plunging in value. Its backers have pumped the company up; now they’re ready to dump the stock before it falls.

Originally published on Medium