In one meeting someone asked the CFO about revenue growth. He looked at the guy and said 'Revenue is an ego game. We could boost revenue tomorrow if we wanted. We run this company for gross profit.' - Twitter
Got me thinking about how companies are reporting their sales order book, price and sell their products.
One company has certainly taken this literally. Of course, Luckin Coffee isn't the only firm in history to have done this.
Just not so long ago (about 1 year), the media widely publicised Luckin Coffee has being one of the upcoming competitors that is likely to give Starbucks a run for its money, especially in China. This was further sensationalised with the listing thereafter in May 2019. I don't vouch for the quality of LK's coffee but after Xiaomi's IPO, the idea of selling low cost + decent quality merchandize suddenly became a very possible and scalable business model for a lot of aspiring entrepreneurs.
Since products were going to be dirt cheap, in order for this to work, you practically need to sell helluva-lot of merchandize. And in the age of data digitization, you don't want to only rely on solely on offline sales through brick and mortar stores. You call in the calvary - the army of bots, data analytic tools, artificial intelligence and all the mumbo jumbo of the tech world. It was all the rage. For a moment, the epiphany was that LK had successfully leveraged China's leading AI and big data technology to drive its sales and any company that didn't incorporate data analytics in its growth strategy was considered part of the older generation of companies. At one point of time, the word on the street was blockchain (it might still be today). Today and who knows for the next 5 years, word on the street will be data, robotics, AI.
But big data and the complex systems that churn the numbers have made due diligence even more challenging. Because of the vast amounts of data, making a decisions around these becomes somewhat like relying on a black box. For portfolio fund managers, not only do you just rely on the information given to you, you pass that information into complex models and these black boxes which you may not fully comprehend, and ultimately make that decision to invest. Caveat emptor and god help you if you have no warranties and indemnities.
But all of machine error stems from human error. The people who deliver the numbers and build the black box are humans. Human subject to fatigue, bias and greed. The relentless pursuit for sales is manifested as greed in different ways: controversial related party transactions, customer kick-backs, fabricating sales figures, etc. All for greed and personal gain.
As LK explodes, many fragments of this starts to fall apart. The founders had apparently invested in other financial products with margins from the banks. Margins which were pledged with LK shares. HNWI could get leverage as high as 100x. This means, for every $1 million deposited, the banks basically allow you to invest in $100 million worth of financial products - bonds, gold, derivative contracts, equities, etc. If those products go to sh%t or the value of your collaterals drop, you either put in more money or surrender your collaterals to the bank.
Either the bankers had spurred the founders to get more leverage due to the rising share prices or the founders get gotten greedy and wanted more money for themselves. Was the COO manipulated by the founders to fabricate sales? What really motivated him to do that? Only time will reveal the outcome of those investigations.
With most of the founders' shares gone today and the dislocation of interest alignment, can investors get any assurance that the business will run normally after this saga?
The ecosystem of banking and financial products continue to amaze me - that greed, in particular the greed for money and prestige can really change a person. Any investment built on fabricated figures and over-leverage will implode eventually. Starbucks didn't become famous overnight. It takes years of pure hard work and consistency to build a legitimate brand from scratch. This should be a wake-up call for both investors and start-ups who still believe that they can change the world in 1-2 years and make a quick buck.