Loans/Equities Default on share-backed loan could cost lenders close to US$200m

The woes of Nasdaq-listed LUCKIN COFFEE deepened last week with revelations of a default on a US$518m margin loan secured against shares in the fraud-wracked Chinese coffee chain. 

As if the disclosure of fabricated sales on April 2 was not bad enough, Luckin chairman Lu Zhengyao and CEO Qian Zhiya last Monday were forced to surrender a significant economic stake in Luckin after margin lenders seized the equivalent of 76.35m Luckin ADSs, or about 30% of outstanding.  

The margin lenders are Credit Suisse, Morgan Stanley, CICC, Haitong International, Goldman Sachs and Barclays, according to people with knowledge of the matter. The first four banks arranged Luckin’s US$645m IPO last May and a US$1bn follow-on/convertible bond in January.  

The shares pledged were worth about US$2bn before Luckin said an internal probe found that its chief operating officer and other employees had fabricated sales totalling Rmb2.2bn (US$310m) in the final nine months of 2019. 

As of last Wednesday, those shares had lost 83% of their value since the April 2 announcement and were worth only US$335m.As well as their share of a near-US$200m hit on the margin loan, the bookrunners on Luckin’s deals are facing potential lawsuits as investors question whether they performed sufficient due diligence ahead of the IPO and follow-on. 

Several law firms are preparing class action suits on behalf of disgruntled shareholders.“The risk of lawsuits over US IPOs is kind of expected but the loss from the margin loan could really hurt the bottom line of the banks,” said a banker away from the Luckin deals.  

A statement from Goldman Sachs, which is acting as the disposal agent for the seized shares, said that if all the shares pledged under the margin loan were sold, Lu Zhengyao’s voting interest in Luckin Coffee would not decrease. However, Qian’s beneficial and voting interests would fall significantly. 

That is because Lu will retain a bigger percentage of supervoting Class B shares after the sale, even though his economic interest will fall. Luckin’s Class B shares lose their 10:1 voting power upon conversion to ordinary A shares, a precursor to the disposal.  

The prospectus for the January follow-on showed that Lu had pledged 30% of his Class B shares as security for a loan, while Qian had pledged 47% of her Class B stock. A company controlled by Sunying Wong, identified elsewhere as Lu’s sister, had pledged 100% of its Class B stock. Additional shares were to be pledged automatically in the event of a margin call, according to the filing.  

LOST MANDATE For the banks involved, the fallout from the scandal does not end with losses on the share-backed loan. Shares in Chinese car rental company CAR INC, also controlled by Lu, have also slumped 50% since April 2. Moody’s cut CAR’s rating to Caa1 on Thursday, warning of a possible change of control and default after CAR said its major shareholder had been forced to sell part of its stake. 

CAR’s liabilities include two US$100m loans, both arranged by Bank of China (Hong Kong), as well as US$500m of US dollar bonds. At least one of Luckin’s underwriters has lost business as a direct result of the scandal. Tencent-backed online healthcare site WEDOCTOR quickly dropped Credit Suisse as one of the sponsors for its Hong Kong IPO of about US$1bn. 

The Swiss bank had led both Luckin’s IPO and follow-on/CB and has the closest relationship with the company.“It’s about perception,” said one source close to the company. “The company wants to distance itself from anything which could potentially affect the IPO.”Credit Suisse declined to comment. Just two weeks ago, WeDoctor picked CMB International, Credit Suisse and JP Morgan as sponsors for a planned Hong Kong IPO of about US$1bn, IFR reported on March 27.  

Citigroup has since replaced Credit Suisse.The scandal has also emboldened short-sellers including Muddy Waters, which revealed a short position on Luckin on January 31 saying it had received a “credible” anonymous report outlining allegations of fraud.Muddy Waters and Wolfpack Research last week accused Nasdaq-listed video-streaming platform iQiyi of inflating its 2019 revenue, prompting a swift denial from the company.  

TAL Education, a Muddy Waters target in 2018, said last week an employee may have inflated sales data.