Super Micro (SMCI) Faces Manipulation Allegations, But Future Is Bright

Super Micro Computer, Inc. (SMCI), a high-performance server manufacturer and storage solutions provider, is the latest target of Hindenburg Research, a well-regarded short-seller. Hindenburg claims that Super Micro is involved in accounting manipulation. I believe Hindenburg’s scrutiny overshadows the company’s bright prospects and the lucrative opportunity for long-term investors. I am bullish on the prospects for Super Micro stock as I believe Hindenburg’s allegations are more than offset by the long runway for growth enjoyed by the company.

Understanding Hindenburg’s Allegations

First on the agenda is understanding Hindenburg’s allegations toward SMCI so one can decide how they affect one’s sentiment toward Super Micro’s prospects. Hindenburg Research’s exclusive report, which was published yesterday, scrutinizes several of Super Micro’s business practices.

To begin with, Hindenburg alleges that Super Micro has engaged in accounting manipulation through improper revenue recognition. According to the short-seller, Super Micro used channel stuffing – a manipulation tactic where a company ships products to buyers without receiving confirmed orders – to inflate revenue. Hindenburg claims that Super Micro recognized more than $200 million in revenue through this unethical business practice from 2015 to 2017. The short report also found that Super Micro rehired executives associated with past accounting scandals.

The second allegation of Hindenburg Research centers around related party transactions involving supply-side businesses owned by Super Micro CEO Charles Liang’s brothers. The company has reportedly paid $983 million in the last three financial years to Ablecom and Compuware, two suppliers controlled by the CEO’s brothers.

According to IFRS standards outlined in IAS 24, a company should properly disclose related party transactions to avoid a conflict of interest and present the business’s true nature to stakeholders. However, Hindenburg believes Super Micro violated reporting standards by distorting financial metrics through related party transactions.

In addition to questionable financial reporting practices, Hindenburg Research also illuminates corporate governance red flags by alleging that the company promotes a corporate culture where loyalty to higher management is perceived as a more favorable employee characteristic than accountability.

Super Micro’s Past Struggles

As discussed above, the accounting manipulation allegations highlighted by Hindenburg Research yesterday have given rise to fresh scrutiny over the company’s past struggles with the SEC. In August 2018, the SEC temporarily delisted Super Micro as the company failed to abide by the Nasdaq listing requirements. This occurred as the company did not file the 10-K report for the financial year that ended on June 30, 2017, within the stipulated period. Super Micro appealed this decision and eventually met the listing requirements, leading to a relisting of its shares.

Soon after this nightmare, in August 2020, the SEC charged Super Micro for accounting violations, and the company agreed to pay $17.5 million to settle these charges. In addition to this corporate settlement, former CFO Howard Hideshima agreed to pay a penalty of $50,000 and disgorgement and prejudgment interest of over $300,000 to settle the inquiry. CEO Charles Liang also agreed to reimburse $2.1 million in stock sale profits to close this investigation.

Yesterday’s Hindenburg report, which initially resulted in a 7% decline in Super Micro stock before the market shrugged off the short-sellers’ allegations, has renewed investor interest in the company’s past legal troubles.

The Bullish Case for Super Micro

At the piece’s beginning, I claimed that Hindenburg’s allegations overshadowed the company’s bright prospects. Now, for the last part, I would like to pinpoint the glossier side of the equation.

There is much to like about Super Micro, hence my bullish position on SMCI stock.

The favorable industry outlook and the company’s strategic partnership with Nvidia Corporation (NVDA) contribute to the positive outlook for revenue and earnings growth.

From a macroeconomic perspective, the company benefits from the strong demand for AI applications as businesses of every scale and size upgrade their server infrastructure to embrace AI applications. Super Micro has reported triple-digit revenue growth in the last three quarters, highlighting how the company has capitalized on the growing AI infrastructure investments committed by companies.

After digesting the total addressable market opportunity for Super Micro products, company management boosted the long-term revenue guidance from $25 billion to $50 billion earlier this month, which is a testament to the company’s rapid growth ahead.

To capitalize on favorable industry conditions, Super Micro is aggressively investing in capacity expansion projects, including opening three new production facilities in Malaysia and the United States. According to the company, these new plants will more than double the current liquid-cooled rack capacity, allowing Super Micro to dominate the fast-growing data center liquid-cooling solutions market.

SMCI’s Collaboration With NVDA

As mentioned earlier, Super Micro’s strong relationship with Nvidia will be a growth driver in the next few years. The company has integrated Nvidia’s GPUs into its servers, enabling the company to offer high-performance computing solutions. In addition, the two tech giants are collaborating on product development to ensure seamless integration of future technologies. This gives Super Micro an edge in a competitive data center server market position.

Although the company may face pressure due to questionable accounting practices in the next few months, Wall Street analysts agree that Super Micro has a long runway to grow. Analysts project Super Micro revenue to grow from just $14.94 billion in Fiscal 2024 to more than $50 billion by Fiscal 2029, aided by the perceived superiority of the company’s products. The high-tech product portfolio will also come in handy in negating the threats posed by competitors such as Dell Technologies, Inc. (DELL) and HP Inc. (HPQ).

SMCI’s Attractive Valuation

In addition to the attractive long-term prospects I discussed earlier, Super Micro’s reasonable valuation has also played a part in my bullish sentiment toward the company. Super Micro currently trades at a forward P/E of 16 compared to the Information Technology sector median of 23.58. This attractive valuation compared to its tech peers stems from the strong earnings growth expected in the coming years.

Is Super Micro a Buy, According to Wall Street Analysts?

The bright long-term prospects for Super Micro discussed earlier have not gone unnoticed among Wall Street analysts. Rosenblatt analyst Hans Mosesmann, a five-star analyst according to Tipranks’ ratings, maintained his $1,300 price target for Super Micro as the analyst believes the company will grow exponentially in the long run despite facing short-term margin pressures. Bank of America analyst Ruplu Bhattacharya also believes that Super Micro will be one of the biggest winners of AI in the long run.

Based on the ratings of 11 Wall Street analysts, the average Super Micro price target is $978.50, which implies an upside of almost 80% from the current market price.

See more SMCI analyst ratings

The Takeaway

In a short thesis published on Aug. 27, Hindenburg Research has questioned the accounting practices of Super Micro, a company that has been penalized in the past for accounting malpractice. Although Hindenburg’s allegations may deteriorate investors’ sentiment in the short run, Super Micro stock will likely recover in the long term as corporate earnings are likely to dictate terms over the long-term stock market performance of any company. Aided by favorable macroeconomic developments and strategic partnerships with AI chip giants, Super Micro is well-positioned to grow.

Disclosure.

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