Drops in Supermicro Shares Continue. Worthy to Purchase at Discounted Prices or Keep Clear?
The narrative surrounding Super Micro Computer (SMCI -3.07%) persisted with its share price dropping on account of its auditor leaving the post. The stock has been on a rollercoaster ride this year, experiencing significant swings in both directions. As a result, the stock has seen a decline of 9% for the year to date.
Let's delve deeper into the recent developments surrounding the stock and assess whether it's worth buying or better to maintain a distance.
Financially questionable claims
The most recent dip in Supermicro's share price is attributed to the departure of its auditor, Ernst and Young, which expressed its unwillingness to associate itself with the financial statements issued by the management. It cited recent information that had come to its notice as the reason for its decision to resign. Interestingly, back in July, Ernst and Young had raised concerns about Supermicro's governance, transparency, and internal controls.
On the other hand, Supermicro has refuted Ernst and Young's assessment, claiming that it does not foresee the need to revise any of its financial reports. It is currently in pursuit of a new auditor to conduct its audit for the current fiscal year. It's important to note that this was the first year that Ernst and Young had been entrusted with conducting an audit for the company.
The credibility of Supermicro's accounting first came under scrutiny in the public sphere in August, courtesy of short-seller Hindenburg Research. The latter accused the company of accounting manipulations, side-stepping sanctions, and self-dealings with related third parties, all with the objective of manipulating the stock price to its advantage. Successfully accomplishing this mission. Short-selling refers to the practice of borrowing a stock from its current owner and then immediately selling it with the intention of repurchasing it at a later date at a lower price.
Shortly after the release of the short report, Supermicro chose to postpone the submission of its fiscal 2024 annual report to the Securities and Exchange Commission (SEC) to review the effectiveness of its internal controls over financial reporting. Subsequently, The Wall Street Journal reported that the company's accounting was also under investigation by the Department of Justice (DOJ), which led to another plunge in the stock price.
Notably, Ernst and Young's concerns predated the short report, and this isn't the first time the company has faced potential accounting issues. In 2020, the SEC fined Supermicro for prematurely recognizing revenue and understating expenses. It was also noted that employees were encouraged to ship products to warehouses on the last day of any quarter, enabling the company to recognize revenue even before the products had reached the end customers. CEO Charles Liang was penalized with a fine of $2.1 million but was not charged with any wrongdoing.
Opportunity for bargain hunting or steer clear?
Although Supermicro has not been charged with any wrongdoing, a plethora of unfavorable allegations have been levied against the company. Given its history of accounting manipulations, investors should be aware of the significant risk involved.
In contrast, Supermicro has reaped benefits from the construction of artificial intelligence (AI) infrastructure. It specializes in designing and constructing servers and rack solutions for clients and has established a niche for itself as one of the first server companies to incorporate direct liquid cooling (DLC) in its systems. AI-powered servers generate a substantial amount of heat and energy, which necessitates constant cooling. DLC has emerged as a viable solution to this challenge.
Recently, Supermicro announced that it had deployed more than 100,000 graphic processing units (GPUs) with DLC solutions. The company's offerings have generally received positive reviews. However, this is a low-margin business, with the company experiencing margin pressure in its last quarter, fiscal Q4, with gross margin decreasing from 17% to 11.2% compared to a year ago. Leading chipmakers, such as Nvidia and Broadcom, have been generating gross margins of around 75%.
While I do not believe that we have witnessed the final revelation regarding Supermicro, nor do I consider it to be an exceptional company, I do believe that it has been a significant beneficiary of the AI buildout and that this trend is likely to continue. Despite the stock becoming significantly undervalued due to its "financial smoothing," risk-averse investors should steer clear of it. However, investors with a higher tolerance for risk could explore the possibility of investing in a small position based on its AI opportunities and valuation.
The controversy surrounding Supermicro's financial statements has led some investors to question its reliability, potentially making it harder to attract funds for investing. Given the company's history of accounting issues and recent concerns raised by its former auditor, investors may want to consider whether the potential returns from its AI infrastructure projects justify the associated risks when it comes to investing their money.
