The upcoming developments for Super Micro's share value.
The upcoming developments for Super Micro's share value.
In the past 30 days, shares of Super Micro Computer (SMCI) have plummeted by 49%, and the company's situation is deteriorating further. The successful Wall Street company is now dealing with the fallout from its former auditor, Ernst & Young, who abandoned the company following October's resignation, disavowing any association with its financial reports.
This move came shortly after Hindenberg Research, a known short-selling organization, accused Super Micro's executives of accounting irregularities, self-dealing, and evading sanctions related to Russia.
Despite the controversy, Super Micro remains a rapidly evolving firm with admirable exposure to the booming artificial intelligence (AI) market. This article explores the potential outcomes for Super Micro over the next few months and delves into whether the company could eventually become an attractive investment opportunity.
A history marked by poor corporate governance
The most disconcerting aspect of Super Micro's current predicament is its questionable corporate governance track record. In 2018, the company faced delisting from the Nasdaq exchange due to its tardiness in filing financial reports. Although the company regained compliance in 2020, a subsequent investigation unveiled numerous accounting violations, such as prematurely recognizing revenue and understating expenses.
These violations included recognizing revenue on products not yet delivered to customers, shipping goods to customers without consent, and delivering misassembled products to them. Super Micro was forced to pay a $17.5 million settlement and also needed to repay $2.1 million from its CEO, Charles Liang, for stock profits earned during the alleged errors, even without being charged with misconduct.
The impact on investors
Super Micro's previous misconduct may provide insights into the latent internal control issues the company may still be grappling with. However, the good news is that these past violations appear relatively mild compared to the high-profile fraud cases, such as Luckin Coffee, which inflated its 2019 sales by $300 million and incurred an $180 million fine.
Nonetheless, the persistent allegations surrounding Super Micro's accounting practices prompt concern about its leadership competence. Hindenberg's August report revealed that three top Supermicro employees who were implicated in the 2018 scandal were rehired, with ex-employees attesting that the company's business culture has not improved since the delisting. Although managerial ability can be challenging to quantify, it eventually manifests in a company's performance due to the multitude of daily decisions that keep it running. Super Micro is also threatened by potential fines and delisting, which might negatively impact its valuation.
The road ahead
Super Micro failed to submit its Aug. 29 10-K annual report by the deadline. The company is now seeking an extension that, if granted, would extend the filing deadline until February 2025. However, given the ongoing Justice Department investigation, it may struggle to secure a new auditor willing to associate with its accounts.
If Super Micro is delisted, it will most likely transition to the less liquid over-the-counter markets. Although this change may have minimal impact on operating performance, it could significantly reduce the company's valuation and the price investors are prepared to pay for the stock in relation to its earnings.
Super Micro may also encounter financial challenges. Holders of its $1.725 billion convertible notes, which mature in 2029, have the authority to demand early repayment if the company is delisted. With only $2.1 billion in cash reserves as of September, such a withdrawal would create pressure on near-term liquidity. Although Super Micro will likely be able to tap capital markets for additional funds, this process will likely come at the expense of higher interest rates or equity dilution for investors.
Successfully raising capital is more advantageous for a company when its stock price is high, as this maximizes the amount of capital raised, while minimizing the number of new shares issued. Conversely, creditors seeking to capitalize on a company's distress will demand higher interest rates.
Time for clarity
On November 5, Super Micro released a preliminary update on its first-quarter earnings. Preliminary revenue estimates indicate a year-over-year growth of 180% to between $5.9 billion and $6 billion. If accurate, the stock's forward price-to-earnings ratio (P/E) would be a mere 7.5, compared to the S&P 500's estimate of 24, making for an appealing investment opportunity.
However, it is essential for investors to exercise caution and await further information before committing to an investment, as these results may be influenced by questionable internal controls.
In light of Super Micro's financial troubles, investors might want to reconsider their strategies for managing their money and investments related to the company. The company's history of poor corporate governance, including accounting violations and failed audits, raises concerns about its financial reliability and future performance.
As the company navigates potential fines, delisting, and loss of investor confidence, they may turn to alternative financing options, such as raising capital through higher interest rates or issuing dilutive shares. These choices could impact the value of existing investments in Super Micro, making prudent finance management crucial for those still holding shares.