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Super Micro Computer Initiation Report

Super Micro Computer (SMCI) is a US/Taiwan based provider of high performance server and storage solutions. Incorporated in 1993 (listed in 2007), the company has been profitable every single year.

Note: I am currently short the stock.

Although net sales have grown tremendously over the past 3 years, the company has struggled to grow gross margins.

Pay attention to the regional split in revenue, because the company has a problematic past. In 2018, Bloomberg did a hit piece on the company saying its products were a conduit for Chinese spyware. While there was no evidence to back that claim, the hit piece finished the stock, which was already reeling from the company delaying its 2017 10-K filing due to accounting irregularities. That's code for inflating revenues and being subject to an SEC investigation.

It doesn't help that the company has suppliers who are also siblings of the founder. That might shed light on why gross margins are poor.

This is not a problem per se, but it raises red flags when the CEO is also borrowing money in a personal capacity from the spouse of Ablecom's CEO.

Did I mention the concentration risk?

Two suppliers accounted for 13.5% and 30.7% of total purchases for FY23, of 44.2% in total. This concentration risk is present in other years as well.

Moving on to valuation

The stock trades at 8.3 times book. Excluding inventory, current assets of $1.73B is barely sufficient to cover liabilities. Hardware is a cyclical industry. 2020-21 were the boom years when even basic logic chips were in short supply and the manufacturers made bank. 2022-23 saw write-downs in inventory across the spectrum. Servers aren't immune to this cycle. Given the company's track record, I wouldn't trust them on inventory valuation. Nor do their auditors, who flagged it as a critical audit matter.

Maybe that's just routine CYA, but Deloitte has served as SMCI auditor since 2003, signing off on the financial statements that the SEC later forced them to re-state.

There are reasons for tech stocks to trade at high multiples to book, but SMCI does not fit that criteria.

Apple (AAPL) trades at 46.3 times book but has a gross margin of 45%. SMCI has a gross margin of 15-18% in the good years. The stock isn't worth 27 times peak earnings, especially at the end of the AI bubble of which it was a beneficiary.

In fact, the only reason the stock managed to run up so much is because the AI meme chasers destroyed the shorts. The timing is good now 'cos short interest is a mere 11%.

My initial target is $105-$120, which would fill the gap from May.

P.S. I get a lot of questions on shorting. So here are my thoughts on how I approach shorting

Good Trading!


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