With its shares down by 49% in the last 30 days at the time of writing, Super Micro Computer's (SMCI +8.71%) situation is going from bad to worse. The former Wall Street darling is reeling after the October resignation of its auditor Ernst & Young, which no longer wants to be associated with the company's financial statements.
The move comes not long after the short-selling organization Hindenberg Research accused Super Micro's management of accounting irregularities, self-dealing, and sanctions evasion related to Russia.
NASDAQ: SMCI
Key Data Points
Behind all the noise remains a relatively fast-growing company with excellent exposure to the generative artificial intelligence (AI) industry. Read below to discover what could happen to Super Micro over the next few months and if the company could eventually become a compelling buy.
A long history of failed corporate governance
Perhaps the most disturbing thing about Super Micro's current predicament is its track record. In 2018, the company was temporarily delisted from the Nasdaq exchange after failing to file its financial reports on time. While the company regained compliance in 2020, it was charged that same year with "widespread accounting violations" related to prematurely recognizing revenue and understating expenses.
The violations included "recognizing revenue on goods sent to warehouses but not yet delivered to customers, shipping goods to customers prior to customer authorization, and shipping misassembled goods to customers." Super Micro settled for $17.5 million, in addition to a $2.1 million clawback from its CEO Charles Liang, who had to reimburse some stock profits received while the errors were occurring, despite not being charged with misconduct.
What does this mean for investors?
Super Micro's prior violations could give clues into the types of internal control failures the company may still be facing. But the good news is the company's past violations seem relatively tame, compared to recent high-profile corporate fraud cases like Luckin Coffee, which overstated its 2019 sales by $300 million and faced a fine of $180 million.
That said, the fact that Super Micro continues to find itself in hot water over accounting-related allegations raises concerns about its leadership quality.
Hindenburg's August report claims three senior Supermicro employees who left in the 2018 scandal were rehired and cites former employees who believe Super Micro's business culture hasn't improved since the previous delisting. While managerial skills are difficult to quantify, they'll eventually show in business performance because of the sheer number of decisions that are made every day to keep a company running. Super Micro also faces the threat of more fines and possible delisting, which could hurt its valuation.
What comes next?
Super Micro has already missed the Aug. 29 due date for its 10-K annual report. However, its management plans to file for an extension that could give it until February 2025 to file the documents. This will require an auditor -- which Super Micro no longer has. With an active Justice Department investigation, it may struggle to find a new firm that's willing to be associated with its financial statements.
If Super Micro gets delisted, it will probably move to the less liquid over-the-counter (OTC) markets. While this probably won't have a direct impact on business operations, it could dramatically hurt the company's valuation and the amount investors are willing to pay for the stock, relative to its earnings.
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Super Micro could also face financial headwinds. A provision allows holders of its $1.725 billion convertible notes (due in 2029) to demand early repayment if the company is delisted. And with just $2.1 billion on the company's balance sheet as of September, such an outflow would put pressure on near-term liquidity. While Super Micro will likely be able to tap capital markets for more cash, this will come at a high cost to investors in the form of higher interest rates or equity dilution.
Generally, it's better for a company to issue more shares when its stock price is high because this maximizes the amount of money raised, relative to the amount of new shares issued. Likewise, creditors will likely demand higher rates from a company in obvious distress.
Waiting for the dust to settle
On Nov. 5, Super Micro announced an update related to its first-quarter results. Revenue is believed to have grown 180% year over year to between $5.9 billion to $6 billion. If accurate, this makes the stock relatively cheap, with a forward price-to-earnings ratio (P/E) of just 7.5, compared to the S&P 500 estimate of 24.
That said, these results are unaudited and may be influenced by poor internal controls. While Super Micro looks like a great deal, investors may want to wait for more information before considering a position.
