Summary

• Super Micro Computer's recent regulatory filings restore some credibility, but competitive pressures and litigation risks remain significant concerns for investors.

• The company faces intense competition, with market share losses and thin margins, alongside high litigation and regulatory expenses impacting profitability.

• Despite risks, Super Micro Computer targets an impressive $40B revenue by FY26, with potential for margin stabilization and appealing valuation multiples.

• I recommend a Hold rating on SMCI stock, awaiting further clarity from upcoming quarterly reports to fully assess Super Micro Computer's business outlook.

Symmetrical rows of metal servers in a dark data center hallway

Freezman

Investment Thesis

Last week’s regulatory filings finally cleared the way for server maker Super Micro Computer (SMCI) to remain listed on Nasdaq while allowing investors to gain deeper insight into the company’s dealings with its manufacturing partners.

On one hand, the filings allow a pathway for Super Micro Computer’s management to regain some of the credibility it lost during its regulatory filings fiasco last year and steer the narrative firmly towards the business fundamentals of its data server empire. This expands the scope for firmly grounding the company’s valuation, but that is just one side of the equation.

On the other hand, the company is still dealing with a highly competitive environment for servers, which could put pressure on its razor-thin margins. The risks from Super Micro Computer’s regulatory and litigation-related threats still need to be considered. And then there is the resumption of insider selling that could dampen some of the investor confidence.

But I have moved to upgrade Super Micro Computer to a Hold after reviewing the filings.

Super Micro Computer’s Filings Indicate Two Main Risks - Plus Competition

In my previous post on Super Micro Computer, I stated how the competitive environment for the company was getting intensely fierce with incumbent market leaders such as Dell also possibly getting upended.

I had noted my observations about Super Micro Computer as well, losing market share:

Market research reports now indicate that Super Micro Computer has ceded 300 bp of the market in 2024 and accounts for 8.3% of the AI server market. At the same time, Foxconn is the new market leader of the AI server market, having likely held single-digit market share in 2023.

Reports indicate Super Micro’s share in the AI server market stands at ~8.3% in 2024, down from the 11% share in 2023.

Exhibit A: Reports indicate Super Micro Computer’s share in the AI server market stands at ~8.3% in 2024, down from the 11% share in 2023. (Omdia)

But these competitive headwinds were only pressures the company faced on the outside. The company’s regulatory paperwork, which has been duly filed with the SEC by the Feb 25th deadline last week, has brought back some credibility to the company, but investors must also be cognizant of some of the inherent risks of investing in Super Micro Computer for now.

First, Super Micro Computer can continue to incur expenses in the forms of litigation, legal proceedings, disputes, claims, and periodic regulatory examinations, as the company itself states in their risks section of the latest annual filing.

Exhibit B: Super Micro still has some risks as listed in their 10K document.

Exhibit B: Super Micro Computer still has some risks as listed in their 10K document. (Super Micro Computer’s filings)

These expenses are usually recorded as general expenses under the G&A line item or the Other Expenses line item of the company’s Income Statement. As can be seen below, Super Micro Computer’s expenses have been growing much faster than its operating income or gross profits in the last 2 quarters of CY24, the same quarters where the company faced challenges in filing its reports.

Super Micro’s expenses are growing faster than its operating income and gross profits.

Exhibit C: Super Micro Computer’s expenses are growing faster than its operating income and gross profits. (Seeking Alpha)

For example, Super Micro Computer states in its filings that the company has already incurred $18.6 million in forensic accounting examinations to date. These expenses act as headwinds for the company’s margins that have started falling already. While TTM operating margins stand at 7.4%, the company’s gross margins are at their lowest ever at 12.4%.

Super Micro’s gross margins are at its lowest ever.

Exhibit D: Super Micro Computer’s gross margins are at its lowest ever. (YCharts)

Second is the concentration risk at various divisions of the company. In terms of its supplies, more than 63% of its supplies come from just 1 supplier, per its Q2 FY25 filing. This is a big jump from the supply concentration risk in the 2023 10-k, where “two suppliers accounted for 13.5% and 30.7% of total purchases” in FY23.

Any shortages in raw material supplies or interruptions could impact the company downstream when honoring its customer commitments.

Within these concentration risks are also the company’s dealings with its contract manufacturer companies, Ablecom and Compuware, which Fortune magazine clearly details in their piece. For example, Ablecom, part of the Liang family network of companies, manufactures over nine-tenths of Super Micro Computer’s server chassis. This creates an opportunity for conflicts of interest to arise that have not posed a threat yet but are a risk that investors should consider.

SMCI’s FY26 $40B Revenue Target Is Impressive Given Competitive Pressures

Once investors are aware of these risks, the question remains: how appealing does the $40B revenue target look?

For markets seem to be extremely reciprocative to management’s FY26 target of $40B. Note that the $40B target is for FY26 and has written off FY25 as a year of “distraction,” as management put it on the last earnings call. But the eventual CAGR growth rate in Super Micro Computer’s top line would get it to 63.5% CAGR, faster than the 55% growth it delivered in the Q2 FY25 quarter, where Q2 revenues were $5.7 billion in the quarter or $20.8 billion on a TTM basis. Management’s growth rate is a lot better than the 22% server capex growth initially noted in the market research reports I highlighted earlier and indicates the company can win back some market share it lost.

Also, management has pointed at delivering 12% gross margins next quarter, which can be an early sign of gross margins possibly stabilizing around the 11-12% mark. If management can deliver 12% gross margins and continue to guide for stable margins moving forward, it would guide for a business environment for Super Micro Computer that is turning around with steady business economics.

Assuming its margin profile stays steady, the 63.5% CAGR that Super Micro Computer is aiming to deliver looks appealing with its forward earnings multiple at 16x 2025 earnings or 11x 2026 earnings.

Super Micro Computer Valuation

Exhibit E: Super Micro Computer Valuation (Seeking Alpha)

The valuation multiples look appealing now, but with the risks in the background, I would still recommend caution for investors looking at Super Micro Computer. Possibly a quarter or two more of reports could clear the air for Super Micro Computer in my view.

Note: Nvidia’s (NVDA) GTC conference is later this month. I think it is reasonable for investors to expect a surprise appearance from Super Micro Computer’s CEO, Charles Liang, at the conference. Alternatively, Nvidia could also name-drop Super Micro Computer during their presentations. Either of these could result in a further sentiment-driven rally for Super Micro Computer.

Takeaway

The recent filings by Super Micro Computer’s management do clear a lot of the troubled air surrounding its regulatory filing drama that had shifted the narrative away from the core business fundamentals.

The valuation makes a lot more fundamental sense now, but there still remain risks in the background, leading to Super Micro Computer’s outlook being in two states until the dust fully clears. I am now recommending a Hold rating on Super Micro Computer.