Super Micro Computer (NASDAQ:SMCI) – (SMCI - $508) – SMCI’s share price was blasted for $125 (20%) on Wednesday when it reported its FY Q4/full-year numbers Tuesday after the close despite beating revenue consensus and announcing a 10:1 stock split. The Company’s gross margin was well below estimates and forward guidance was much lower than estimates. The Company’s gross margin plunged to 11.2% from 15.5% in Q3 and 17% in Q4 2023. The operating margin fell to just 6.4% from 9.8% in Q3 and 10.3% in Q4 2023.
I first presented SMCI as a short in the February 11, 2024 issue of SSJ when the stock was at $740. This is the second time I exposed teh red flags at SMCI: Super Micro Computer Red Flags. In February I remarked that its 10.1% operating margin was quite low, particularly for a company that is supposedly an innovative tech company trading with a 57.6 P/E and 4.5x revenues (at the time). In comparison, AMZN’s AWS operating margin was 26% in 2023 while MSFT’s operating margin was 43.5%. Now SMCI’s operating margin is just 6%.
SMCI’s EPS declined 18.6% in Q4 from Q3 despite the fact that revenues rose 37.8% QoQ. That shows the degree to which SMCI has no ability to control the prices it pays to suppliers or dictate the prices of the products it sells. Let’s face it, the bulk of its business is building racks to hold servers at data networking centers – not exactly a business with room for innovation or creating products with competitive advantages. The consumer equivalent of SMCI’s products is television and stereo racks.
SMCI also has revenue concentration and accounts receivable payment risk. Its top three customers accounted for 61.4% of its revenues and two of these customers accounted for 19.3% of its accounts receivable. Admittedly these are probably big tech companies like Meta (NASDAQ:META) and Microsoft (NASDAQ:MSFT). But at some point there’s going to be an oversupply of data center, cloud computing capacity – just like there became a big oversupply of fiber-optic capacity during the dot.com/tech bubble – and there will be a dramatic drop-off in server rack orders from its largest customers.
Another issue is the rate at which the Company is burning cash. For the full-year FY 2024 SMCI’s operations burned $2.47 billion in cash, including $630mm in Q4. Its operations thus are consuming over $600mm in cash per quarter right now. It funded that cash burn by issuing $1.6 billion worth of shares and a $2.3 billion convertible bond deal in its FY Q3. Both of which are highly dilutive to existing shareholders.
SMCI’s P/E has corrected down to 25.5. In my opinion that is still too high, particularly if earnings per share continue to decline. The Street consensus for its FY 2025 is $44.29. Over a four-quarter average, that’s $11.07/share, or 84% above the Q4 EPS. It’s hard to believe that the Street still has that kind of earnings growth built into its models.
SMCI’s best case is that EPS stay flat for the next four quarters. But I don’t see that happening. I expect that several big companies who are spending heavily on AI chips and server capex will start to cut back. This will adversely affect SMCI.
I expect earnings to continue to decline. That means a 25 P/E for a business with 6% operating margins and declining earnings is too high. Hell, the homebuilders have much better margins right now and they trade at an average of an 8 P/E. If SMCI can replicate its Q4 EPS over the next four quarters, and we apply an 8 forward P/E because it’s a low-margin business with no earnings growth, that implies a forward stock valuation of $192/share.
The easiest money-shorting SMCI has already been made. But I think this stock will get cut in half over the next year, which would put it at $250 where it was trading before AI mania engulfed the markets.