The future world will be powered by artificial intelligence (AI). Or, at least, that's what I've been told. Investors have bid up AI stocks to the moon over the past two years, betting that consumers will love new AI-powered chatbots and other algorithmically powered products. One company that has benefited mightily is Super Micro Computer (SMCI -5.68%), a company that assembles high-performance servers and storage solutions for technology companies. Essentially, it puts together computer chips for technology companies to power and sell AI tools.
Over the last three years, Super Micro Computer stock is up close to 1,500% due to the demand for AI computing tools from semiconductor giants such as Nvidia. But in the last few months, the stock has gone into the gutter. Shares are down over 50% off of highs set in March 2024. Now, a prominent short-seller in Hindenburg Research has released a report alleging the company is manipulating its accounting figures through self-dealing.
Betting on AI servers
Super Micro Computer could not have been set up better for the AI technology wars of the past few years. Companies such as the cloud giants, OpenAI, and Meta Platforms are scrambling to build server space to give enough computing capacity for these power-hungry AI tools such as ChatGPT. Supermicro's specialty is quickly designing and assembling efficient data centers and servers for these customers. Essentially, it is a way to outsource server assembly to a third party.
Revenue has soared in the last few years. Over the last 12 months, Supermicro has posted revenue of just under $15 billion. Three years ago, this number was only $4 billion. With this growth, net income has ballooned to over $1.2 billion compared to close to zero a few years back. After its drawdown, the stock now trades at a market cap of $32 billion, or a price-to-earnings ratio (P/E) of 27. This is not a demanding valuation if you believe revenue will grow at a rapid rate, but investors are also weighing the fact there may have been a short-term bubble in AI spending over the last year. Time will tell which outcome will be correct.
Now, there are short-seller allegations to deal with.
Accounting irregularities are a warning sign
Where there is smoke there is usually fire, and Hindenburg Research sees a lot of smoke at Supermicro The aptly named short-selling group recently released a report on the company with numerous allegations that should concern any shareholder.
The investigation turned up undisclosed related-party transactions, the rehiring of previous executives who were caught up in an accounting scandal, and the loss of major contracts for large AI customers to Dell. The most damning may be the allegations of self-dealing to promote revenue growth, though.
For reference, Supermicro's CEO Charles Liang has two brothers who operate Supermicro's customers Ablecom and Compuware. The companies have been paid $983 million in the last three years from Supermicro and do little business with anyone else. The companies buy products from Super Micro Computer and then eventually sell these products back to Super Micro Computer. While not proof of intentional circular accounting to boost revenue growth, this is what an illegal practice would look like from the outside.
And this is just the start of the allegations in the report. There are more alleged suspicious accounting practices and claims that Supermicro is violating U.S. sanctions against Russia and China. Yikes.
SMCI PE Ratio data by YCharts
Expect volatility to continue, watch for a short report refutation
With these big claims and the fact that Supermicro operates in a fast-growing sector, expect stock volatility to continue. The company went up by over 1,000% in just a few years. There's no reason it can't come back down to earth over the next couple.
In the meantime, any investor in Super Micro Computer needs to look for management to refute the allegations in the Hindenburg report. Whether in a conference call or a letter, the company needs to prove that it is not doing circular sales and self-dealing with related parties to boost sales or illegally sell to foreign countries. If it isn't doing these things, it should open up its books to lawyers and regulators to prove it.
Now, if they can't prove it, this is a huge red flag for Supermicro shareholders. If the company is purposefully lying about its accounting figures, that would likely prompt many investors to immediately sell the stock. On the whole, there is a lot of risk for Super Micro Computer shareholders right now, and I think it is best to avoid the stock for the time being. Buy some safer blue chip stocks instead for your portfolio.
