Supermicro's Selloff is an Opportunity. Here's Why I'm Buying the Stock.

Super Micro Computer (Nasdaq: SMCI) has been one of Wall Street’s darlings of the past year.

The high-performance server company competes in one of the fastest-growing and most lucrative markets in the world. It assembles cutting-edge processors from NVIDIA and AMD with the necessary power, networking, and cooling, and then installs them into the data centers of Amazon, Google, and other large tech companies.

“Supermicro” has also been one of the stock market’s very best performers. After providing an 87% investment return in 2022 and then a 246% return in 2023, it was up another 200% YTD in 2024 through mid-July.

But then August came, which felt like running into a brick wall.

Despite reporting an impressive 143% growth in revenue and 78% growth in earnings per share, investors were expecting even more. Dark clouds and bearish conjecture began to surround the company, suggesting its growth days were slowing or that it didn’t have enough pricing power to capture lucrative margins.

But then even bigger issues began to arise, which suggested much deeper and more serious problems.

The most worrisome of these was a long-winded bearish report that came from notorious short-seller Hindenburg Research. The report directly attacked Supermicro’s internal financial controls, its related-party transactions, its aggressive sales culture, and its its international sales to Russia.

Things got even worse one day later, when Supermicro notified investors that it would need to delay its official annual report filing to the SEC. Specifically, it needed “to perform an assessment of the design and operating effectiveness of its internal controls over financial reporting”.

After flying high and rising more than 2,500% during the previous three years, Supermicro’s stock has come crashing back down to Earth. It’s given back half of its total gains and has fallen more than 50% this summer.

This demands some further digging from an investment analyst. I dug into a very deep and unsexy rabbit hole this week. After quite a bit of reading and more than a few cups of coffee, I’ve come to the conclusion that the stock is a buying opportunity right now.

Here’s why.

Firstly, let’s directly address the issue. Companies typically need to delay or restate their SEC filing when they notice (or someone else has noticed) that their financial reporting isn’t 100% accurately reflecting the underlying business performance.

The SEC has zero-tolerance for inaccurate reporting. So the restatement is typically a hectic period of getting everything up-to-snuff as quickly as possible.

Fixing internal controls isn’t necessarily a doomsday scenario, but a bigger issue could be that the previous results weren’t correct. If the company decides it was overstating its revenues or earnings, it has to come back with its tail between its legs and then tell investors they were actually lower.

That can lead to reduced confidence in the leadership team that causes some investors to sell. Or it could result in a lower multiple that investors are willing to pay for the stock.

But even more concerning would be if the restated filing would cause a company to violate its existing debt agreements. Many times when a company borrows from others, it is bound by covenants that require it to maintain certain amounts of cash or certain multiple of its interest payments that are covered by earnings. In other instances, the covenants could be tripped by specific events, such as delaying a filing with the SEC or a fundamental change in the business. In those cases, the people who are loaning money want to be repaid in full and to avoid the risk of not getting their capital back during a problematic event.

So my rabbit hole took the form of how Supermicro raised $1.5 billion through convertible notes back in February.

This was a significant event, since the company had never raised this much debt ever before. It needed the proceeds to fund its growth and to keep up with the growing demand for AI chips in the data center.

There’s a lot of standardized legal protections in there. But (Aiii) is worth looking into, as it mentions that a Fundamental Change could also cause the company to default.

So what qualifies as a “fundamental change”?

The takeaway is that unless Supermicro sells the company outright, goes bankrupt, or gets delisted from the Nasdaq, it is largely protected from defaulting on its convertible notes.

That means Supermicro really needs to cooperate with the SEC and do everything it can to comply with what they’re asking for. It will include better internal controls, more disclosures, and most likely restating the financial statements of the previous two quarters.

The 7investing Key Takeaway

There’s more to the story too, which includes allegations of improper relative-party transactions or of servers that got sold to Russia and Iran. But I believe those to be secondary in importance, at least to the threat of Supermicro defaulting on its debt.

Another counter-intuitive bullish indicator is that the short interest on Supermicro’s stock has skyrocketed to 17%. That’s very high, and it’s the highest the stock has had during at least the past decade. The combination of the Hindenburg report and the delayed 10-K have led to an all-time high of skepticism and an all-time low in trust of Supermicro.

All of the factors mentioned above have led me to recently raise my conviction rating in the stock. I am now raising my conviction rating on Supermicro to…

To see 7investing’s updated Conviction Rating on Supermicro (as well as why) and to get immediate access to Simon’s insights in our Community Forum, join 7investing today. For only two more days, if you use promo code “august” at checkout, you’ll get a 7 day trial of our service for absolutely free!

Supermicro’s Selloff is an Opportunity. Here’s Why I’m Buying the Stock.

Digging into the Convertible Notes

What Might Cause a Default

The 7investing Key Takeaway