Spruce Point Capital Management Announces Investment Opinion: Releases Report and Strong Sell Research Opinion on Super Micro Computer, Inc. (Nasdaq: SMCI)
Spruce Point Capital Management, LLC ("Spruce Point" or "we" or "us"), a New York-based investment management firm that focuses on forensic research and short-selling, today issued a detailed report entitled, "Micro And Macro Issues At Super Micro Computer" that outlines why we believe shares of Super Micro Computer, Inc. (Nasdaq: SMCI) ("SMCI" or "Super Micro" or the "Company") face up to 40% to 50% downside risk, or $42.39 ? $50.86 per share. All figures referenced are in US Dollars, unless otherwise specified. Download or view the report by visiting www.SprucePointCap.com and follow us on Twitter @SprucePointCap for additional information and important updates.
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Spruce Point Report Overview
Based in San Jose, California, Super Micro is a technology hardware provider of predominantly server and storage systems. The Company has a history of financial challenges that have resulted in financial restatements, its stock being delisted and charges for "widespread accounting violations." As we outline below, Super Micro is also amplifying the risks for its shareholders by targeting larger customers such as Facebook and by pursuing wildly optimistic revenue targets with an unjustifiable ?growth at all costs' mentality. Key findings from our report include:
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A long and documented history of accounting violations, most recently settling charges with the SEC in 2020. Super Micro was fined $17.5 million by the SEC and its Founder and CEO Charles Liang was ordered to return $2.1 million of profits from stock sales during a period in which financial results had to be restated. In its report on the Company, the SEC stated that Super Micro's executives, "pushed employees to maximize end-of-quarter revenue and minimize expenses, without devising and maintaining sufficient internal accounting controls to record revenue and expenses in conformity with U.S. Generally Accepted Accounting Principles ("GAAP")." The Company continues to be led by CEO Liang today, and we believe the Company's accounting problems continue to linger. Investors should be wary that Super Micro has had multiple financial restatements in the past, has had its stock previously delisted and shows new signs that financial reporting challenges remain.
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Super Micro is pushing an aggressive revenue growth story, yet it has historically generated negative free cash flow. Given the Company's documented history with aggressive revenue recognition, we caution investors not to put undue reliance on its bold revenue or net income projections. Neither the recent exuberance of the Company's CEO nor the Company's long-term revenue claims, which project out figures beyond 12 months, are backed by any reported backlog that should give investors strong confidence. In fact, the reality is quite the opposite. Super Micro's fine print explicitly warns that sales are difficult to forecast and dependent on orders received and fulfilled in the quarter. What's more, Super Micro recently experienced a large quarterly increase in deferred revenue of $86.0 million, with $69.6 million of the increase described as a non-cancellable, non-refundable advance cash consideration. Spruce Point cautions that this is a relatively new disclosure and indicative of a change in business practice that merits a higher degree of scrutiny and disclosure. The hardware sales business that Super Micro is in is a historically low margin business and one that is subject to declining price pressures and is notoriously dependent on maintaining high research and development and capital spending requirements to maintain competitiveness. In order to accurately assess the Company's competitive position, Spruce Point has evaluated its financial performance over a long-term horizon. Based on our analysis, we see that it has reported cumulative revenues of $27.4 billion, GAAP Net Income of $1.0 billion, $164 million of Adj. Cash from Operations (CFO) and Adj. Free Cash Flow (FCF) of -$142 million since 2015. Spruce Point cautions investors not to put undue reliance on the Company's GAAP Net Income or EPS as a measure of its performance, given its extremely low cash flow conversion.
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Rising financial strains as focus shifts to larger customers and over-reliance on Facebook (Meta Platforms) as a material customer. Based on Spruce Point's extensive research, we believe Super Micro is now targeting larger customers, which carries with it greater risks that include larger discounts and margin concessions along with worsening payment terms. In fact, we find that Super Micro's working capital has intensified while its debt dependency to fund cash flow deficits has been increasing. During its regular earnings calls, the Company reports on basic metrics such as cash conversion cycle, days inventory, sales and payables. However, the Company fails to provide these metrics in SEC filings and does not even provide a basic definition to allow investors to check these calculations. Based on an industry accepted measure, we find the Company's cash conversion has been worsening in the past few years and is well above management's "target" of 85-90 days. More concerning is the fact that the Company's recent SEC filings disclose the growing profile of a large and material customer accounting for 21.9% of revenues in the most recent quarter. However, Super Micro does not identify this customer by name in its SEC filings or on its conference calls.
Based on our research and knowledge of the space in which the Company operates, we identified this customer as Facebook (Meta Platforms). A heavy reliance on Meta Platforms is cause for substantial concern as Facebook's own investors have expressed skepticism with its loss-making endeavors in the Metaverse and slowing advertising revenues. As the recent headlines have shown, Facebook has had to announce layoffs and is implementing cost cuts due to these challenges. Industry reports already indicate that Facebook is suspending and delaying investment in new datacenters. This presents growing risks to Super Micro's ability to achieve its financial targets. As a result, Super Micro investors are unknowingly making a bold and implicit bet on the success of Facebook, the Metaverse and the continued growth in cloud spending while multiple indicators suggest growing problems.
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New signs of financial reporting deficiencies identified. Super Micro's cash interest expense (disclosed at the bottom of the cash flow statement) is higher than its reported interest expense on the income statement. The last time this occurred was during a financial restatement period. We find that recent changes in balance sheet debt are deviating materially from changes in debt through the cash flow statement. The Company provides balances and interest rates for its current short-term credit facilities and term loans outstanding. Spruce Point warns that Super Micro may be under greater financial stress than is illustrated. Based on the Company's disclosures, Spruce Point estimates its Q1 2023 interest expense should have been $2.3 million vs. the $4.0 million cash interest expenses reported. Based on our research and assessment, we believe this indicates either that Super Micro carried a significantly higher intra-quarter debt balance, or there are other "hidden" liabilities not accounted for on the balance sheet.
- We estimate between 40%?50% downside risk to Super Micro's share price. The Company's sell-side promoters seem equally paralyzed and divided among its assessment on the share price. At least two of five analysts have "Neutral" ratings and a fair value price target in the $64 price range, implying 25% downside. Spruce Point agrees with these analysts and doesn't believe any have highlighted the growing issues and risks we've identified. Perplexingly, Super Micro's valuation multiple has actually expanded to the highest valuation among its cash-generative technology hardware peers in the face of its growing struggles to generate cash, rising customer concentration risks, and softening in technology spending and valuations. We also warn investors that in the recent periods, CEO Liang has sold a record amount of stock. His sales are mirrored by the Company's CFO, who recently reduced his stock holdings by 70%. Given the overall weakening of its financial position and continuing concerns over the quality of its financial reporting, we believe SMCI should trade at or below its long-term revenue multiple. By applying a range of 0.35x ? 0.40x to 2023E revenues, we arrive at a price target of $42.39? $50.86 per share (40% ? 50% downside risk).
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Please note that the items summarized in this press release are expanded upon and supported with data, public filings and records, and images in Spruce Point's full report. As a reminder, our full report, along with its investment disclaimers, can be downloaded and viewed at www.SprucePointCap.com.
As disclosed, Spruce Point has a short position in Super Micro Computer, Inc. and owns derivative securities that stand to net benefit if its share price falls.
About Spruce Point
Spruce Point Capital Management, LLC is a forensic fundamentally-oriented investment manager that focuses on short-selling, value and special situation investment opportunities. Spruce Point Capital Management, LLC is a member of the Financial Industry Regulatory Authority, CRD number 288248.
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