Nikada
Spruce Point just published a short attack piece on Super Micro (NASDAQ:SMCI) found here. The stock price has dropped 10% today probably due to this report.
I have reviewed the Spruce Point Capital Report and disagree with most of it but not all. I will go point by point to the main points made in the report.
1. Wild Revenue Target
“The CEO’s aggressive, if not outlandish and wildly optimistic revenue targets”
“The CEO is already claiming revenue targets of $8 – $10 billion for 2024 while touting it will soon be a $20 billion revenue company”
These targets are not far off from historical growth rates.
2. Concentration
“21.9% of revenues were from this lone customer. Based on our research, we find that the largest customer is Facebook / Meta Platforms. Facebook itself has been struggling and publicly announced cost reduction measures”
If it is Meta (META), then that is a real concern. The only legit one in this report in my opinion. However, the report also shows no customer over 10% the last 3 fiscal years. So, this appears to be a one time thing.
3. Prior Accounting Restatement
“SMCI has a documented history of prematurely booking revenues, understating expenses and improperly accounting for inventory.”
I wrote an article about this when it happened expecting little in restatements to occur. That is what actually eventually happened, minor restatements. Spruce Point is beating a dead horse that occurred over 4 years ago.
4. Interest Expense
“SMCI’s cash interest expense (disclosed at the bottom of the cash flow statement) is higher than its reported interest expense on the income statement”
This one is ridiculous. We’re talking about $138,000 difference between book interest expense and cash interest expense. That is less than 0.01% of net worth.
5. Inventory Accounting
“SMCI appears to be keeping two sets of books for its inventory, one reported under FIFO to creditors and another under the weighted average cost method to equity investors”
They also mention the auditors are spending a lot of time on this, so a restatement is highly unlikely.
6. Inaccurate Adjusted Earnings
“Despite having deficient financial controls necessitating a settlement with the SEC, it wants investors to ignore the costs to remediate the controls”
Most of this happened long ago. I also totally agree with SMCI adjusting out non-operating expenses unlikely to recur. That is what most companies using adjusted earnings do. And most companies do use adjusted earnings.
7. Insider Stock Sales
“In the recent eight-month period from Feb 28th – Nov 11th, CEO Liang has sold the most shares in his history in a manner we believe was not transparent, and without proper SEC disclosure. His stock sales are mirrored by the CFO, who recently reduced his stock holdings by 70%.”
Very misleading in my view. The CFO has never held much stock so any sales are a large percentage. The CEO’s stock holdings have declined by less than 5% over the past year. Not too different from CEOs of other rapidly rising stocks. It is also not different from his history.
8. No Free Cash Flow
“SMCI has no proven free cash flow and is subordinating shareholders by taking on more debt to fund cash flow deficiencies”
And
“SMCI’s history shows that its cash flows are irregular and lumpy, so we evaluate it over a long-term horizon. Based on our analysis, over the past 7yrs+ we find that it has reported cumulative revenues of $27.4bn, GAAP Net Income of $1.0bn, $164m of Adj. Cash from Operations (CFO) and Adj. Free Cash Flow (FCF) of -$142m”
This is a total misunderstanding of the characteristics of a growth company. When a manufacturer grows, they need more inventory, plant, furniture fixtures and equipment and receivables to support that growth. Many growth companies have low or even negative free cash flow for that reason.
9. Stock Repurchases Stopped
“SMCI astutely repurchased stock in 2020-2021 ahead of the recent increase in its share price. However, if the Company’s claims are accurate, and revenue will be $8 – $10 billion in 2024 growing to $20 billion, why has it ceased repurchases for over a year?”
Yes, they were astute. The stock was a screaming buy in 2020 and 2021. The economy is now slowing rapidly and most CEOs have little visibility going forward. It’s a conservative decision for a company described as very aggressive by Spruce Point.
Takeaway
I do have some concerns about Super Micro, but other than the concentration with Meta (if true) none are new from this report. I respect Ben Axler, the head of Spruce Point and have agreed with some of his reports in the past. In fact, I believe he is (or was) a follower of mine. But I believe there is little here.
I have owned SMCI stock and have written about them on SA in the past. I called them a month ago with a list of questions to possibly do another article. They told me they do not talk to investors, only professional stock analysts. They did talk to me last time, so this is a change, and not for the better. In fact, I find it unacceptable. My sense is Spruce Point had the same issue I did when trying to contact management.
I am also concerned whether they will be able to maintain the current historically high margins, though I think they can keep growing revenues through a recession.
I expect the stock to regain much of what it lost today as I think this report has little of substance in it.
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