Should Super Micro Computer’s response to the short-selling report ease investors’ fears?

After the Labor Day holiday in the US, Super Micro Computer (SMCI -1.00%)or Supermicro as it’s commonly called, responded to a recent short-selling report from Hindenburg Research. The company sent a letter to its customers and partners and filed the letter with the SEC.

The question is whether the company’s response should ease investors’ concerns?

Brief report and response

Last week, Hindenburg — who has a short position in Supermicro and therefore benefits when the stock falls — raised several issues about how Supermicro does business. The charges included evading sanctions and shipping banned components to Russia, management self-dealing and accounting manipulation.

The day after Hindenburg released its report, the company announced it would delay filing its fiscal 2024 annual report with the Securities and Exchange Commission (SEC). Management said it needed additional time to review “the design and operational effectiveness of its internal controls over financial reporting.”

Some investors were particularly concerned about these turns of events because the company was fined by the SEC in 2020 for early revenue recognition and understatement of expenses. CEO Charles Liang was not charged with any wrongdoing, but, according to the SEC, he had to “repay the company $2.1 million in stock profits he received while the accounting errors occurred” . Before that, in 2018, Nasdaq Composite suspended and then temporarily delisted the stock for failing to file its financial statements on time.

The release of Hindenburg’s report and the latest delay in its submission have hurt the stock.

In Liang’s letter to its customers and partners on Tuesday, Supermicro said neither the short report nor the filing delay will affect its products or services. It added that its liquid cooled solutions continue to grow and remain well positioned.

Meanwhile, it said it does not expect the delay to have any material impact on its fiscal fourth-quarter or full-year results. It added that the short report contained “false or inaccurate statements” and misrepresented information it had already shared publicly. Ultimately, the company said it would “address (Hindenburg’s) statements in due course.”

The denial was pretty standard. Meanwhile, it wasn’t great that the company’s first action after the short report was to delay its 10-K filing, especially given its past history.

Image source: Getty Images.

Margin issues

While the missing vendor report and late filing have caught the attention of investors, those aren’t the only problems Supermicro has faced lately. The company’s shares fell 20% in early August following its fourth-quarter results, after it reported a very disappointing gross margin.

Gross margin, which weighs heavily on profitability, came in at just 11.2 percent in the fiscal fourth quarter, down from 17 percent a year ago and 15.5 percent in the previous quarter. Among the reasons for the decline, the company blamed low prices to win new models and high costs to grow its Direct Rack Liquid Cooled (DLC) AI GPU clusters. Its gross margin is expected to gradually improve over its new fiscal year and return to the 14% to 17% range.

Different industries have different margin profiles, but gross margin can say a lot about a company and how valuable its offerings or services are. Semiconductor companies that use artificial intelligence (AI) have a much higher gross margin. Nvidia had a gross margin of 75.1% last quarter, while Broadcomwas 74.8% and Advanced microdevices‘ was at 49%. Even a foundry operator like Taiwan Semiconductor Manufacturing had a gross margin of 53.2% last quarter.

Supermicro has a structurally low gross margin, well below other companies riding the AI ​​infrastructure wave. And despite the company being in one of the best possible demand environments for AI infrastructure, its gross margins have continued to deteriorate. That’s worrying.

Is the stock a buy now?

SMCI PE Ratio data (before) by YCharts

Trading at a forward price-to-earnings (P/E) ratio of just under 13, Supermicro’s valuation is no longer frothy.

However, this is a low-margin company with a history of accounting problems that just missed filing its annual report. Yes, it benefits from developing AI infrastructure, but it’s not a differentiated technology company like Nvidia, or one that has scale and technology advantages like TSMC. della and Hewlett Packard Enterprisefor example, there are server companies that also offer direct liquid cooling.

As such, I would stay on the sidelines because there are better ways to play AI infrastructure with companies that have higher margin and less controversy.