/Supermicro's Shadows of Controversy
How to evaporate money
from 11/06/2024, by uni — 9m read
In the whirlwind of the 2024 stock market, few companies have generated as much excitement as NVIDIA Corporation ($NVDA). As artificial intelligence becomes ubiquitous across industries, NVIDIA has ascended to become the world's most valuable company. Capitalizing on this trend, server manufacturers like Dell Technologies ($DELL), Hewlett Packard Enterprise ($HPE), and notably Super Micro Computer, Inc. ($SMCI) have rebranded themselves as AI server companies. Astonishingly, Supermicro's stock skyrocketed twelve-fold over the past year, joining the S&P 500 Index and outperforming NVIDIA by four times in the first quarter of 2024. But is this surge a reflection of genuine innovation, or is it a case of extreme market hype? More importantly, could there be underlying issues behind these impressive numbers?
Supermicro distinguishes itself from competitors like Dell and HP by emphasizing cost-effectiveness, scalability, and deep customization. Their "building block" architecture allows customers to upgrade individual components as needed, avoiding the constant push for new server generations. It's akin to a Lego set for data centers, designed for organizations with long-term, scalable visions. Their close collaboration with NVIDIA enhances their offerings, equipping them to deliver the latest AI-focused graphics cards. CEO Charles Liang boasts that their rack-scale liquid cooling solutions can slash power usage by up to 40% - a significant draw for companies conscious of the bottom line1. On paper, these strengths make Supermicro an enticing choice in the server space. Yet, they don't fully explain the explosive growth the company has seen over the past year.
While Dell and HP rely heavily on proprietary support services and bundled software ecosystems, Supermicro's approach is refreshingly open. They use standard parts, offer transparent drivers, and provide BIOS access - all without locking anything behind paywalls. This gives customers a level of flexibility rarely offered in enterprise hardware. Supermicro has made a name for itself by tailoring systems to specific industry needs without breaking the bank. However, the speed of their growth has raised some eyebrows. Dell and HP, while steady, haven't seen this kind of leap, prompting questions about what's fueling Supermicro's acceleration. As one industry insider put it, "There's no reason Dell can't do exactly what they're doing," yet Dell and HP remain tied up with their broader support infrastructures and mainstream markets2. Supermicro seems to have tapped into a niche these giants have yet to match, but whether this trajectory is sustainable is a story still unfolding.
Supermicro's history isn't without blemishes. In 2018, the company's failure to file their 10-K stemmed from an internal investigation revealing issues with revenue recognition practices - they were recording $200 million in sales prematurely, painting a rosier picture of their financial health than was accurate3. This triggered a prolonged review, delaying their filings and resulting in a temporary Nasdaq delisting. By 2020, the SEC formally charged Supermicro and its former CFO, Howard Hideshima, for these accounting missteps. The company agreed to pay a hefty $17.5 million penalty, while Hideshima faced additional fines, and CEO Charles Liang reimbursed $2.1 million in profits from stock sales4. Though they settled without admitting wrongdoing, this episode cast a shadow over the company's financial integrity.
Amid the AI boom, we've witnessed Supermicro's stock jump in an unprecedented way - so much so that it seems almost too good to be true. The demand for high-performance GPUs for machine learning is consuming NVIDIA cards like the H100 faster than they can be manufactured. One would think Supermicro could effortlessly capitalize on this demand, but it appears they've stumbled in what should have been an easy victory. Despite extremely favorable market conditions, concerns have arisen about the company's practices. In August, investment research firm Hindenburg Research released a report detailing alleged fraudulent activity committed by Supermicro5.
Key Takeaways from the Hindenburg Report:
Accounting Manipulation: Supermicro allegedly continued engaging in premature revenue recognition and understating expenses just months after being relisted on Nasdaq. The report states, "Revenue was prematurely booked even when equipment could not be delivered, was faulty, or was not ready for sale." Additionally, there has been a pattern of rehiring senior employees (such as Howard Hideshima) who left in the wake of the 2018 scandal. Notably, the company's auditor at the time, Deloitte & Touche, resigned in March 2023.
Related-Party Transactions: Supermicro's main chassis and water-cooling suppliers, Ablecom and Compuware, are owned by CEO Charles Liang's brothers and have received $983 million from Supermicro over the last three years. Ablecom, which is also partly owned by Liang and his wife, sells components back to Supermicro at the same price it acquires them, raising questions about the value added in these transactions. This pattern hints at potential "round-tripping," a technique to artificially inflate sales through related-party transactions.
Export Control Violations: Supermicro may have breached U.S. export controls by shipping products to sanctioned countries, including Russia and China. The report notes that "Super Micro exports to Russia have spiked more than 3x since the invasion of Ukraine." Supermicro has also partnered with Fiberhome Technologies Group, a company watchlisted by the U.S. government for involvement in surveillance and repression of Uyghurs. This isn't the first trade violation for Supermicro; they previously pleaded guilty in 2006 to violating a U.S. embargo by selling computer systems to Iran, resulting in a $150,000 fine6.
The company's recent decline isn't due to market sentiment or missing a key sale; it's because of significant accounting issues. Their reputable audit firm, Ernst & Young (EY), resigned, stating they would not stand by the numbers being released. This is not a trivial matter. An auditor, especially a Big Four firm, publicly resigning and making such a statement is about as alarming as it gets for a public company.
In their resignation letter, EY stated:
"We are resigning due to information that has recently come to our attention which has led us to no longer be able to rely on management's and the Audit Committee’s representations and to be unwilling to be associated with the financial statements prepared by management, and after concluding we can no longer provide the Audit Services in accordance with applicable law or professional obligations." - EY's Resignation Letter to Supermicro
This language is stark. Accounting firms don't just quit for no reason - EY walking away suggests something is seriously wrong with Supermicro's books. When a Big Four firm like EY jumps ship this dramatically, it's time to exercise extreme caution regarding the stock.
Supermicro was originally required to file its annual financial statements for the fiscal year ending June 30, 2024, by August 30, 2024. However, the company extended the deadline to deliver its audited financial statements until December 31, 2024. On November 5th, the company announced it doesn't know when it will file annual results for the latest fiscal year7. This uncertainty caused their shares to drop by 17%, and the company has since lost almost 80% of its value, wiping out over $55 billion in market cap since being added to the S&P 500.
Adding to the complexity, Supermicro's previous auditor, Deloitte, also resigned last year, which is highly unusual. EY didn't even complete a full year's audit before resigning. This pattern of auditors stepping away adds to the growing list of concerns.
The leadership structure raises further questions. CEO Charles Liang has several family members involved in the company; his wife holds a significant role, and his brother Steve runs their main supplier, Ablecom. Substantial sums are moving through these family firms, which could present conflicts of interest. The board is predominantly composed of family members, making it challenging to enact changes. It may require a special shareholder meeting, and significant investors could potentially pressure the CEO to implement changes or face liquidation of their holdings.
In response to the fraud allegations and the auditor's resignation, Supermicro stated:
"Following a 3-month investigation led by Independent Counsel, the Committee’s investigation...has found that the Audit Committee has acted independently and that there is no evidence of fraud or misconduct on the part of management or the Board..." - Supermicro
