This semiconductor giant has fallen from grace

The tech hardware industry often faces intense scrutiny, and Super Micro Computer (SMCI) is now under the spotlight. Following the resignation of its auditor, Ernst & Young (EY), due to concerns over transparency and internal controls, SMCI’s stock plunged 40% in a single day. In today’s FA Alpha Daily, we explore how these accounting concerns and troubled client relationships could impact Super Micro’s future..

FA Alpha Daily by Valens Research

Super Micro Computer (SMCI)?has been facing intense scrutiny and controversy in recent months, leading to a steep decline in its market value.

This sharp downturn continued after the company’s auditor, Ernst & Young (EY), resigned over concerns about transparency and internal controls, resulting in a 40% drop in share price in just a single day.

Auditor resignations are usually seen as a major red flag for investors, as they can indicate unresolved disagreements or governance issues within a company.

Super Micro’s case is particularly concerning because EY’s resignation closely followed Hindenburg’s damning report.

This report was not just a surface-level critique; it was based on a comprehensive three-month investigation involving former employees and industry experts, along with a review of legal records and trade documents.

The investigation uncovered what it described as serious accounting problems, including the potential for inflated revenue figures, hidden related-party dealings, and alleged export control violations.

Looking at past instances, auditor resignations often foreshadow significant issues. In SunPower’s case, EY also resigned following allegations of misconduct among senior executives and concerns from the SEC over the company’s accounting practices.

These issues eventually led SunPower to file for bankruptcy and delist from Nasdaq, showing the potential fallout when trust in a company’s financial practices collapses.

Similarly, Deloitte resigned from its role as auditor for Tingo, an agritech firm, following SEC investigations into fraudulent practices initially raised by Hindenburg Research.

Like Super Micro, Tingo’s troubles were exposed by a short-seller report, leading to an unraveling of investor confidence and delisting from Nasdaq.

Hindenburg’s report on Super Micro was detailed and wide-ranging. Among the most concerning allegations were claims of improper revenue recognition and undisclosed related-party transactions.

For example, the report pointed to dealings with companies controlled by Super Micro’s CEO’s brothers, where transactions seemed to serve mainly to inflate revenues.

These companies, Ablecom and Compuware, provide components to Super Micro and also lease factory and warehousing space to it, despite Super Micro’s own facilities.

According to Hindenburg’s findings, around 99.8% of Ablecom’s U.S. exports were to Super Micro, making the arrangement look suspiciously circular and calling into question the legitimacy of these transactions.

Beyond the financial manipulations, the report highlighted Super Micro’s alleged violations of U.S. export controls.

It revealed that since the start of the Ukraine war, Super Micro’s exports to Russia had reportedly increased, potentially supplying high-priority components that could be diverted to military uses.

The report also suggested that some of these transactions were conducted through Turkish and Hong Kong shell companies, possibly as a way to evade sanctions.

For a company like Super Micro, which operates in a sensitive industry where regulatory compliance is essential, such allegations are particularly damaging.

These violations could lead to severe consequences, including potential sanctions from the U.S. government, adding to the company’s already mounting challenges.

Another significant issue raised by Hindenburg relates to Super Micro’s questionable relationships with its customers.

Key clients, including CoreWeave, Tesla, and AWS, have either cut ties or shifted their business to competitors due to issues with Super Micro’s product quality and after-sales service.

For instance, Tesla, which had previously sourced servers from Super Micro, recently signed deals with Dell.

This trend extends to other major clients like CoreWeave, which also moved towards Dell after reportedly experiencing issues with Super Micro’s service.

Super Micro now finds itself in a precarious situation. The departure of EY and the unresolved issues raised by Hindenburg have eroded investor confidence, and the company’s recent performance reflects these challenges.

In the coming months, Super Micro will face pressure not only to address these issues but to prove that it can operate ethically and maintain the trust of both its customers and investors.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist & Director of Research at Valens Research

Today’s highlight, Super Micro Computer (SMCI) is one of the top stock picks from?FA Alpha 50?this month. To see more stock picks like this,?become an FA Alpha?and get access to?FA Alpha 50.