🗞 The Rise and Fall of SuperMicro Computer

Happy Sunday!

Here’s what’s on the docket for this week’s newsletter:

• 🏰 The World’s Largest Digital Moat?

• 🍟 A Fast-Food Falloff

• 📉 The Rise and Fall of SuperMicro Computer

Let’s dive in!

Earnings Roundup

• 🏰 Alphabet: The World’s Largest Digital Moat? Alphabet reported earnings on Tuesday and needless to say, put any concerns about diminishing relevance in the world of AI to rest.

  Across its entire ecosystem, Alphabet now has 7 different platforms with more than 2 billion monthly active users.

  • Chrome

  • Workspace

  • Android

  • Google Play Store

  • YouTube

  • Gmail

  • Google Maps

  No other company comes near that level of scale on the internet. In fact, there’s so much progress being made across Alphabet’s sprawling initiatives, it’s difficult to know what to talk about.

  For example, let’s take a look at YouTube. YouTube became Alphabet’s 2nd ever business to reach $50 billion in total revenue (subscriptions + ads) on a trailing 12 month basis. With ~70% of that revenue coming from ads, that means YouTube generates more than $15 billion from subscriptions. To put that number in context, that’s nearly half of Netflix’s streaming revenue over the last 12 months.

  As for Alphabet’s other initiatives, Waymo continues to make massive strides. The autonomous vehicle company now delivers more than 150,000 paid rides every week, and that number is set to expand as they just received clearance to launch rides in Austin and Atlanta as well.

  But perhaps the most impressive of all Alphabet’s subsidiaries this quarter was Google Cloud. Over the last 4 and a half years, Google Cloud has quadrupled its revenue while expanding operating margins from -61% to 18%. Google’s CFO Anat Ashkenazi credited the record profit margins to scale as well as headcount management.

  Alphabet’s stock jumped more than 5% on the report.

• 🍟 A Fast-Food Falloff: Many of the largest quick service restaurants in North America reported earnings over the last two weeks, and one theme seems clear. Consumers are feeling pressured.

  Between McDonald’s, Chipotle, Starbucks, Wendy’s, and Domino’s each company reported sequential declines in their comp store sales figures.

  Here are quotes from each company’s conference call addressing the consumer environment.

  • McDonald’s: “The industry environment remains challenging. There's no doubt about that. I mean, I think consumers are under pressure. The industry is contracting in a number of our largest markets. And in fact, that contraction worsened in the third quarter.”

  • Wendy’s: “Yes, look, I would talk a little bit about Q3. We're still in a very challenging environment, I would say, with the consumer.”

  • Chipotle: “We're keeping a really close eye on the consumer, as you can imagine. Also a close eye on this very competitive market that we're in today, given the macros and what's going on with value wars in QSR and fast casual”

  • Domino’s: “we knew consumer spending would be pressured in 2024 and that the QSRs that offered the strongest value would win. That proved to be right”

  • Starbucks: “Regardless of the consumer environment, we must be at our best to succeed.”

The Rise and Fall of SMCI

From March 2022 to March 2024, SuperMicro Computer — an IT provider known for its high performing and energy efficient servers — saw its market cap rise from just over $2 billion to nearly $67 billion. A ~30-fold increase within the span of 24 months.

Yet, despite soaring revenue and a seemingly endless AI-driven appetite for its products, SuperMicro’s stock has collapsed by more than 78% over the last 8 months.

Here’s a look under the hood of SMCI’s meteoric rise and rapid collapse:

Right Product, Right Time

In 1993, a Taiwanese-American named Charles Liang decided to branch away from his role as Chief Design Engineer at Micro Center Computer. Liang, who had a background in electrical engineering and several patents to his name, had an idea for higher-performing and more energy efficient servers that corporate clients have growing demand for.

Accompanied by his wife and 3 others, Liang launched SuperMicro Computer in San Jose, California in 1993, and within a year, had become one of the leading providers of servers to systems companies in North America.

Since the beginning, SuperMicro’s products have been on the leading edge among its industry peers in terms of speed, energy efficiency, and performance. Customers have called them “the fastest, most compact, energy-efficient” servers available. And despite two decades of innovation and competition, SMCI still remains one of the top providers.

So naturally, as AI entered the mainstream throughout 2021/2022 and the tech companies all over the globe started rapidly expanding their high-performance computing infrastructure, SuperMicro was there to benefit.

Unveiling Ugly Truths

Still led by Liang, there’s little doubt about the company’s intense focus on its product. Where the doubt does begin to creep in however is around the company’s accounting practices.

Beginning around March of 2024, SuperMicro’s stock began to fall from its highs. Between a combination of a broad tech sector selloff, a fresh stock offering signaling a lofty valuation, and accelerated insider sales, SMCI’s stock began to creep lower heading into the summer.

However, it wasn’t really until August when investor’s optimism for SuperMicro came to a grinding halt. On August 27th, Hindenburg Research — a short-selling activist firm — released a lengthy report that uncovered some ugly history about the company. Here are some of the most concerning:

• In 2018, SuperMicro was delisted from the NASDAQ for failing to file financial statements on time. Often a sign of weak internal controls.

• In 2020, SMCI was relisted but then charged by the SEC for “widespread accounting violations”, most notably channel stuffing.

• Later that year, SMCI re-hired most of the executives they had let go due to their involvement with the accounting scandal.

• Multiple disclosed and undisclosed related party transactions. Most of which are business agreements with the Charles Liang’s brothers.

To top it off, less than a month after the short report was released the US Department of Justice began of probe of their own into SMCI’s accounting practices.

Where there’s smoke, there’s fire

After Hindenburg’s short report, SuperMicro’s stock had already collapsed by more than 60% from its highs.

However, this week, investors received even more concerning news that sent the stock down another 47%.

On Wednesday, one of the largest accounting firms in the world Ernst & Young, announced that it is resigning as SMCI’s auditor. Here’s what they stated in their resignation letter:

“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.”

As of 2023, SuperMicro was paying Ernst & Young almost $5 million per year in audit fees. For Ernst & Young to pass that up because they were “unwilling to be associated with the financial statements prepared by management”… it’s quite damning.

While SuperMicro’s story isn’t finished yet, it’ll be one to closely follow.

Somewhere between the insatiable end-market demand and the endless accounting red flags sits the truth.

SuperMicro reports earnings this Tuesday (November 5th).

Meme of the week

With a heavy debt-load, negative profit margins, and declining auto demand, there was a point in early 2023 when it appeared that Carvana was heading towards bankruptcy.

Yet, after the online used car retailer reported its 3rd consecutive quarter of positive GAAP net income on Wednesday, investors seem to have put those worries behind them.

With the stock jumping more than 20% on the results, Carvana is now more than a 60-bagger off of its lows from 22 months prior.