Welcome to Super Micro galaxy

Those who don’t learn from history are having an absolutely blinding year.

One big winner this month is Super Micro Computer, a maker of server equipment that floated in 2007 with a $250mn market value. It’s now worth $56bn, the Nasdaq-listed stock having risen 222 per cent since mid January and 1,000 per cent over the past year.

Chances are you can guess why. Here’s what Bank of America writes in a note dated February 15, with our emphasis.

We think this provider of server and storage solutions will be a beneficiary of AI-driven demand growth (>50% of revenues now tied to accelerators like GPUs). We believe the market for AI servers is much larger than is factored in Street models. We expect the market for AI servers to grow, on average, 50% CAGR over the next three years, vs. historical growth of the overall server market (5.5% CAGR over the past 17 years), and we expect Super Micro’s revenue to grow even faster driving market share gain. Super Micro has a growing backlog and is expanding capacity to support strong revenue growth. It has established itself as an early launch partner for companies like Nvidia, AMD and Intel for CPUs and GPU accelerators. And we think its ability to work with multiple new designs and technologies will serve it well as myriad AI-related processors debut in the next several years.

It’s classic “in a gold rush, buy shovels” stuff, similar to the 1990s arguments that put stratospheric valuations on telco equipment makers like Lucent and Nortel (both RIP). Under-appreciated problems back then included that shovels weren’t particularly difficult to make, and that there were low barriers to entry on shovel-making, and that lending prospectors money to buy shovels made the whole business a leveraged bet on the gold price going up forever.

But history, as Kurt Vonnegut wrote, is merely a list of surprises that can only prepare us to be surprised yet again. The spirit of Vonnegut survives in the writings of analyst Ruplu Bhattacharya and team at BofA:

Super Micro is in an intensely competitive market which requires aggressive pricing. We expect margins to remain in the lower end of target range (14-17%) to support revenue growth and share gains. We view the company as supply constrained (strong market demand, but GPU availability can limit sales growth). Yet Super Micro’s trading multiple has re-rated higher rapidly so far in 2024.

So sell. No, wait, the other one. Buy.

Our PO of $1040 is based on 26x our C25E EPS of $39.28.

BofA tells clients that, unlike rivals, Supermicro “creates server technology from the ground up, and designs its own chassis, motherboard and other pieces of the server”. Building shovels racks to order means Supermicro can tailor each blade server and data storage hub for optimal performance while navigating around industry shortages, says the broker.

It also identifies as key competitive advantages Supermicro’s US manufacturing hubs and its “close proximity to leading semiconductor companies in San Jose”. Being neighbours apparently means it gets to experiment first with new kit from Nvidia and Intel.

(There’s more to read about the in-house design processes in a series of disputed Bloomberg Businessweek reports alleging that China had pressured Super Micro sub-contractors to include “spy chips”. Supermicro has repeatedly dismissed the claims.)

Since 2009, Supermicro has grown revenue by about 21 per cent per year, which is approximately the same pace as the broader server market. But because AI etc needs bigger racks, Supermicro has guided for 2024 revenue to approximately double.

BofA’s top-of-the-range forecasts are pinned on Supermicro’s market share going from 10 per cent to 17 per cent in the next three years, and for its total addressable market in AI to grow to $136bn by 2026 from $38bn last year. The idea is also that, by 2026, the AI server market will be split 50/50 between model training and inference, from 90/10 per cent currently, so total growth will be sustained even after demand for training servers levels off after this year.

One possible wrinkle in the hypothesis is that Supermicro’s not a big supplier to tech’s top tier.

So-called hyperscale datacentre operators like Amazon AWS, Microsoft, Alphabet and Meta prefer to build their own server farms. Supermicro’s core customers are smaller, conventional cloud service providers and enterprises for whom IT investment is measured by cost-benefit rather than by its resale value.

How many SMEs will catch the AI bug? BofA reckons it’ll be far more than the consensus expects, albeit only from next year . . . 

…and Supermicro’s gross margins on custom racks will remain much higher than for the off-the-shelf kit sold by its rivals:

The trend there so far is… uh-oh …

(There’s more to read about Supermicro’s customer base in its 2020 settlement with the SEC, where the regulator identified “widespread accounting violations” related to “prematurely recognising revenue and understating expenses” from at least fiscal year 2015 through full-year 2017. Supermicro restated results and paid a $17.5mn penalty to settle the investigation.)

A quick note also on Supermicro’s suppliers. Among the most important are Ablecom and Compuware, which last year accounted for 6.6 per cent of its cost of sales. Ablecom’s CEO and largest shareholder is Steve Liang, the brother of Supermicro CEO Charles Liang. Compuware is an affiliate of Ablecom in which Charles Liang and his wife own a 10.5 per cent stake.

In 2018, Supermicro shares were suspended on Nasdaq due to filings failures. Charles Liang then borrowed $12.9mn from his brother’s wife to repay margin loans. As of June 2023, the unsecured, interest-bearing loan was still outstanding and had swelled to $16mn due. In light of all that, negotiating better prices from Ablecom and Compuware might not be easy.

So anyway. That’s the trade-off required. It’s going to be a simple case of keeping build prices low enough to take share in a midmarket that’s growing in unpredictable ways, while also generating twice the profit margin of rivals, while also maintaining neighbourly relationships with the key suppliers, and not upsetting the CEO’s in-laws. BofA says all that’s worth $1040 per share today, 26 times its 2025 EPS forecast, or 36 times the Street consensus.

And extraordinarily, the market almost agrees:

🤪

Further reading:
— This is nuts. When’s the crash?