Should Investors Worry About Super Micro Computer's Short Attack? Or Should They Buy the Dip?
Super Micro Computer (NASDAQ: SMCI) stock came under attack from short-sellers this week, with the computer server specialist being accused of several financial improprieties.
The question for investors is: Should they be worried about the allegations and sell the stock, or is any dip in the share price a buying opportunity?
The short report
Short-selling is the process of an investor borrowing a stock from a current shareholder and then immediately selling it with the intention of buying it back later at a lower price. Short investors often pay a borrowing cost, which is interest a broker collects to lend out the stock.
The more heavily a stock is shorted, the higher the borrowing rate tends to be. In fact, sometimes borrow rates can get quite high. Earlier this year, borrowing costs to short Trump Media & Technology Group got as high as a 900% annual rate.
Now, while shorting often gets a bad rap because investors often feel that short-sellers are betting against their investments, short-sellers do play an important role in the market, as they can expose overlooked risks regarding a company and/or its stock.
In some cases, short-sellers can call out fraud and even criminal activity. This was the case with Insys Therapeutics, which played a large role in the fentanyl epidemic that hit the country.
Sometimes short-sellers will make their short theses public in order to try to drive down a stock's price, which would help them make a profit. These reports can be a mixed bag. They can be pretty accurate, but they can also appear to be exaggerated or even misleading.
Super Micro Computer, or Supermicro as it is also known, is one of the highfliers of the artificial intelligence (AI) infrastructure build-out. This month it became the latest subject of a short report from Hindenburg Research. In its report, Hindenburg accuses the company of accounting manipulation, evading sanctions, and related-party self-dealings by management.
Image source: Getty Images.
Should investors worry about the Hindenburg report?
The purpose of a short report like the one on Supermicro is to bring attention to what could be serious issues and ultimately send the stock lower. Shorting stocks is inherently more difficult than being long on stocks, for a few reasons. One is that the risk is technically unlimited. When you buy a stock, you can only lose the amount of your investment, if a stock goes to zero. But with shorting, stocks can continue to go up, and you can lose more than your initial investment.
At the same time, when longs go down, they become a smaller part of your portfolio, but when shorts go up, they become bigger. Finally, short investors have to deal with borrowing costs that can eat into their returns as well.
Given these dynamics, it is often best for short-sellers if their theories on a stock are proven true sooner rather than later. And that is why you will often get these public reports, which tend not to be subtle in their intent. But just like with long investments, sometimes short theses play out, and sometimes they don't.
Regarding Supermicro, it is worth noting that the company does have a history of accounting manipulation. The SEC fined the company in 2020 after finding that its former CFO had prematurely recognized revenue and understated expenses over a three-year period. The SEC said that the company pushed employees to maximize quarter-end revenue and would recognize revenue for products shipped to warehouses, not customers.
CEO Charles Liang was fined $2.1 million. Meanwhile, the stock had to be temporarily delisted from the Nasdaq Composite in 2018 for not filing financial statements on time.
Time to buy the dip or stay away?
Not helping matters for Supermicro, the day after the short report, the company announced that it would delay the filing of its 10-K report for fiscal 2024 with the SEC, saying management needed more time to assess the design and effectiveness of its internal controls over financial reporting. At the very least, that's not great timing.
In addition to these potential accounting issues, the company is also currently dealing with gross margin issues as well. Last quarter, it saw its already thin gross margin fall from 17% a year ago to 11.3%. It's been seeing strong revenue growth from the AI infrastructure build-out, but its thin margins indicate that it sells pretty commoditized products.
Given the questions raised by the short-seller's report, the ill-timed filing delay, and weak gross margins, I'd stay on the sidelines with Supermicro stock.
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Geoffrey Seiler has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
