Super Micro Computer Could Still Generate High Long-Term Alpha
Despite recent valuation expansions, SMCI's $Super Micro Computer (SMCI.US)$ fundamental growth, driven by AI and HPC partnerships, is expected to offset long-term valuation multiple contractions, indicating market-beating returns.
SMCI's robust partnerships with Nvidia, Intel, and AMD, coupled with a strong focus on AI servers and liquid cooling technology, position it for sustained growth amid rising AI demand.
Potential regulatory hurdles and competition from Dell and HPE may slow growth, but SMCI's strategic inventory management and technological advancements aim to mitigate these risks, indicating long-term competitiveness and alpha.
In my opinion, investors are very likely to get market-beating returns from Super Micro Computer stock if investing at the present valuation. While the company's earnings and revenue growth expectations are already well priced into the stock based on its recent valuation multiple expansions, I think the total fundamental growth should offset the depletion in valuation multiples I expect over 10 years. The long-term growth of the company is supported by vital partnerships consolidating its position in AI and HPC—indeed, there could be several periods of high growth that Wall Street analysts are not currently forecasting because they are largely unforeseeable. These could include more proactive utilization of AI in federal budgets for deflationary effects, which I think could be highly accretive to SMCI. In addition, SMCI's capabilities could cross over to defense utilities. That being said, these outcomes are somewhat speculative and difficult to time, and I think exposure to SMCI should be met with moderate expectations due to the present valuation.
Operational Analysis
SMCI designs, develops and manufactures high-performance, high-efficiency server and storage systems for enterprise, cloud, and data center applications. It has a strong partnership with Nvidia (NVDA), integrating Nvidia's GPUs into its server designs. SMCI also works closely with Intel (INTC) and AMD (AMD) to incorporate their latest chips into its products, including Intel Gaudi2/3 and AMD MI300X/A GPUs. Musk's AI startup, xAI, is also partnering with SMCI and Dell (DELL) to build AI infrastructure, including server rack solutions. SMCI has also partnered with SiMa.ai and CVEDIA to develop and deploy advanced AI-powered solutions for urban environments.
SMCI designs, develops and manufactures high-performance, high-efficiency server and storage systems for enterprise, cloud, and data center applications. It has a strong partnership with Nvidia (NVDA), integrating Nvidia's GPUs into its server designs. SMCI also works closely with Intel (INTC) and AMD (AMD) to incorporate their latest chips into its products, including Intel Gaudi2/3 and AMD MI300X/A GPUs. Musk's AI startup, xAI, is also partnering with SMCI and Dell (DELL) to build AI infrastructure, including server rack solutions. SMCI has also partnered with SiMa.ai and CVEDIA to develop and deploy advanced AI-powered solutions for urban environments.
SMCI has a strong focus on the AI server market, which already represents circa 50% of its revenues. This is a market that is expected to grow rapidly, with estimates stating suggesting an 18% CAGR by 2032 is reasonable to expect. In addition, SMCI has a strong focus on the liquid cooling market, particularly direct liquid cooling ('DLC')—this allows for the increasing power demands of AI and high-performance computing ('HPC') workloads. These technologies can reduce overall power consumption in data centers by up to 40%. CEO Charles Liang has noted that many customers are still in the process of preparing their data center infrastructure for liquid cooling, meaning that growth in this area is likely to be gradual for now and be high later.
I think there is also future potential accretion for SMCI based on what I predict will be much higher levels of AI infrastructure investment from the U.S. federal government over the next few decades. I think that the emphasis that the federal government will be placing on AI is currently underestimated by many Wall Street analysts. I think the reason the federal government will do this is because AI and automation have the potential to reduce the cost of production, which can have widespread deflationary effects on the economy. This will be highly beneficial to Western global influence and strengthen the dollar as we are miles ahead of China, the second AI leader, in development right now. This is a catalyst that I think could lead to outsized growth for SMCI, potentially contributing to long-term alpha being achieved even though the valuation is already very high. In addition, SMCI's technology is not used for defense, but as its capabilities scale, I think that its products will be tapped by defense contractors for capabilities in high-performance-compute related to modern warfare. While these outcomes and catalysts are not certain and are somewhat speculative, I think it is important to include them in an analysis of why SMCI might deliver strong long-term returns.
Financial & Valuation Analysis
These are the current results in growth over the last three years:
These are the current results in growth over the last three years:
Revenue and normalized income growth have been phenomenal, but the company has purchased a large amount of inventory in the last trailing twelve months, leading to a significant loss of free cash flow, and TTM free cash flow per share is -$36.46, compared to $11.84 for fiscal 2023. This is arguably not a problem and is necessary because the company needs to maintain satisfaction by being able to meet demand in a timely manner. In effect, this short-term loss in free cash flow allows the company to maintain net income growth over the next few years. In addition, the high levels of inventory protect it from potential geopolitical supply chain disruptions, and the vast inventory supports the rapid integration of new technologies.
As I do not consider the free cash flow at present to be a long-term risk of any high magnitude, I want to focus on future full-year estimates from Wall Street for normalized income and revenue for SMCI. Analysts' consensus normalized EPS estimate for June 2024 was 100%, and for June 2025, this reduces to 42%. Furthermore, in June 2026, this reduces to 24%. The consensus is that revenue growth will also drop from 110% for June 2024 to 58% for June 2025 and 19% for June 2026. As a result of this anticipated drop in growth, which I do think is accurate because the company is unlikely to be able to maintain the high levels of adoption it has currently experienced as a result of the recent enterprise spending boom on AI, the company's valuation multiples are likely to drop considerably over the long term, in my opinion. As I mentioned, future catalysts that could be unforeseen by many Wall Street analysts might occur, and management has prepared itself shrewdly for these with high levels of inventory. However, this is not guaranteed and is somewhat speculative, so while I have incorporated this into my valuation multiple contraction estimate, I have moderated it to be more in line with the Wall Street consensus.
Despite the massive growth that the company has seen recently, many analysts consider the contraction in multiples and price from the March 2024 high to be a buying opportunity. I do not disagree that buying at the present price could lead to significant alpha if my outlined growth catalysts come to fruition, which I mentioned above and am bullish about. If we are to take Wall Street's word for it and then be slightly more optimistic based on my macro outlook, a reasonable revenue CAGR could be 27.5% over the next 10 years. The current price-to-sales ratio is 4.2, and I expect this to contract to around 2.5 by the end of the period. The current revenue per share is $218.52. Therefore, my 2034 price target is $6,200, indicating a price CAGR of 21%.
Risk Analysis
I think the West has very little choice at this time than to spend heavily on AI to mount itself as the leading power in the world and to drive deflation in its domestic economy and then internationally. This will support the dollar as the global reserve currency due to high levels of productivity and margin expansion in U.S. companies. However, risks to my thesis that might detract from the long-term growth in AI and HPC demand that would be accretive to SMCI are important to note.
I think the West has very little choice at this time than to spend heavily on AI to mount itself as the leading power in the world and to drive deflation in its domestic economy and then internationally. This will support the dollar as the global reserve currency due to high levels of productivity and margin expansion in U.S. companies. However, risks to my thesis that might detract from the long-term growth in AI and HPC demand that would be accretive to SMCI are important to note.
I think that regulatory hurdles related to AI adoption could slow growth for SMCI. The European Union has approved the AI Act, which will govern the development, placement, and use of AI systems in the EU. This is likely to lead to increased compliance costs as SMCI will need to make sure its hardware meets the requirements for high-risk AI systems. Failure to meet these demands could cause growth inhibition for it's EU revenue and increase development costs related to regulatory approval. Furthermore, while the U.S. currently lacks federal AI legislation, there are ongoing efforts to regulate AI. Therefore, SMCI will likely be under increased scrutiny from the FTC, EEOC, CFPB, and DOJ. There could arise complex, conflicting regulatory requirements, particularly in the U.S. compared to its Asia markets. In addition, regulatory requirements are likely to be sector-specific. These regulatory constraints could significantly slow the rate of the company's growth, introduce higher development costs, and make certain projects redundant.
Based on my research, SMCI has about a 5% share of the server market. It has been gaining ground rapidly, especially in AI servers, and its partnership with Nvidia makes it a key differentiator. However, it faces competition from larger rivals like Dell and Hewlett Packard (HPE), who, from my research, are the two main competitors. Dell's share of the server market is around 20%, according to my research, and HPE's is somewhere between SMCI and Dell. JPMorgan analyst Samik Chatterjee's estimate for SMCI is that it will capture 10-15% of the AI server market by 2027. In my opinion, from the company's recent statements and the fact that a significant portion of total revenue in recent quarters came from selling AI-related server solutions, AI-servers are likely to be the company's highest revenue generator over the long term. However, the company is going to face competition, and I think there is also the potential for new rivals to emerge as the market expands, so it is important for management to continue to solidify its moat and be prepared for regulatory, demand, and technological shifts well in advance.
Conclusion
SMCI looks expensive on the surface, but on close analysis, the stock is not too expensive to generate high long-term alpha based on long-term fundamental growth predictions, even if the valuation multiples contract over the long term. I am personally bullish about SMCI, but I think growth expectations should be somewhat moderated because there may be periods of regulatory restraints on AI demand, and also, the catalysts that I have noticed that may be undervalued on Wall Street may not come to fruition at such intensity as I predict. That being said, even in a conservative baseline instance, I predict SMCI will beat the market over 10 years.
SMCI looks expensive on the surface, but on close analysis, the stock is not too expensive to generate high long-term alpha based on long-term fundamental growth predictions, even if the valuation multiples contract over the long term. I am personally bullish about SMCI, but I think growth expectations should be somewhat moderated because there may be periods of regulatory restraints on AI demand, and also, the catalysts that I have noticed that may be undervalued on Wall Street may not come to fruition at such intensity as I predict. That being said, even in a conservative baseline instance, I predict SMCI will beat the market over 10 years.
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