SMCI big crash after fraud: Buy the dip before earnings?

Super Micro Computer is scheduled to release the fiscal Q1 2025 earnings post-market on Nov 5th. The upcoming earnings report is overshadowed by recent auditor concerns events that have had a devastating impact on investor confidence, with SMCI's stock crashing nearly 50% following the scandal. In this earnings preview, we analyze the key factors that investors should be mindful of as SMCI is going through one of its toughest periods.

One of the most pressing issues facing SMCI is the resignation of Ernst & Young, its auditor, which has raised alarm bells regarding the reliability of the company's financial statements. EY cited concerns over SMCI's internal controls and board independence, stating it could no longer rely on management's representations. The resignation comes after a short-seller report by Hindenburg Research accused SMCI of accounting manipulation, leading to a delayed filing of the previous fiscal year's report and an ongoing investigation from Department of Justice.

According to the short sale analysis from moomoo, SMCI's short interest saw an unusual increase as early as Oct 15th, which may indicate that investors had already positioned themselves in advance to short sell the stock in anticipation of this plummet.

SMCI is facing pressure to address its compliance problems with Nasdaq's listing regulations after missing the deadline to file the necessary 10-K report. The company must present a compliance plan by November 16th to avoid possible delisting. This challenge is intensified by the threat of additional SEC sanctions, which could include fines, trading suspensions, or even delisting.

According to Bloomberg, SMCI is expected to report Q1 revenue of $6.47 billion, representing a 205% YoY increase. Adjusted net income is projected at $480 million, up 142% YoY. Historically, SMCI surpassed market forecasts 6 times out of the last 8 quarters. However, given the current circumstances, these figures may be less relevant to investors than the broader context of the company's governance issues.

TF International analyst Ming-Chi Kuo "best Apple analyst on the planet" stated that, based on past experience, the resignation of auditors is a very serious matter, and the probability of the company being suspended or delisted is increasing. There might be significant changes in the top management and board of directors, and the possibility of a merger or acquisition cannot be ruled out. Analysts from Mizuho and Wedbush have expressed concerns over the company's ability to meet these expectations amidst its current challenges. The consensus among analysts is cautious, as the market's reaction to the auditor's resignation and ongoing investigations have significantly impacted investor sentiment. Many analysts have revised their ratings, with some downgrading the stock from "buy" to "hold", reflecting the uncertainty surrounding SMCI's future.

Looking ahead, a crucial point of interest will be SMCI's efforts to appoint a new auditor and restore investor confidence. The company's management, led by CEO Charles Liang, is under intense scrutiny, and significant changes, including potential leadership restructuring, might be necessary to regain credibility. Additionally, any updates on the internal investigation and measures taken to enhance corporate governance will be closely watched.

Is it a buying opportunity now? Better not now. A single-leg options strategy could be considered in this situation. If you believe in a potential recovery for SMCI, a long call option could be appropriate. Conversely, if you anticipate more negative developments, a long put option might be the better choice.

Rationale for the single-leg options strategy:

1. Limited downside risk: Purchasing call or put options limits the downside risk to the premium paid for the options. This is advantageous in a highly uncertain environment, as it allows investors to hedge against potential losses without the risks associated with short selling or direct holding, such as unlimited losses.

2. Potential for significant gains: Depending on your market outlook, if SMCI's stock price continues to decline due to ongoing negative developments, a long put strategy could yield substantial returns. Conversely, if you anticipate a recovery, a long call strategy offers the potential for significant gains. The current trajectory and unresolved issues make both options worth considering.

3. Event-driven catalysts: The upcoming earnings report and any announcements regarding regulatory compliance or management changes could serve as catalysts for further stock price movements. An option position allows investors to benefit from potential development.