Super Micro Computer: Nvidia’s Close Ally With Sound Valuation (NASDAQ:SMCI)

My thesis

While analyzing the biggest AI players I discovered that the train has gone as most semiconductor stars are already overvalued, based on my analyses. Fortunately, there is a less known company called Super Micro Computer (NASDAQ:SMCI).

SMCI’s revenue growth trajectory almost perfectly mirrors Nvidia’s (NVDA), which is a strong indication that combining products of these two companies in building data centers to power AI is the industry’s best practice. This strong technological bond is also backed with long-lasting good personal relationships between the CEOs of these two companies. SMCI’s pace of innovation is impressive as it adapts its offerings to Nvidia’s new releases almost simultaneously. But what is extremely important is that SMCI’s valuation is sound as the stock is fairly valued. Buying one of AI winners at a fair share price looks like a Strong Buy opportunity and I certainly start my position in the stock. I think that the current correction in semiconductors is a good opportunity to dollar average and increase stake in this promising stock.

SMCI stock analysis

The rally of the last year and a half in most semiconductor stocks was fueled by the emerging AI trend. Nvidia is widely considered to be the major AI winner and its stock rallied massively since early 2023. However, SMCI is the stock that notably outperformed even NVDA for a long time since January 2023 and started lagging just recently.

In my latest analysis about Nvidia, I have described in detail why I believe that the emergence of Large Language Models (LLMs) is a new secular megatrend. I will not describe the same reasoning regarding it again in order not to waste time. Indeed, I will focus on SMCI’s potential to successfully capitalize on this this megatrend.

Super Micro Computer develops and manufactures high-performance server solutions, which are vital for data centers that power LLMs. High-performance servers’ market is poised to benefit from the booming investments in data centers for AI. This opinion is backed by the forecast from market.us, projecting a 30% CAGR for the global AI server market by 2033.

The industry of AI servers is thriving, which is a strong catalyst for SMCI. On the other hand, industry growth does not guarantee success if the company’s positioning in this industry is questionable. Fortunately, it is not SMCI’s case as there are a few strong indications that it is poised to capitalize well on the AI servers’ industry growth.

Below chart shows that revenue growth of Nvidia and SMCI are closely tied, and lines mirror each other. To me this is an indication that combining Nvidia’s chips with SMCI’s server solutions is considered as the best practice in building AI data centers. Having a reputation of products having perfect compatibility with Nvidia’s is a massive catalyst for SMCI because Nvidia dominates the GPU market with an 88% share.

Strong technological partnership between SMCI and Nvidia is also underscored by the appearance of Nvidia’s CEO during a speech by Super Micro Computer Inc CEO Charles Liang at Computex Taipei. Jensen Huang described himself as Liang’s long-time partner and SMCI’s “best sales guy”, which indicates that SMCI’s revenue is likely to continue repeating Nvidia’s revenue growth trajectory. Therefore, it is not surprising that consensus for both SMCI and NVDA expect the current fiscal year’s revenue to double.

Super Micro is also extremely quick at upgrading its product to match Nvidia’s new releases. For example, Jensen Huang presented Blackwell family of AI accelerators on March 18. Within just 80 days, on June 4, SMCI introduced its products that are compatible with Blackwell, which is an impressive pace of innovation. The company’s R&D spending looks extremely efficient because the company allocates around $100 million per quarter to innovation, which is quite immaterial compared to the above $40 billion market cap. Nevertheless, modest R&D spending is not a problem as long as SMCI has tripled its revenue over the last few years.

SMCI’s profitability profile dynamic is also quite impressive as the operating margin has skyrocketed in the last few years in line with the massive revenue growth. The trend of profitability profile improving is likely to continue since consensus estimates project FY 2026 EPS to be three times higher compared to FY 2023.

Intrinsic value calculation

The discount rate for my discounted cash flow (DCF) model will be derived using the CAPM model. The below working demonstrates why SMCI’s weighted average cost of capital (WACC) is 11.5%.

I think that using consensus estimates as my revenue projection is a prudent choice. A 20% projected revenue CAGR for the next five years does not look aggressive considering all the opportunities created by AI tailwinds and SMCI’s firm strategic positioning.

I incorporate a 6% perpetual growth rate for my DCF model. It is common to see opinions that assuming a perpetual growth rate that is higher than the GDP growth makes no sense, but I do not share this view. Just look at the below chart where it is shown that companies like Cisco Systems (CSCO) and Oracle (ORCL) have been consistently delivering an above 6% revenue growth over decades. I did not add more companies to the below chart because it would have been non-readable, but there are several more companies that have been delivering an above 6% revenue growth rate for decades as well.

SMCI’s TTM levered FCF margin is negative, as the company invests aggressively in expanding its capacity to meet surging demand. Therefore, I use a zero FCF margin for the base year. Nevertheless, the correlation between revenue and EBITDA growth is strong and this adds me optimism about the company’s ability to expand its FCF margin in future. That said, incorporating 150 basis points per year FCF expansion looks realistic enough, in my opinion.

Putting all the assumptions together into the DCF template resulted in a $45 billion intrinsic value, which almost perfectly matches with the current market capitalization of SMCI.

Despite a limited potential upside from the perspective of the above working, I think that the valuation is compelling to initiate a position in SMCI. We see that the correction is happening among stocks of prominent semiconductor names like NVDA and AMD as prices are plunging since mid-July. In this situation, it is likely that SMCI will follow as well, and this will provide investors with good opportunities to increase their stake and dollar-average the price of their SMCI holdings.

Moreover, we should not forget that the DCF’s WACC incorporates current high interest rates. According to my calculations, softening WACC from 11.5% to 10% boosts intrinsic value to almost $61 billion. That said, the Fed’s rate cuts which are likely to start in late 2024 and continue through 2025 will certainly beneficially affect SMCI’s valuation.

What can go wrong with my thesis?

The recent trend that is currently happening among the biggest semiconductor names might be not just a correction. In my recent analyses about NVDA and AMD I revealed that these names are notably overvalued, and current trends might mean that the market is reassessing valuation in these names. The stock market is driven by sentiment in the short term and if these giants’ stocks continue falling, SMCI will highly likely follow as well despite having a sound valuation. While this will be good for investors who plan to start position in SMCI and increase stake during pullbacks, I have to warn that the stock price recovery might take several quarters if the overall market sentiment cools down.

Investors also should be aware that SMCI faces fierce competition in its niche. According to the 10-K report, SMCI competes with large and well-known companies like Cisco, Dell (DELL), Hewlett-Packard Enterprise (HPQ), and Lenovo (OTCPK:LNVGF). When a company competes with such formidable players there are always various substantial risks. The most apparent one is the risk to lose technological race which will make a company’s products inferior compared to competitors.

While good relationships between CEOs of SMCI and NVDA is apparently beneficial for SMCI, providing valuable opportunities and strategic benefits, there is a risk that partnership between these two companies might suffer if personal relationships deteriorate. Moreover, strong bond with Nvidia also creates significant dependence on Nvidia’s success. If Nvidia starts losing its positions in the GPU industry, SMCI will also highly likely suffer.

Summary

I think that SMCI is a compelling investment opportunity as its valuation is sound and the company is well positioned to drive revenue growth in line with Nvidia’s. The bond with the company that dominates the AI chips industry looks very strong, which is a big positive catalyst. The AI servers’ industry is expected to thrive, and being Nvidia’s close technological partner makes SMCI firmly prepared to capitalize on the AI megatrend.