Here’s my two cents for what it’s worth and of course caveat: I could be wrong.
I have owned SMCI since January 2023.
I started trimming once it topped 10% of my holdings as I am not as comfortable with extreme concentration as many members of the board, but it keeps popping back up past 10% and I hate to keep trimming because it’s been such a great winner. So I’ve stopped.
In thinking about SMCI’s future we must consider two things: the growth of the market and the competition.
Growth of the Market
Everyone says it can keep on growing so who am I to disagree? But seriously, I do agree. When I bought SMCI and NVDA (earlier, in 2021) it was not for AI per se and certainly not LLMs because LLMs hadn’t come out. I bought them for the data center market –the “hype” about LLMs has exploded this market but this market was already going to be big and growing forever.
Before LLMs there was ML (machine learning) and that is real and extremely useful and not going away, and ML sucks up a massive amount of data – think UPST and its 1600 or whatever parameters for every person for every loan payment. In addition to that, you have business intelligence etc. etc. Data never shrinks (except during periods of extreme optimization) – it only grows and grows.
So whatever happens to LLMs and how many players there are or aren’t, (and I do think the titans will invest what it takes for however long in this space to make it useful; they have the money and the desire and believe there is a positive outcome to all this, even if they don’t quite know where it is yet) business intelligence and ML aren’t going away.
That’s not to say that there might not be temporary over-purchases and pullbacks, this market will definitely be cyclical, but look out 5-10 years, and data will grow, which means stocks that support the data center will grow.
So nothing wrong with the growth of the market here. And certainly nothing wrong with the growth of the market for at least a year or so, as we know that’s that backlog.
Now let’s turn to the competition. This is what everyone is worried about. Racks are a commodity, anyone can build them, SMCI has no IP moat. That’s all true.
From what I understand, the biggest competitors for SMCI are HPE (HP Enterprise) and Dell. Other competitors come up in google searches but they appear tangential and many are performing very badly re: revenue growth.
Here’s what others on seeking alpha say about HPE and DELL:
HPE is divided into several business segments, starting with the server business. Rack-mounts and tower-based servers, HPE is focused on all-purpose servers as well as storage servers. Not driving the company as it once was, the so-called Compute segment remains safely in the 10% or greater source of revenue.
More of a growth industry is Intelligent Edge, where HPE is putting together solutions for companies in data-first modernization. This includes the edge-to-cloud strategy of making cloud storage as seamless as possible, and their own cloud platform, Green Lake.
Today, Dell provides a comprehensive suite of IT solutions, including servers, storage devices, networking products, and software. Catering to a diverse clientele, from individual consumers to large enterprises and public institutions, Dell customizes its solutions to address specific customer needs.
SCMI + OTHERS
So immediately we see a big difference between SMCI and HPE and DELL: SMCI is focusing exclusively on the racks and HPE and DELL are not. In fact, HPE and DELL see bigger opportunity elsewhere and who can blame them? As everyone points out, anybody can build racks, there may be a price war, so the natural inclination is to put your effort into more upscale targeted solutions right?
But maybe SMCI’s greatest weakness is it strength – that’s all it builds, all day every day, and it’s not going anywhere else (at least that we can tell). They are opening a new manufacturing facility in Taiwan and later this year in Malaysia, where they can build these racks even cheaper.
We see SMCI’s margins going down in this recent earnings report and immediately think it’s a cause to worry (I know I worried). But what if that’s SMCI’s strategy? Let’s make these quality racks as cheaply as we can and sell them with low margins and let’s be the best (or at least in the top tier) racks for a price so low that nobody wants to compete. And yet still make a great profit on volume.
If you are a little guy breaking into the field, how are you going to raise the funds to build a plant to compete with let’s say for comparison – the Amazon of racks. Thin margins with massive volume. You are not. Sure you can build racks, they are a commodity, but there are so many places to go that will be more lucrative than a price war with the King of Racks, and you are going to have to convince the titans that your racks are better or they will have to be a lot cheaper.
So that leaves us to worry only about the big flop if volume drops precipitously. Certainly a possibility and something to keep an eye out for.
I tend to be a very long-term hold kind of person. A big mistake I’ve made in the past is to look out 5 years and ask myself, can I see this company really winning then and if I can’t see clearly, I either don’t go in or I sell. That kept me completely out of zoom, but look how foolish that was in the short term – I lost out on an obvious gain because I could see past that gain and could see there were no adjacencies. But I have learned from this board that thinking short term can work too.
Is SMCI a forever hold? Likely not (whereas I believe NVDA is, as long as Jensen Huang is there). But does it seem like a good bet for the near future? Yes, indeed. May I trim again? Yes, I may – depending especially on the next investor call with the full earnings report. Also, FWIW, I think the CEO is uninspiring and glassdoor ratings are borderline unacceptable. Two minuses I think about all the time. However, how inspiring must you be when all you do is build racks of excellent quality really cheaply?
I will always be looking for data that will change my thesis. But until I see it, I’m holding. It’s still a small company, it’s financials are great, and it’s up 550% in one year. Congrats to all of us who have held!