Super Micro Computer: Inspur Ban, X.AI Founding, And Hardware Shortage Are Large Positives

In my last article, I discussed how Super Micro (NASDAQ:SMCI) was at the center of a major AI tailwind driven by its extremely close relationship with Nvidia (NVDA). This tailwind has continued, with NVDA stock up dramatically and reports of AI server shortages in March as large enterprises and startups invest heavily in AI.

There are two more major developments that the market may not be fully appreciating.

1. The addition of Inspur, the #3 server maker in the world, to the entity list, with one article describing the policy for Inspur as similarly restrictive to Huawei (i.e., very restrictive).

2. The entry of Elon Musk into the AI space at large scale, which should cause significant additional demand in SMCI’s end markets.

Inspur Added to The Entity List

Inspur largely relies on US chip makers like AMD (AMD), Intel (INTC), and NVIDA to supply the chips for their servers, and being on the entity list will limit their ability to meet global demand for server hardware. This ban, especially if it is actually as restrictive as Huawei (i.e., not just advanced chips but most chips), will limit Inspur's ability to do business anywhere outside of China. At a recent conference, Nvidia management stated:

Inspur is a partner for us, ... they are helping us stand up computing for end customers. And as we work forward we will probably be working with other partners, for them to stand-up compute within the Asia-Pac region or even other parts of the world.

Similarly, AMD management stated at a recent conference:

AMD, like everyone in our industry, we, of course, follow all of the guidelines of export controls from the U.S. government, including, of course, the Entity List. And so, we did see that news, but we're seeking clarification as I think the rest of the industry is, because Inspur is a large holding company. It serves many, many markets. So, we're looking to get clarification on those guidelines. Of course, we'll abide by the resulting information.

This development should increase SMCI's international market share significantly. Inspur has a similar role in the server market to SMCI in the sense that they are focused on AI and the “ODM+” space. Inspur claimed the largest share of the AI server market in 2020, this is likely not current but clearly their share is large.

Inspur has many offices throughout Europe, Asia, South America, and the Middle East. Notably, it has relatively few offices in North America.

A review of their case studies shows that all of their case studies are essentially in Europe, the Middle East, or Asia, meaning they have substantial business outside of China. SMCI may now be first in line to address a portion of this business.

The banning of the #3 server maker globally should be a large positive for SMCI and could cause a 5% or more increase in revenue alone, with an emphasis on international revenue. SMCI currently has just over 41% of revenue outside of the United States, so they have the infrastructure to address this demand.

Some of this may already be somewhat priced into both the stock and to revenue as it's very possible that some investors and SMCI customers began to make decisions with this possibility in mind in the last six months or earlier. However, it is likely not fully accounted for by either investors or customers, meaning the positive impact of this to SMCI remains substantial compared to the current valuation.

ODM+

To understand how Inspur and SMCI are similar to each other and different from Dell (DELL) and Hewlett Packard Enterprise (HPE), it can be helpful to understand what Lenovo (OTCPK:LNVGY) describes as ODM+. ODM+ is targeted at hyper-scale and/or very large and sophisticated enterprises that have custom needs for their own data centers, and reduced need for support.

The largest players in this space are, in order of size, Inspur, Super Micro, and Lenovo, and Inspur has now been largely removed from the picture, and while Lenovo is still a player, the fact that it is headquartered in Beijing cannot be a positive in the current environment. Supporting the bull case for SMCI, Lenovo was very bullish on ODM+ on their recent call.

In summary, the addition of Inspur to the entity list is a substantial positive that should add materially to SMCI international revenue.

Elon Musk Founding of X.AI

According to sources (1, 2, 3), Elon Musk has bought a large numbers of GPUs (and likely other required hardware) renamed Twitter into X Holdings, and founded a company X.AI which will pursue large scale generative AI research, possibly/likely using Twitter as a world class platform to do so. This is significant in both a tangible sense and a general sense. In a tangible sense, Elon Musk is said to have purchased over 10,000 GPUs already, which is likely $200-400m+ of additional revenue in an AI hardware and server industry that was single digit billions per quarter in 2022 (though it may be larger now). In other words, the announced GPU purchases and associated server needs will already be a ~5% boost to SMCI’s overall end market alone this quarter. In all likelihood, significant additional AI hardware investment will follow from X.AI, possibly billions or even tens of billions worth.

In a general sense, it is meaningful because it points to the broader fact that a large number of major global organizations have started making very large AI investments over the past few months. This has caused major shortages (1, 2) of AI hardware. H100 GPUs are being offered above initial the official price on eBay. Super Micro is either one of the top few or the leading AI server manufacturers now that Inspur is on the entities list, and should experience benefits from the strong demand that is causing these shortages.

Longer Term Perspective

It is important to appreciate that the current activity in generative AI is just the tip of the iceberg in the bigger picture of the AI industry. Generative AI in the current ChatGPT and stable diffusion/dall-e is merely focused on learning about how existing patterns of information co-occur with each other in the observed world. There are huge additional fields which are likely to be even more valuable and receive even more enterprise investment. The scale of AI spending that is likely to happen over the next few years is truly large. This past week Amazon CEO Andy Jassy stated:

Most companies want to use these large language models but the really good ones take billions of dollars to train and many years and most companies don’t want to go through that.

This likely means that in aggregate the AI hardware industry is likely to approach > $100b at some point in the next five years, and Super Micro is positioned to be one of the premier server manufacturers in this space.

Risks

In addition to the risks mentioned in the last article, part of SMCI's advantage comes from its close relationship with Nvidia. NVDA stock has appreciated dramatically since my earlier SMCI article, however, if Nvidia loses their world leading role in AI at some point in the future, SMCI's advantage would be reduced materially. This is not an immediate concern but is very possible over the long term. However, if it were to happen in five years, hopefully, SMCI will have achieved a scale that gives it separate sources of competitive advantage.

Conclusion

Taken together, these two developments amount to a major positive shift in the fundamentals since my last article and support the SMCI bull case. It is also important to appreciate that while SMCI will benefit substantially from the current AI spending, SMCI has also diversified away from this area because it does general data center infrastructure work that is not AI dependent, and the addition of the Inspur to the entities list will be a major positive in this non-AI area as well.