SGH: Two Stories – One Truth

SMART Global Holdings, Inc. (SGH:US, "SGH") relied on its subsidiary SMART Brazil for 62% of its 2018 revenue. This revenue was only possible because of a tax incentive for which SMART Brazil no longer qualifies. We show that management was not clear with investors about the grave risk Brazil posed to continued SGH profits before it happened and, even more appalling, did not adequately update investors after it happened on July 1, 2019.

SGH management still has not been clear about the severity of the adverse events in Brazil. Our extensive analysis and on-the-ground due diligence in Brazil and India reveal that SGH's new strategy and recent acquisitions won't replace that lost profit margin.

One recent SGH acquisition, InForce, had been owned by two SGH directors and Chairman/CEO Ajay Shah, who personally profited $5 million from the deal. Moreover, according to Indian filings that we pulled, SGH paid $12 million, or over 13x sales for this de minimis business that appears to be only accretive to insiders rather than shareholders. This related-party transaction puts a spotlight on Shah's complete control over SGH. He is Founding Managing Partner of SGH's controlling shareholder, Silver Lake Sumeru, which with Silver Lake owns over 40% of SGH shares. Shah also sits on one of the two boards that oversee Silver Lake Sumeru's investment.

SGH's short life post-IPO can be characterized by aggressive leverage, asset stripping, and cash sweeping, dumping the husk onto public markets. Crippled by the loss of the subsidy in Brazil, SGH is no longer smart money.

SGH built its SMART Brazil business on a Brazilian subsidy for local tech, providing SGH customers tax benefits up to 28% of gross sales, allowing SGH memory to sell at a premium to international prices. Without the subsidy and with no other advantages, SGH cannot compete head-to-head in the global commodity memory market.
In June 2019, Brazil released details of its new subsidy program. Under it, SMART Brazil can't earn its OEM customers enough points to qualify. We have uncovered meetings and statements demonstrating that SGH knew the dire impact of this change but has not been clear about the gravity of it with shareholders.
As a strategy re-direct, in 2018 SGH acquired Penguin Computing; it has high fixed costs and low operating margin of 6% (1Q18). This raised SGH costs and diluted its margins. In July 2019 SGH acquired Artesyn Embedded Computing and Inforce Computing. This was a step backwards, as in 2010 SGH had shut down its embedded computing subsidiary.
The related-party Inforce acquisition turned a $12 million profit for SGH executives, with $5 million for Ajay Shah himself. SGH disclosed little about the deal. Shah is CEO/Chairman of SGH, founding partner of Silver Lake Sumeru and a member of the board that oversees Silver Lake's investment in SGH. Silver Lake and its affiliates own 40% of SGH shares.
SGH is practiced at murky disclosure. SGH shows KiWan Kim in California as President of SMART Brazil. But in Brazil and according to filings there, Rogério Nunes is its CEO/President. SGH doesn't mention him in SEC filings, but we discovered Nunes has held full control over SMART Brazil since before SGH bought it 17 years ago. Omitting to disclose key-man Nunes allows SGH to conceal his compensation and any SGH share ownership/sales, or potential conflicts of interest. Nunes is director of two trade associations that lobby the Brazilian government, and he founded another that seems laser-focused on SGH interests in Brazil, sometimes against Brazilian interests.
The failure of SGH to immediately disclose the impact on revenue of the lost subsidy, its failure to provide details of the InForce related-party deal, its concealment of key-man risk in Brazil and his failed lobbying to save the subsidy, all starkly reveal management's indifference to good governance through their lack of clarity to shareholders.
Silver Lake and its affiliates have already extracted much more from SGH than they invested to buy it. Since the IPO, 2017, they have sold over $270 million of stock. Meanwhile, executives have been doing the same: their $26 million of sales since the IPO compares to just one open market purchase.

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SGH: Two Stories – One Truth

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