Even after Hewlett-Packard Co. (NYSE: HPQ) took a hefty $8 billion impairment charge to clear some of the burdensome goodwill on its balance sheet, the computer, consulting, services, and enterprise hardware company remains mired in debt and continues to hold limited attraction for investors. Furthermore, anyone surprised by the size of HP's "goodwill" write-down should expect even bigger "one-time" charges in future.
Of course, HP may parcel out future charges in smaller chunks, but the same logic that forced the $8 billion charge announced earlier this month will force the company to take similar steps in future. The company must lighten its balance sheet and get rid of unsightly goodwill numbers that are like horrid scars on its corporate face. Before the latest impairment charge, HP's net goodwill as at the end of the fiscal quarter ended April 30 was a titanic $44.9 billion, helping to boost the company's total assets to $127.8 billion.
A large chunk of the "assets" is empty gas, though. The accumulated goodwill, for instance, is treated as an asset, even though the value of the underlying "assets" has fallen precipitously since HP began piling them up with a spate of acquisitions over the last ten years. The latest charge, for instance, is assigned only to the company's services business and is related primarily to the $13.9 billion purchase of Electronic Data Systems in 2008.
Other large acquisition-related goodwill exists on HP's balance sheet, but none is more controversial than the $10 billion purchase of Autonomy Corp. in 2011. HP paid a whopping 64 percent premium on Autonomy's closing stock price one day prior to the announcement of the transaction last August. Many in the investment community panned the acquisition on the conviction that HP overpaid for the British enterprise information management software company. I didn't like it either because it represents some of what is wrong with the company today. (See: Five Sources of Risk in 2011.)
HP insists the goodwill write-downs that follow transactions like the purchase of Autonomy and EDS do not "result in future cash expenditures or otherwise affect the ongoing business or financial performance of its services segment," said the company in a statement announcing a batch of organizational changes for enterprise services business. That's correct, but it's also baloney. It's the type of switcheroo companies lob at investors and shareholders after a transaction they thought was solid had gone bad.
Here's how I see it, in HP's case. The company paid about $10.2 billion for Autonomy, representing "24 times Autonomy's trailing earnings before interest, taxes, depreciation and amortization," according to a Bloomberg News calculation. Before the Autonomy deal, HP had also made other good-deals-gone-bad, including its $1.2 billion purchase of Palm Inc. The transaction helped HP secure Palm's WebOS, but soon it discontinued the devices and took a "one-time charge" of about $1 billion in goodwill write-down.
Previous acquisitions that helped to balloon HP's "goodwill" include the 2010 purchase of ArcSight Inc. and 3Par Inc., for $1.5 billion and $2.35 billion, respectively. The excess premiums paid for these companies are sitting like two tired elephants on HP's balance sheet, distorting its financial profile. And, while HP and companies in similar situations may claim goodwill charges are not cash transactions and don't hurt the enterprise on a long-term basis, they do represent actual monetary (or stock) outlays initially. A write-down, no matter how it is described, is an admission that resources were misused and demonstrates initial poor judgment on the part of the executives and board.
All this has long-term implications for the enterprise. These events foster the creation of an environment of seeming ineptitude and lack of trust in company senior executives. For example, would I trust HP if it were to announce today another big purchase? Would I believe the management had done its due diligence? Do I think they seriously consider long-term fiduciary responsibility and are not pandering to their own whims? And would I be certain the board of directors isn't just hurling another dart at a board and hoping to hit the jackpot? Investors clearly think HP isn't a hot investment, and the reasons for this certainly include its acquisition history.
HP's market value of $38 billion, as at the time of writing this article, is about half its 52-week high, which is 64 percent below the two-year peak and vastly less than the $227 billion market capitalization of IBM Corp. (NYSE: IBM), not to mention the even more stunning $592 billion for Apple Inc. (Nasdaq: AAPL). Look at their annual fiscal revenues, though, and the three companies seem more or less in the same range. Apple had $108.3 billion in fiscal 2001, IBM $107 billion for calendar 2011, and HP $127.3 billion for its fiscal 2011. Something is off-base here if the capitalizations are so much different.
Of course, the companies' sales growth rates are also quite different, although HP's and IBM's are tracking similarly. But that's not the issue here. HP's financial position is weak (long-term debts as at the end of the April quarter were $26 billion versus $8.3 billion in cash and short-term investments), and it will get weaker if the company, under new CEO Meg Whitman, pursues wrongheaded acquisitions similar to the ones her three predecessors did.
The wounds former CEOs Carly Fiorina, Mark Hurd, and Léo Apotheker inflicted on HP are deep and can't be written off.