HP & Autonomy: Another Bubble, Another Bust

The announcement last week by Hewlett-Packard Co. (NYSE: HPQ) that it bought software company Autonomy for much more than it was worth, and the allegation that Autonomy cooked the books to inflate its value, shows once again that America's corporate governance is fraught with irregularities and accounting improprieties that go unnoticed and unchecked until it's too late.

The latest foible leads us to ask: If company shareholders can't trust the accountants, whom can they trust? If investors cannot have faith in those who sit on the board of a publicly held company to be the guardians of their interests and to do due diligence on acquisitions, then why should they have confidence in a company's claim that its financial health is sound?

The Autonomy debacle has contributed to a staggering $8.8 billion writedown at HP, which translates to approximately 80 percent of the $11 billion dollars the company paid for Autonomy. In addition to the significant financial loss in the fourth quarter, the effects of this jolt to HP go beyond the company's internal financial position and reflect a tardiness on the part of corporate America that has yet to implement checks and balances that prevent accounting fraud. Unfortunately, identifying the true value of a company is often a belated exercise -- something that happens when the true nature of the financial abuse catches up with current reality.

Our country's recent financial history bears out this point. In the late 1990s and early years of the 21st century, we witnessed the tech bubble in which corporate valuations were inflated and investors made hefty investments in many high-tech companies based on revenue projections that in hindsight were never cross checked and could never be substantiated. When demand fell, inventory rose, layoffs occurred, and accounting scandals hit companies like Lucent Technologies and WorldCom, dragging the economy into a recession. Even today, inflating stock prices based on hype more than a company's ability to generate revenues still has a place in America's corporate modus operandi, as we have seen this year with the Facebook IPO.

HP's acquisition of Autonomy follows this trend, and the question of who should take responsibility is a reasonable one. It would have been a nice gesture of humility and an act of leadership if HP CEO Meg Whitman took at least some responsibility for this latest fiasco. After all, Whitman, and most of HP's current board members, gave their blessing to this deal. Instead Whitman put the blame on her predecessor and the accountants that audited Autonomy. Whitman said during a conference call:

The CEO at the time and the head of strategy who led this deal are both gone, Léo Apotheker and Shane Robison. With regard to the board, you're right. Most of the board was here and voted for this deal, and we feel terrible about that. What I will say is the board relied on audited financials, audited by Deloitte, not brand x accounting firm but Deloitte. And by the way, during our very extensive due diligence process, we hired KPMG to audit Deloitte, and neither of them saw what we now see after someone came forward to point us in the right direction.

Reflecting on the acquisition process, Léo Apotheker issued a statement characterizing the due diligence process as "meticulous and thorough", and noted that HP hired two of the largest, most respected auditing firms. He said further:

According to HP, the accounting issues it discovered pre-date its acquisition of Autonomy. As such, it's apparent that Autonomy's alleged accounting misrepresentations misled a number of people over time – not just HP's leadership team, auditors and directors. In fact, the alleged improprieties apparently came to light only after an internal whistleblower raised the issue in the spring, well after my departure.

A spokesman for Deloitte LLP in the UK is quoted as telling The Wall Street Journal that "Deloitte UK categorically denies that it had any knowledge of any accounting improprieties or any misrepresentations in Autonomy's financial statements, or that it was complicit in any accounting improprieties or misrepresentations."

In the same article, Michael Lynch, founder of Autonomy, said:

We completely reject the allegations… I can't understand how you can write down $9 billion of value and say somehow this was all caused by something you didn't notice when you did due diligence with 300 people.

I could not agree more. Failing to find out the true value of Autonomy prior to the acquisition may help us understand other mind-boggling decisions such as the rather rash move, approved by the board, to spin off HP's PC business and then reverse course a few months later only to announce it would keep that business.

And what of the future? Can we now trust Catherine Lesjak, HP's chief financial officer, when she said on the conference call that HP is still looking at eliminating 29,000 people and that this will help turn the company's fortunes around? Based on what? On the figures from the same financial auditors who gave us the Autonomy valuation?

The Autonomy debacle confirms that HP's leadership team is weak, incompetent, and lacks judgment, especially when we recall that many in the tech world, such as Oracle Corp.'s CEO Larry Ellison, said at the time that HP had paid too much for Autonomy. As other OEMs forge a path forward, HP's inability to reverse its downward slide could become irreversible.

Let us hope HP can pull itself together and find a leadership team with enough insight and backbone to steer the company back to prosperity. Its customers and shareholders deserve that.