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HP & Autonomy: Another Bubble, Another Bust

The announcement last week by {complink 2376|Hewlett-Packard Co.} 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.

17 comments on “HP & Autonomy: Another Bubble, Another Bust

  1. _hm
    November 26, 2012

    Is tihs forerunner to software bubble? When you try to analyze many of charges and prices of software organizations, this looks impending trend. Another was facebook.

     

  2. The Source
    November 27, 2012

    _hm

    There have been a number of bubbles and busts in recent times whether it's the tech bubble or the housing bubble and since then we've seen analysts call out companies like Groupon and Facebook for their overvalued stock prices at the time of their IPOs. Now we have the case of Autonomy.   This problem won't go away anytime soon.

    The question in the Autonomy case is how did Autonomy's officials misrepresent its financial results and not get caught by reputable accounting firms that were analyzing the numbers? Why was HP convinced that Autonomy was worth billions of dollars when others in the industry had their doubts?   Why did HP not notice this discrepancy? This mistake in not in the millions of dollars, this is an $8.8 billion mistake. This incident tells us a lot about HP's management team and its board.   They don't have a grip on what it's going to take to get HP out of its problems anytime soon.  

    Thanks for your comments.

    Nicole   

  3. The Source
    November 27, 2012

     

    Dear Rich,

    I'm sure that you will be interested in the findings of the US Securities and Exchange Commission's Enforcement Division and the UK's Serious Fraud Office for civil and criminal investigation – two agencies that are now investigating the Autonomy case.  

    With regard to your point that there is a reliance on “third-world companies like KPMG and Deloitte” to audit companies' financial statements, let me point out that Autonomy was a UK software company, KPMG is headquartered in Europe and Deloitte's headquarters are in the US.   These are not companies that can be classified as “third-world companies” as you have described them.

    Thanks for reading my article, and I appreciate your comments.

    Nicole

     

  4. Taimoor Zubar
    November 27, 2012

    I think HP hasn't been known for acquiring companies and this may be one of the few companies they have ventured into acquiring. It's interesting to see HP take this path for growth. Although this decision might not have proved to be a smart one as of yet, this path may have a lot of potential for HP in future.

  5. Taimoor Zubar
    November 27, 2012

    @Nicole: I won't blame HP entirely on this one. The evaluation for Autonomy had come from a reliable source and could be trusted on. It would have been better if they had also set up an internal team to perform the analysis before acquisition.

  6. prabhakar_deosthali
    November 27, 2012

    Whether it is bank fruad, overvaluation of a company on sale or any such financial scandal, it looks like the accounting people are joining hands under the table and duping the investors.

    Those sitting on the company boards need to be more vigilant to avoid playing in the hands of these accounting manipulators

  7. Wale Bakare
    November 27, 2012

    What's essence of having tools that cannot  perform your required tasks for you? And whose onus the problem would be eventually, the contractor or algorithm meant for the valuation?

  8. The Source
    November 27, 2012

    TaimoorZ,

    You've noted that the acquisition of Autonomy may prove to be a smart move, and I will say that HP needed a strong data analytics strategy to move forward.   Companies are grappling with managing petabytes of data.   Autonomy's software does a good job of analyzing unstructured data and finding insights from that data that can help companies make better business decisions. Autonomy's IDOL technology will help HP better serve its current customers as well as provide data analytics services to new clients.

    We will see in the long run whether this move pays off, but the acquisition does put HP in a better position to help companies tackle complex information management problems as corporate data grows exponentially. Still, just the thought of Autonomy misrepresenting financial results at the time of purchase and the subsequent $8.8 billion write down at HP opens up the possibility that customers may now question the value of Autonomy's tools.   This comes at a time when IBM, Oracle and other companies are charging ahead with their big data strategy.

    Thanks for your comments.

    Nicole

  9. The Source
    November 27, 2012

    Prabhakar_deosthali,

    Former Autonomy CEO, Mike Lynch, has fired off a letter to HP's Board of Directors. Here's a link to the letter.

    http://www.scribd.com/doc/114627598/Mike-Lynch-Open-Letter-to-HP

    I know this will interest you.

    Nicole 

  10. _hm
    November 27, 2012

    @Nicole: I agree. To me, many of board members may not have much in common with technology or they may not have much vision. They are of follower type, and not leader type. It is unfortunate, but they should also be very open and listen to all employee about their view. This might have helped them.

  11. Anna Young
    November 27, 2012

    Nicole, We'll need forensic accountants and all kinds of experts to help us determine who's telling the truth between HP's executives, the former executives at Autonomy and the accounting company that inspected the books. At the end, I bet we still won't be any closer to the truth and none of this will recover the “goodwill” charge HP took and help the company repair its damaged reputation.

  12. prabhakar_deosthali
    November 28, 2012

    Nicole,

    Thanks for the link.

    From the letter written by Autonomy CEO, it looks like HP has bungled things somewhere else and booking the losses against Autonomy ,to cover up things.

    It will be interesting to know HP's reply to this letter

  13. mfbertozzi
    November 28, 2012

    @Nicole: thanks for the very interesting link; it is a very transparent message from Mike and the only question is about the timing; often, it happens resigned (or fired) CEOs published their perspective of the story, its relationship with public opinion, the market and some flash on company's future. I am wondering the reason for waiting this wise vision and message once they have left the company, but maybe there are confidential reason for avoiding more info.

  14. The Source
    November 29, 2012

    Dear Anna,

    I see that you have your doubts about the results of the investigation, and I suspect that others feel the same way.   As you may know, the US Securities and Exchange Commission's Enforcement Division and the UK's Serious Fraud Office for civil and criminal investigation are now investigating this case. It would be a very troubling situation indeed if HP and everyone else concerned doesn't get the answers they deserve. We all need to know who is responsible for misrepresenting Autonomy's financial results? Also, if the allegations by HP are true, how was the financial impairment calculated by HP? It would be a truly sad situation if after the investigation we are no closer to the truth. I don't believe this will be the case. 

    Thanks for your comments.

    Nicole 

  15. The Source
    November 29, 2012

    Prabhakar_deosthali,

    This will interest you.  The lawsuits begin.

    http://www.reuters.com/article/2012/11/29/hp-autonomy-auditors-idUSL1E8MS8ZX20121129


  16. The Source
    November 29, 2012

    mfbertozzi,

    It's quite obvious that HP's problems are much deeper than the problems surrounding the Autonomy acquisition.  Moody's has cut HP's credit rating, and says the company faces “competitive pressures, and execution challenges.”  You can read more here:

    http://articles.marketwatch.com/2012-11-28/markets/35404863_1_negative-outlook-long-term-credit-ratings-credit-profile  

     

     

  17. Mr. Roques
    November 29, 2012

    HP was desparate and probably felt they needed to do something. Bad move.

    When speaking about bad numbers, what about Facebook? … :-/

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