BackHP’s loss: a folly unfolds, by the numbers
The acquisition of British software maker Autonomy looked troubled even before accounting problems
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For Hewlett-Packard Co. (HP), the alarm bells started ringing less than a year after the technology company bought a British software maker for $11.1 billion.
Unhappy with the business’s sagging performance, HP ousted the software company's mercurial Cambridge-educated founder and sent a team to England to review its books in May. It was then that a senior finance official at the British company stepped forward, raising questions about the accuracy of the numbers.
Months of investigation followed, prompting HP’s accusations on Tuesday that the British software maker, Autonomy, had engaged in “serious accounting improprieties". Before the deal, HP claimed, Autonomy inflated its sales. The problems went undetected by outside accountants—both Autonomy’s auditors and a firm that HP hired to vet the deal.
The accounting issues at Autonomy, which sells software that examines data for patterns, cost HP more than $5 billion.
Now, the Autonomy matter has been referred to regulators in two countries, and the US Federal Bureau of Investigatio (FBI) has opened a case, according to people briefed on the matter who were not authorized to speak publicly. HP is also considering its own legal action.
“This took time" to uncover, said Meg Whitman, HP's chief executive officer (CEO). The issues, she said, “were designed to be hidden".
In recent years, what was once a giant of Silicon Valley has been buffeted by management turnover, board controversy and waning profits. HP, which previously rivalled the likes of International Business Machines Corp. (IBM), Cisco Systems Inc. and SAP AG, has watched the value of its stock erode sharply.
Even before the accounting problems, the Autonomy acquisition looked troubled. Within weeks, the deal contributed to the downfall of the CEO at HP and led to squabbles among company's directors, including Whitman, who took over in September 2011.
In the latest quarter, the company reported a $6.9 billion loss, dragged down by the Autonomy mess and continuing problems in the business that resulted in an overall charge of $8.8 billion. On Tuesday, the stock continued falling, dropping 12% to less than $12, its lowest point since 2002.
“We intend to be very aggressive in recovering value for our shareholders," said John Schultz, HP's chief counsel. Individuals will be examined as well as accounting firms, he said, adding: “we’re not limiting it to Autonomy".
Autonomy’s founder, Mike Lynch, rejected HP’s claims, denying that his former company committed any accounting chicanery or misled anyone about its financial information. He indicated that the company’s practices were in line with international accounting standards.
In August 2011, HP’s CEO at the time, Leo Apotheker, shifted strategy unexpectedly. All in the same announcement, Apotheker disclosed plans to buy Autonomy, killed two major products, and publicly mused about selling the company’s personal computing business.
While many Wall Street analysts said HP was overpaying for Autonomy, Apotheker believed that HP, which sells printers and computer servers as well as PCs, needed to move more aggressively into software. In buying Autonomy, he was buying into one of the biggest trends in tech, the analysis of voluminous data.
Autonomy specializes in finding patterns among so-called unstructured data, such as emails, online video, or Web surfing. Lynch is a Cambridge-trained PhD in signal processing who previously founded a company that searched for fingerprint patterns. He made a reported $800 million from the sale of Autonomy. A brilliant man known for a brutish office manner, he bonded with Apotheker, a multilingual German software executive.
But with weeks of striking the deal, Apotheker was out, and Whitman was named to the top spot. During the deal negotiations, she had complained about the Autonomy price to other board members, according to several people briefed on the matter. Lynch’s other close ally at HP during the sale of Autonomy, a chief technology officer named Shane Robison, left HP toward the end of 2011.
Early in her tenure, Whitman resolved to increase Autonomy’s customer base with existing HP clients and to look for ways to put the software inside HP products. Whitman and other executives gushed about the opportunities, describing ways Autonomy’s number-crunching technology could take on IBM in data analysis, and Amazon.com in cloud computing services.
After securing the deal, Lynch tried to keep Autonomy far from HP’s bureaucracy. He mostly worked in London and initially kept Autonomy’s main office in a San Francisco high-rise decorated with pictures of famous theoretical mathematicians, and not at HP’s Palo Alto, California, headquarters.
“He told his people, Meg, anyone who’d listen, that HP should not get involved with Autonomy," said an executive who worked with both companies who asked not to be named to preserve professional relations. “Meg figured we should leave them alone, so they could stay entrepreneurial."
The lack of cooperation between the two companies quickly became evident. At a going-away party, an HP lawyer presented Lynch with a sweatshirt with the word “integration" and a line through it.
Autonomy, too, was facing challenges after years of fast growth but poor customer relations, according to Leslie Owens, an analyst with Forrester Research.
“They didn’t invest in R&D (research and development); they didn’t have regular software releases; they weren’t transparent with a road map of where they were going; they didn’t seek customer feedback," she said. “Customers complained, but the promise of managing all their information and making better decisions was so attractive. They bought more."
Soon after the HP acquisition, Owens said, Autonomy announced a new version of its core product.
“We asked for a demo," she said, and “we're still waiting".
Sales plummeted soon after Autonomy became part of HP. Whitman said she initially thought this was because of Lynch’s lack of experience running a big company. In hindsight, however, she ascribed it to Autonomy conforming to HP’s rules.
According to HP, Autonomy sold hardware such as servers, but the company booked these as software sales in some instances, thus underplaying expenses and inflating the margins.
“They used low-end hardware sales but put out that it was a pure software company," Schultz said.
Computer hardware typically has a much smaller profit margin than software.
“They put this into their growth calculation," he said.
An HP official, who spoke on the condition of anonymity because of ongoing inquiries by regulators, said the hardware was sold at a 10% loss. But the loss was disguised as a marketing expense.
The amount registered as a marketing expense appeared to increase over time, the official said. This was notable, because HP was reviewing a period in which Lynch appeared to be shopping Autonomy to HP and other companies.
“It was a wilful effort by some company executives to mislead investors and potential buyers," Whitman said.
HP also contended that Autonomy relied on value-added re-sellers, middlemen who sold software on behalf of the company. Those middlemen, which the HP official characterized as “small companies that relied on Autonomy products for the majority of their sales", reported sales to customers that didn’t actually exist.
HP also claimed that Autonomy was taking licensing revenue upfront, before receiving the money. That improper assignment of sales inflated the company’s gross profit margins.
HP said it discovered the problems only after Lynch’s departure. Soon after he was fired, several senior Autonomy executives also resigned from HP. Lynch said he has started another company and expected these executives to join him.
Now, HP is dealing with the fallout. Last week, HP passed along its findings to the US Securities and Exchange Commission and the Serious Fraud Office in Britain.
“I knew HP was going to be a challenge," Whitman said. “I've been around long enough to know you have to play the hand you’re dealt."
©2012/The New York Times
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