Part 3 in the series "From pioneer to fallen giant: How Hewlett Packard’s long list of failed acquisitions cost its reputation."
Read Part 1 "Billion dollar bungles" here;
and Part 2 "The Autonomy Deal – Part 1: Leo Apotheker's Downfall" here.
The Autonomy deal – part 2: Corporate conspiracy and cover-up
In the first article in this series, we looked at how in the first decade of the 21st century, Hewlett Packard lurched from one disastrous acquisition to another. We then zoomed in on one of the most controversial of HP’s acquisitions – the Autonomy deal – which quickly fell to pieces.
In this article, we’ll pick up the story in summer 2012. Meg Whitman, HP’s CEO, had signaled she had given up on any attempt to properly integrate the newly purchased Autonomy by firing its founder, Dr Mike Lynch.
This could have been the end of it. Like so many of HP’s previous failed acquisitions, the Autonomy story might be now remembered as an embarrassing footnote in HP’s long history.
Instead, more than a decade on, the HP-Autonomy saga is still playing out in the headlines and in courtrooms in the UK and US. The origins of this battle are the day in November 2012 when HP launched a calculated attack on Autonomy’s leadership, claiming with extraordinary bluster it had been defrauded when acquiring the company. The latest season in this long-running drama will start in a few days in a California court, where Dr Lynch is being tried as a criminal.
Backing up a few months to July 2012, it was plain that HP was in serious trouble. Since the start of 2011, its share price had fallen from $20.5 to barely over $6.
By this point, it was obvious that HP would have to conduct a write-down of its assets to bring its book value back in-line with its market value. This accounting exercise was the responsibility of CFO Cathie Lesjak. As explained in the previous article in the series, Lesjak was firmly against the Autonomy acquisition and fought tooth-and-nail to kill the deal. She asked her team to conduct an analysis of Autonomy’s value to see if an impairment should be recognized.
Her team concluded that the fair value of Autonomy approximated the carrying value. In other words, no impairment was necessary. Indeed, as documents uncovered in the various court cases that followed show, HP’s accountants still saw potential in Autonomy. They suggested its poor performance was due to “execution issues caused by challenges with operating Autonomy in the HP environment and loss of the legacy Autonomy management team.” In their opinion, Autonomy was still worth what HP paid for it.
This was an unhelpful view insofar as HP still needed to find ways to bring its book and market cap in-line with one another. Logic would dictate other HP assets and business lines would have to be written down.
But CEO Meg Whitman was desperate to avoid that outcome. Let’s consider her position. Whitman had recently lost a bruising gubernatorial race, where she came under personal attack for hiring an illegal immigrant as a housemaid, and managed to blow $140m of her own money.
It is reasonable to assume that if she took the job at HP, she would recoup some of those losses, both financial and reputational. Whitman would be forgiven if she was utterly dismayed when she walked into the dumpster fire that was HP. Presiding over the rapid decline of what was once a Silicon Valley giant would not do much for her resume.
HP’s eyes turned to Autonomy once gain – as detailed in the previous article, it was a deeply annoying leftover from the Apotheker regime. Cathie Lesjak, still CFO, didn’t want to HP to acquire it in the first place.
HP began to create a negative narrative about the Autonomy business. They were going to ruthlessly target it so it would become the scapegoat for the failings of HP’s declining empire.
To reach the end goal of publicly pointing the finger at Autonomy, HP embarked on a series of financial manipulations.
First, they fiddled with growth rates. Documents show that HP dramatically cut the projected revenue growth for Autonomy on the basis that its revenues had declined while under HP’s management.
Then, in October, HP’s accountants took out the expected synergies. That allowed them to reach a valuation of $1.6bn.
But of course, under that analysis, HP would effectively be admitting to the market that it had made a mess of the integration, and wouldn’t gain a cent of revenue growth it said it would when it acquired Autonomy. Such a narrative would make it appear that Meg Whitman and her allies had failed to make anything of the Autonomy deal. Whitman realised this. Internal HP communications show how she had the figures changed to put $2.3bn worth of synergies put back in.
The third move was to play with discount rates. A higher rate was applied to Autonomy to make its value smaller. While HP had applied a discount rate of 9.5% to Autonomy in August 2012, by October, it artificially increased that rate to 15% to come up with the impairment it wanted. As with the synergies, Whitman intervened at the 11th hour, the night before the board was due to meet to discuss the impairment, asking that this was increased again to 16%.
HP’s finance team were, understandably, getting worried about these entirely arbitrary calculations that they were being asked to make. One HP accountant described the results as “nonsensical”.
By October 2012, HP had formulated a valuation for Autonomy of $2.2 billion – a write down of $8.8 billion – through a combination of lower growth rates, lower margins, lower projected synergies, and the “nonsensical” discount rate. This wasn’t the result of methodical review based on detailed accounting or a report from external advisors.
But all this begs a huge question: where does fraud come into this?
After all, Dr Mike Lynch is about to be tried for wire and securities fraud as a result of HP’s claim. However, as seen in court documents, in October 2012 after weeks of work by HP’s finance team, there was nothing to suggest a suspected fraud orchestrated by Autonomy’s people was the reason behind their write-down of the company.
That’s what made HP’s next move all the more incomprehensible.
On November 20, 2012, it told the market it had been the victim of “serious accounting improprieties, misrepresentations and disclosure failures” during the course of the Autonomy acquisition. HP said this was the reason for $5.2bn of the $8.8bn write-down announced that day. In a press release, HP said that it had run an “intense internal investigation” into these “improprieties”, which included a “forensic review by PwC” of Autonomy’s financial records.
This was a flat-out lie. No investigation took place, let alone a “forensic” review. The conclusion HP came to – that Autonomy and its leadership was somehow crooked – was pre-determined to fit HP’s narrative. The $5.2 billion figure was cooked up in the weeks preceding, it was not the result of extensive evidence gathering.
HP peddled this myth all in a bid to save face and direct the market away from its own steep decline. On the same day, HP released its latest set of disappointing results: reporting revenue was down 7% and net losses reached $6.9 billion. It was a “tough quarter across the board” as CNN put it.
After the initial shock of HP’s bombshell write-down announcement, investors and the media began poking around more deliberately.
HP’s Head of Investor Relations was clearly uncomfortable, stating in internal communications that he thought it “disingenuous” that HP were not being up front about the fact that the expected synergies had not been achieved post-acquisition.
And it wasn’t just HP staffers who were unhappy. As a New York Times piece points out, HP’s external accounts, Ernst & Young, did not believe there were accounting irregularities involved.
An email exchange involving Lesjak and HP’s Chief Communications Officer highlighted that the media couldn’t understand how HP had reached the $5.2 billion figure. The CCO asked if the finance team could prepare an infographic to help show HP’s working.
But of course, there was no detailed working. So when Lesjak asked for more details, she received an email on 30 November from a member of her team stating, “we've never formally prepared anything to attribute the irregularities to the amount of the write down”.
In another email trail between Lesjak and the HP communications team she argued it would be better not to “go down this path” with the media, since she herself could not explain how the $5.2 billion figure had been arrived at.
The fact that a major corporation’s CFO could not explain the basis of a market-critical announcement speaks volumes. Lesjak’s haziness on the matter was exposed when she was cross-examined in a British court years later.
HP could not justify its claims then, nor can it justify them now. The company’s track record on acquisitions was so poor, and its overall performance so abysmal, that its leadership made a calculated decision to concoct a claim of fraud rather than admit the Autonomy integration was yet another HP management disaster. And when difficult questions arose about the write-down, HP’s leadership closed ranks and doubled down on their claim, despite the doubts of colleagues and external consultants.
To this day, HP continues to demand its pound of flesh, somehow convincing itself it has been a victim. It has spent millions of dollars on lawyers and PR in the process. This is shareholder’s money, all to protect the reputation of Meg Whitman and her CFO.
All too predictably, the Silicon Valley company and its army of lawyers has got its way. The US Government orchestrated the extradition of Autonomy’s founder, Dr Mike Lynch, and he will face trial in California this month.
It is a stark and shocking reminder of two things: one, the once great Hewlett Packard lost its way long ago, and has burnt through cash trying to acquire its way out of trouble, and two, the lengths corporate America will go to avoid facing up to difficult truths.
