So HP has put its hands up and said that it is taking a $5 billion hit on its $10 billion Autonomy acquisition. Note: most are assuming it is an $8 billion hit. They're wrong. Check the press release:
HP today announced a non-cash impairment charge of $8.8 billion related to Autonomy in the fourth quarter of its 2012 fiscal year. The majority of this impairment charge, more than $5 billion, is linked to serious accounting improprieties, misrepresentation and disclosure failures discovered by an internal investigation by HP and forensic review into Autonomy’s accounting practices prior to its acquisition by HP.
As I looked over the reporting on this topic I was puzzled. Sure, HP paid a massive premium for a company that for years had question marks over its accounting practices. But if this is another CA in the making then were the auditors, audit committee and analysts generally asleep at the wheel? Or is this a case of a business model HP could not understand? That's hard to tell at this stage of proceedings.
So far, HP has only said that some 10-15% of the write off relates to Autonomy's hardware business - one that it was exiting at the time of the acquisition. That's around $0.5-0.75 billion of the total provision and I am guessing most of that will likely represent goodwill and possibly trade debtor write downs. Inventories only represented about $170,000 at the tme of acquisition. That leaves a whopping $0.32-0.58 billion in the 'shady deals' bucket.
Without further detail, it is difficult to know exactly where HP is pointing the finger unless it is implying multi-year restatements are in order. The problem with that analysis is that a quick drive by at the 2010 Autonomy accounts doesn't show anything especially noteworthy in the cashflow or balance sheet to indicate where irregularities might have occurred. Cash balances are readily provable - unless of course we are seeing another Satyam. My personal take is that is highly unlikely but then I have been spectacularly wrong on this point in the past.
If HP's current analysis is correct then it suggests:
- Due diligence at the time of acquisition was less than pristine. The Register hints at this. Given what I have seen in recent months, this does not surprise. High level executives get bees in their bonnets about changes of direction or acquiring market share and all fiscal sense goes out the window. Analysts grumble but almost never do enough homework to discover the facts other than to pontificate around valuations.
- Mike Lynch, founder and CEO Autonomy plus former CFO Sushovan Hussain are up to their armpits in questionable financial engineering over a long period of time, operating at a level of skill that auditors failed to detect. Past grumblings by analysts may support that theory. If true then the auditors were blind to miss the danger signals coming out of reports stretching back over many years.
My questions are somewhat mundane. Bloomberg observes that:
“It seems very late in the day that HP would find accounting irregularities,” said George O’Connor, an analyst at Panmure Gordon & Co. “It looks as though they’re trying to find a way to write off the deal.”
I agree. HP has had ample time to find problems. Unless of course it went comatose after acquiring the company. I cannot believe that given the furore over the purchase at the time and the eventual sacking of then CEO Leo Apotheker.
- What happened other than due diligence falling to the then CEO and chief strategy officer? Was everyone else who was party to the deal silent about deal risks or was HP so desperate to find something upon which to hang a software hat that proberty was tossed over the side? If so then caveat emptor.
- The CFO left in November 2011 so how come it wasn't until after May 2012 that problems emerged? That's two full quarters during which any serious problems would have emerged. HP can take a pass on the December 2011 quarter but it doesn't have that same luxury for Q1 2012.
- Is HP trying to convince us that a whistleblower was what it took to force sunshine onto a botched investment? I understand the importance of whistleblower evidence but this seems highly contrived.
- Why did it take from May until now for HP to 'fess up on this issue? They can argue it has taken time to do the work but if there were strong suspicions then its board has a duty to inform the market at the earliest opportunity.
- There is a suggestion in the current explanation that Autonomy was engaged in channel stuffing in the pre-acquisition period. This would be obvious relatively quickly and would have to be on a significant scale to make a demonstrable difference to financial statements. Movements on the balance sheet were certainly large but then I would expect auditors to undertake significantly more test work to ensure those numbers made sense. If not - then they're in the coconut shy for a hefty law suit.
- How does current management continue to have faith in Autonomy when it wants to write off 50% of the investment? That doesn't make sense. What parts of the business does it consider worth retaining and/or developing?
This is likely the tip of the iceberg. HP is setting itself to get at least some compensation from Autonomy shareholders. The chances are slim though they can always go after Deloitte as auditors - a likely sencond string course. The fact they have asked the UK's Serious Fraud Office to investigate implies evidence of serious criminal action. It will be interesting to see if the UK's fraud enforcers are up to the task - they don't have a great track record in this area.