Business | Investment

New HP scandal stuns market

Alleges massive accounting scam that forces firm to take $8.8b writedown for its UK unit

  • Reuters
  • Published: 12:59 November 21, 2012
  • Gulf News

  • Image Credit: REUTERS
  • A logo of HP is seen outside Hewlett-Packard Belgian headquarters in Diegem, near Brussels, in this January 12, 2010, file photo.

San Francisco/New York: Hewlett-Packard Co stunned Wall Street by alleging a massive accounting scandal at its British software unit Autonomy and taking an $8.8 billion (Dh32.3 billion) writedown, the latest in a string of reversals that renewed questions about the competence of the storied company’s board and senior managers.

HP said on Tuesday it discovered “serious accounting improprieties” and “a willful effort by Autonomy to mislead shareholders,” after a whistleblower came forward following the May ouster of former Autonomy Chief Executive Mike Lynch.

The news sent the company’s shares plunging 12 per cent to a 10-year low of $11.71. HP, which for decades was synonymous with technical excellence and innovation as one of the bedrock companies of Silicon Valley, now has a market value of roughly $20 billion, down from $155 billion in April of 2000.

CEO Meg Whitman took the helm at HP a little over a year ago when her predecessor, Leo Apotheker, was fired after less than a year on the job. Apotheker’s one big strategic move during his brief tenure was the $11 billion acquisition of Autonomy, intended to hasten HP’s transformation into a software and services company but which was criticised by many analysts as over-priced.

“Most of the board was here and voted for this deal, and we feel terribly about that,” Whitman said on a call with analysts.

Tuesday’s announcement came just three months after the company took a write-down of almost $11 billion on its EDS services division.

Acquisitions

HP has for years relied on deal-making, acquiring businesses ranging from EDS to Compaq to Palm, but has largely failed to articulate a clear strategy or establish a strong position in growth businesses like computer services or mobile computing.

“To put it bluntly ... this story has been an unmitigated train wreck, and it seems every time management speaks to the Street, there is new negative incremental information forthcoming,” said ISI Group analyst Brian Marshall.

HP said it has referred the alleged accounting wrongdoing at Autonomy to the US Securities and Exchange Commission’s enforcement division and the UK’s Serious Fraud Office for civil and criminal investigation. HP also said it would take legal action to recoup “what we can for our shareholders”.

Both agencies declined to comment.

Lynch, in an interview with Reuters, “flatly rejected” HP’s allegations and said he was “shocked” but confident he would be absolved of any misdeeds. The Irish-born executive said he had not been notified by HP about the allegation before it was made public, nor had he been contacted by any authorities.

Whitman said the investigation of Autonomy’s finances — both external and internal — will take multiple years as it winds it way through the courts in both countries.

She defended the board’s handling of the acquisition and blamed HP’s auditors for failing to detect the problems.

Auditing

“The board relied on audited financials, audited by Deloitte. Not Brand X accounting firm, but Deloitte,” she said, adding that KPMG was hired to audit Deloitte.

“Neither of them saw what we now see after someone came forward to point us in the right direction,” Whitman said.

On Tuesday, a person familiar with the situation told Reuters that the Federal Bureau of Investigation was probing the HP-Autonomy allegations in concert with the Securities and Exchange Commission, although the inquiry was at an early stage.

HP and Autonomy were not available to comment on the FBI probe, and the FBI declined to comment.

The alleged accounting issues also put a spotlight on the investment banks and law firms involved in the acquisition.

Autonomy was represented by Frank Quattrone, an investment banker who was the target of widespread criticism — and criminal prosecution — for his activities during the first dot-com boom. After one trial ended in a hung jury and a second ended in a guilty verdict that was overturned on appeal, the charges were ultimately dropped.

HP’s lead adviser was Perella Weinberg, a boutique investment bank with little experience in big tech deals. Its attorneys included the blue-chip firms Gibson, Dunn & Crutcher; Freshfields Bruckhaus Deringer; Drinker Biddle & Reath; and Skadden, Arps, Slate, Meagher & Flom, which advised the board.

Inflated sales, revenue

Whitman on Tuesday stood by Autonomy’s technology and products, saying the unit would still be the growth engine for HP. The sprawling company, which employs more than 300,000 people globally, aims to focus more on enterprise services in the mold of International Business Machines Corp.

But the former eBay CEO and California gubernatorial candidate has yet to overcome years of management turmoil and strategic missteps, including a plan to sell the personal computer unit that was later dropped.

HP disclosed the Autonomy allegations in conjunction with its fourth-quarter earnings, which showed a 6.7 per cent decline in revenues as well as a $6.85 billion loss.

It took $8.8 billion in charges in the quarter, with over $5 billion tied to the problems at Autonomy. The rest of the charge related to the “recent trading value of HP stock and headwinds against anticipated synergies and marketplace performance,” HP said without elaborating.

HP had embarked on its own internal investigation, including a forensic review of Autonomy’s historical results by PricewaterhouseCoopers and HP General Counsel John Schultz.

It accuses Autonomy’s former management of inflating revenue and gross margins to mislead potential buyers. It said Autonomy executives mischaracterised revenue from low-end hardware sales as software sales and booked some licensing deals with partners as revenue, even though no customer bought products.

It said Autonomy claimed its gross margins were in the 40 to 45 per cent range while realistically they were in the 28 to 30 per cent range.

Money-losing sales

Moreover, Autonomy always represented itself as a software firm but 10 per cent to 15 per cent of its revenue came from money-losing sales of low-end hardware, HP said.

The company also claimed that Autonomy was booking licensing revenue upfront before deals closed.

Schultz said since the accounting troubles occurred prior to the acquisition of Autonomy, it took a long time before HP was in a position to make the news public.

“Not surprisingly, Autonomy did not have sitting on a shelf somewhere a set of well-maintained books that would walk you through what was actually happening from a financial perspective inside the company,” he said. “Indeed critical documents were missing from the obvious places, and it required that we look in every nook and cranny.”

Yet there had been rumblings in the industry for years that Autonomy’s results might not be quite what they seemed.

As early as 2009, hedge fund manager Jim Chanos had identified Autonomy as a shorting opportunity, according to a source familiar with his views.

Chief among his concerns, according to the source, was that Autonomy was claiming a 40 per cent market share against the likes of Microsoft Corp, International Business Machines Corp and EMC Corp in the MORE

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