How the Autonomy scandal could derail HP's turnaround
According to the dictates of crisis management, a company that discovers a harmful impropriety should make a clean breast of it right away. Then, after the inevitable storm, it can move on. And that must have been the narrative HP was crafting when it announced a $5 billion writedown yesterday related to what it called serious accounting improprieties.
Whitman sought to throw the old Autonomy under the bus, along with Mike Lynch, Autonomy's founder, and Léo Apotheker, her predecessor at HP who arranged the $11.4 billion acquisition. But she had a different plan for Autonomy's data-management technology. “Autonomy technology will play a significant role in our growth strategy over the long term,” Whitman assured investors in a conference call. HP, she said, would “move this business from startup to grown-up.”
Instead of closing the door on an unfortunate and overpriced acquisition, Meg Whitman has opened up a cluttered and messy closet that will take some time to clean up. After only one day, it's starting to look like HP's handling of the Autonomy issue will plague it for years with lawsuits, investigations, ugly shouting matches, and, in a worst-case-scenario, the unwanted attentions of an activist shareholder. If HP was a slow motion train wreck before, the company's post-Autonomy fate could be even worse.
In the past, I've been somewhat hopeful that Whitman could turn things around at HP, despite inheriting a decade of botched strategies. But the problem HP's Autonomy writedown isn't that it was done, it was how it was handled. Few have emerged to praise HP this week. Some analysts said it reflected poorly on the board and management. One who had defended the stock even issued an apology to investors.
Meanwhile, there are plenty of people questioning or criticizing the writedown. Starting with Lynch, who has been waging his own PR campaign and slamming HP for “significant mismanagement” and fostering a culture of “internecine warfare.” Deloitte, the accounting firm for Autonomy before the HP deal, “categorically denied” HP's allegations. HP said it hired another firm, PwC, which did find misstatements. Only one firm can be right. So HP has also pitted two accounting giants against each other.
Independent observers are also raising disconcerting questions about HP's writedown. Starting with this one: Just how much of the $5 billion writedown is due to the actual restating of Autonomy's accounting versus, say, HP's decision to overpay for the company. I raised that question yesterday, as did others. Lynn Turner, a former chief accountant for the SEC, wondered how improperly recording $200 million in revenue can lead to a writedown 25 times as large.
Whitman steered around this question by telling investors that the writedown was related not just to misstated financials, but also to “the associated impact on the expected financial performance of the business over the long term.” The wording is not only vague, but allows for speculation about future earnings. It's so broad it can mean whatever HP wants it to.
Nor did Whitman explain the other $3.8 billion HP was writing down -- nearly half of the total -- beyond saying it was “linked to the recent trading value of HP stock.” HP got a pass on that one, because an accounting scandal is so much more deliciously lurid than another reminder that HP's stock is falling.
Another question HP hasn't resolved: The company alleged Autonomy was recording software sold to value-added resellers, and not to the end user. But how is that different from the practice of PC manufacturers recording shipments rather than actual sales to end-users? Analysts following the PC industry know this can allow unscrupulous companies to stuff their channels at the end of the quarter, only to bring them back early in the next quarter.
Until HP can clear up these questions, the Autonomy mess is not going to go away. Instead, regulators from the SEC and the UK's Serious Fraud Office will be investigating. The FBI is even getting involved (so anyone at HP conducting an illicit affair might want to delete their secret Gmail accounts now). There are sure to be lawsuits on all sides that will wend their way through the courts for years.
Given all this, it's hard to imagine how HP will come out ahead from this crisis. Instead, the winners are likely to be attorneys, consultants, and accounting firms hired to wage the legal battles. Down the line, investment banks could even get a piece of the action. HP's stock has become so cheap -- it's trading at one fifth its recent revenue and about half its enterprise value -- some believe it could attract an activist shareholder who would agitate for HP to do break up the company, something investors have called for in the past.
That would bring investment banks and attorneys even more advisory fees. And many of them are likely to be the same firms that helped HP and Autonomy in what was clearly an ill-advised transaction. HP spent $182 million on charges related to the Autonomy deal last year. There is a lot of talk about tech ecosystems these days, but for a crisis-prone giant like HP, the real ecosystem are these attorneys and advisors.
What HP set in motion with the Autonomy writedown wasn't a key part of its turnaround. It was another train wreck that will play out for years. This is a case study in crisis management than actually enhances the crisis.