Anatomy of an USD 8 billion mistake:
HP & Autonomy merger

Zachary E. Fender
BMGT 335-800
July 14, 2013

Introduction. Hewlett Packard (“HP”) under the executive management of former Chairman Ray Lane and former CEO Leo Apotheker, wanted to acquire a leading software company providing technology solutions in the unstructured data search & retrieval specialty. British software company, Autonomy, was identified as a good candidate and in August 2011 HP published their intent to acquire it. Apotheker was not a popular HP CEO and was criticized about his famous failure with the Palm acquisition which cost USD 1.5 billion. He persuaded HP Board of Directors to proceed with a merger and the result was a disaster: USD 8 billion write down.
History of deal. HP had a string of high level executive changes that led to a hasty decision to spend a colossal amount of USD 11 billion to buy a software company that used accounting standards different from the USA. Carly Fiorina then Mike Hurd then Leo Apotheker and now Meg Whitman constituted the ever-changing CEO position. HP CEO Apotheker overruled the opinion of the HP CFO and persuaded the HP Board of Directors to proceed with the acquisition. New and current HP CEO, Meg Whitman, was on the HP Board of Directors that approved the deal and has survived the fallout. A deal was made with the Autonomy founder and CEO, Mike Lynch. Soon afterwards, problems emerged and the entire Autonomy management team departed including Mike Lynch, albeit USD 500 million wealthier.
Synergies and benefits originally planned. Both companies announced that a merger would bring together data search technologies. HP technology could search structured data; whereas, Autonomy technology could search unstructured data. Autonomy sales deals were usually very large, i.e. over USD 100,000, and to large companies or governments. Larger deals have a longer sales cycle so Autonomy was likely facing slower growth opportunities having accomplished many large deals over the years.
Risks identified. HP’s Chief Financial Officer, Cathie Lesjak, and other managers and outside financial experts considered the valuation and offer of USD 11 billion to be extremely expensive and grossly overvaluing Autonomy. Deals that are hurriedly executed usually have problems surface later. Due diligence by independent and internal professionals takes time. HP is a hardware centric company which has a different culture and operating mentality than a software company. Goliath size companies acquiring small companies and expecting the management team of the acquired company to simply adopt operating procedures and new reporting responsibilities is an unreasonable expectation.
Lessons learned. Accounting principles used in the UK are different than those used in the USA. IFRS is used in the UK and allows companies to recognize revenue liberally; whereas, US GAAP is used in the USA and strict revenue recognition guidelines are used. When HP did a valuation of Autonomy it used techniques to determine the present value of Autonomy but the revenue reported by Autonomy would not be recognized under usual circumstances in the USA following US GAAP. A CEO should listen carefully to the CFO especially when concerns are significant and advising against the deal or the value of the merger. Extra care and due diligence is required when two companies considering a merger are headquartered and operating in different countries. Different accounting standards and principles are involved and therein lies a risk that the financial statements may not be comparable. Revenue recognition and footnote disclosures for all key accounting policies and procedures may be considerably different.
Surprises. Three of the four Big 4 leading accounting firms were involved in this merger. Deloitte, Pricewaterhouse Coopers and Ernst & Young were involved in varying capacities. With a deal the size of USD 11 billion, HP’s Board decided to get a second opinion of the Autonomy’s financials. Deloitte was Autonomy’s external auditors; Ernst & Young was HP’s auditors; Pricewaterhouse Coopers was retained to review and give another opinion. Despite all three firms’ involvement the deal resulted in an USD 8 billion write down as an over valuation. Consequently, many lawsuits from HP shareholders claiming losses and value depreciation of their shareholdings have been filed. Some litigants claim that the HP Board and accounting department were aware of the accounting discrepancies and argue that the merger should have been aborted and did not pass due diligence.
Already knew. As a long standing customer of HP, I knew HP had a product range including various hardware and software and services. These were offered at the retail level to individual consumers, e.g. university students, and to companies of all sizes: small, medium and large. HP had three lines of software prior to the merger with Autonomy: 1) archiving, 2) enterprise content management (ECM), and 3) backup & recovery. HP has annual sales approximately USD 125 billion. Autonomy was a British company with software providing pattern recognition capabilities. Annual sales of Autonomy were USD 1 billion.
Conclusion. This deal was a major move in the computer and hardware industries. HP has a history of failing to integrate and take advantage of acquired companies and therein wasting USD millions and USD billions. Large companies acquiring small companies and then attempting to integrate the corporate cultures struggle to keep long-standing employees of the acquired firm. As key managers and specialists leave after a merger skill sets may disappear and customer relations may falter. A desperate highly compensated corporate executive having just failed in a major deal with another company hastily made a decision to proceed with a huge acquisition involving USD 11 billion and the result was that the deal was overpriced by a whopping USD 8 billion. Despite the calamity HP CEO Whitman is gifted at damage control and spins press releases and investor relations to convey a commitment to making the Autonomy product line successful and an integral part of HP going forward.

Reference
Lawsuit Alleges HP Tried To Kill Autonomy Deal, Steven Burke, May 8, 2013 http://www.crn.com/news/applications-os/240154489/lawsuit-alleges-hp-tried-to-kill-autonomy-deal.htm?pgno=1 Appendix A
Lawsuit Alleges HP Tried To Kill Autonomy Deal
By Steven Burke
May 08, 2013 8:20 PM ET
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A new class-action lawsuit alleges that Hewlett-Packard (NYSE:HPQ) sought to withdraw its $11.1 billion acquisition of British software maker Autonomy just weeks before the controversial deal was finalized.
The 115-page lawsuit, which was filed in the U.S. District Court, Northern District of California, San Francisco, on May 3 on behalf of Dutch pension fund PGGM Vermogensbeheer, B.V. and other shareholders, alleges that "unbeknownst to investors before HP's offer to acquire Autonomy closed on October 3, 2011, HP was actively seeking to withdraw its offer to purchase" the big data software company.
That bid to withdraw the offer is a critical matter since HP announced just over a year after closing the Autonomy deal that it was taking an 85 percent write-down, or an $8.8 billion charge, against earnings because of what it has called "serious accounting improprieties" at Autonomy. That write-down on November 20, 2012, sent HP shares plummeting 12 percent in a single day, wiping out $3.1 billion of HP's market capitalization.
The lawsuit alleges that then-HP Executive Chairman Ray Lane, who is still on the HP board of directors, "asked HP's financial advisors [Barclays and Perella] whether HP could back out of the deal before it closed," but was told that "U.K. takeover rules made that impossible."
"For HP to invoke a material adverse change condition under the City Code before its Autonomy transaction closed on October 3, 2011, HP would have been required to demonstrate to the Panel that circumstances had arisen affecting Autonomy which HP could not have reasonably foreseen at the time of the announcement, of HP's [Autonomy] offer on August 18, 2011, and which were of an entirely exceptional nature," according to the class-action lawsuit. "Given the numerous publically-available red flags about Autonomy that made it reasonably foreseeable that Autonomy was overvalued and/or engaging in accounting improprieties when HP announced its offer on August 18, 2011, HP could not successfully withdraw the offer."
Among the "red flags" pointed to by the class-action lawsuit are "no less than 14 reports" from the Center For Financial Research and Analysis (CFRA) "questioning Autonomy's purported growth and financial reporting." The lawsuit also points to a number of reports from Paul Morland, a technology analyst with brokerage firm Peel Hunt, including a June 2009 Autonomy report entitled "Accounting Red Flags." In addition, a July 23, 2010, Peel Hunt report noted that the firm remained "concerned about [Autonomy's] constant attempts to flatter the true picture and announce growth rates which we believe are well above actual rates."
What's more, the lawsuit investigation by lead counsel points to "information developed from former HP and Autonomy employees" and [U.K. IT consultant] Alan Pelz-Sharpe "who referred Autonomy to the United Kingdom's Serious Fraud Office for 'alleged suspicious practices' before the Autonomy acquisition closed on October 3, 2011." The suit also alleges that Morland "alerted HP's Investor Relations Department about Autonomy's manipulative accounting practices prior to the Autonomy acquisition."
The lawsuit alleges that Lane, HP CFO Cathie Lesjak and then-new HP CEO Meg Whitman "recklessly disregarded, and/or turned a blind eye to, Autonomy's overvaluation and impairments, reluctantly allowed the Autonomy acquisition to close, and resolved to try to quietly clean up the HP/Autonomy debacle internally."
HP did not respond specifically to the allegations that the company attempted to withdraw the $11.1 billion Autonomy offer or to whether Lane, Lesjak and Whitman "reluctantly" allowed the deal to close.
But HP did supply CRN a statement in which the company again pointed to alleged accounting misrepresentation by Autonomy management.
"As we have continually said, HP relied on the audited financial statements and the representations of Autonomy's management and its auditors regarding Autonomy's business and revenue," HP said in a statement. "Those facts and figures appear to have been willfully manipulated by certain Autonomy employees prior to the company's acquisition, to mislead investors and potential buyers.
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"HP (NYSE:HPQ)'s position is the same as it has been from the beginning. We have handed over our information of serious misrepresentations in Autonomy's accounting to the proper authorities, namely the SEC and the Department of Justice and in the U.K., the Serious Fraud Office. We continue to cooperate and provide requested information to the relevant authorities on an ongoing basis."
The lawsuit is being brought by successful San Francisco attorney Ramzi Abadou of Kessler, Topaz, Meltzer & Check LLP. Abadou has won a number of significant class-action settlements, including a $925.5 million settlement with United Healthcare Group and a $100 million settlement with AT&T (NYSE:T).
Several HP solution provider partners, for their part, said they still see a great opportunity to bring game-changing big data solutions to customers with what they see as superior HP-Autonomy technology.
"I believe the Autonomy technology is important technology that will help NWN customers solve problems," said Mont Phelps, the CEO of NWN, a $266 million HP enterprise partner headquartered in Waltham, Mass. "The issue with regard to the lawsuit as to whether they paid too much or not is frankly not an important issue for me. I can understand shareholders being concerned about it. No one wants to pay too much. But at the end of the day, this is technology that will be beneficial to our customers. It's still early for [big data solutions], but what happened with the acquisition is not relevant to whether we carry the technology or what we do with it to help our customers' solve business problems. That is a shareholder and Wall Street issue that is not going to affect us."
Another top solution provider CEO, who did not want to be identified, said he is anxious to see HP, which is just rolling out a major Autonomy channel initiative, aggressively offer the software through channel partners. "We are anxious to learn about Autonomy and get involved with the product," said the CEO. "Who doesn't want to have services related to a software product like Autonomy? That's the dream for us and for HP when they bought them. We are looking for to channel engagement with Autonomy."
HP Software Executive Vice President George Kadifa recently told solution providers on a partner webcast that HP is "definitely" recruiting partners to sell the Autonomy iManage product line focused on document management in the legal profession. "In that area we are actually the No. 1 player," he told solution providers. "We basically service about 80 percent of the large law firms. And now what we are doing is going to the enterprise and offering that kind of service to the enterprises. That is an area where we welcome channel participation because the set of opportunities is much larger, and we are very, very focused on expanding that set of opportunities."
Whitman, for her part, has repeatedly stressed that HP is firmly committed to the Autonomy product line. "I still get questions about our commitment to Autonomy, and we are 100 percent committed to Autonomy," she told partners during the recent webcast. "And Autonomy actually is doing quite well this quarter. Of course it is a smaller business than we had been led to believe. But the good news is it is growing. Everywhere you go, people talk about the magic of the Autonomy business and the Autonomy technology. So just in case anyone is wondering: are we committed? 150 percent committed. This could be a big business for HP. So we are delighted."
PUBLISHED MAY 8, 2013

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