HP’s Explanation Still Makes No Sense
My Bloomberg colleague Jesse Drucker has an article today that puts some numbers on Hewlett-Packard Co. (HPQ)’s allegations of book-cooking at Autonomy Corp. HP says the financial-reporting improprieties at Autonomy caused more than $5 billion of the $8.8 billion writedown that it disclosed yesterday.
The article underscores how HP’s explanation doesn’t make sense. About $200 million of Autonomy’s revenue had been recorded prematurely or improperly over a two-year period beginning in 2009, HP’s general counsel, John Schultz, said in an interview for Drucker’s story. Autonomy’s former executives deny HP’s claims. That would be equivalent to about 12 percent of Autonomy’s revenue for 2009 and 2010 combined.
This is the only hard number quantifying the supposed accounting errors that HP has disclosed so far. Let’s assume for the moment that what Schultz said is true. That doesn’t explain more than $5 billion of writedowns. Some writedowns, perhaps. But not more than $5 billion worth. Maybe HP will eventually provide a more thorough explanation.
The real story here is that HP grossly overpaid -- again -- for an acquisition. The $11 billion purchase price was more than 11 times Autonomy’s $931 million of revenue for the 12 months ended June 30, 2011.
In other words: HP was the sucker. Now it’s trying to shift the blame elsewhere, which shouldn’t come as a surprise. Here are some other observations on the HP mess:
-- The $200 million revenue issue is one of two examples HP has given of “accounting improprieties and misrepresentations” at Autonomy. In its statement yesterday, HP said the other was “the mischaracterization of revenue from negative-margin, low- end hardware sales with little or no associated software content as ‘IDOL product,’ and the improper inclusion of such revenue as ‘license revenue’ for purposes of the organic and IDOL growth calculations.”
HP said “this negative-margin, low-end hardware is estimated to have comprised 10-15% of Autonomy’s revenue.”
That doesn’t seem like an accounting issue; it wouldn’t change the numbers Autonomy reported before it was bought. Autonomy’s income statement showed only one revenue line, which didn’t distinguish between types of revenue. Even if HP is correct to call this a misrepresentation, it still doesn’t explain how Autonomy’s financial-reporting improprieties were responsible for more than $5 billion of the writedowns at HP last quarter.
-- During a conference call with investors yesterday, HP Chief Executive Officer Meg Whitman said this about Autonomy’s outside accounting firm, Deloitte LLP in the U.K.: “The board relied on audited financials -- audited by Deloitte -- not Brand X accounting firm but Deloitte.”
Brand X may look good compared with what the Public Company Accounting Oversight Board said about Deloitte & Touche LLP, the Big Four accounting firm’s U.S. affiliate, in a May 2008 inspection report. The report was released in October 2011. Quality-control problems included “a firm culture that allows, or tolerates, audit approaches that do not consistently emphasize the need for an appropriate level of critical analysis and collection of objective evidence, and that rely largely on management representations.”
Autonomy’s reputation for aggressive accounting wasn’t a secret. Dan Mahoney, who heads the accounting-research firm CFRA in New York, said in an e-mail this morning that, “from 2001 through 2010, our firm wrote 14 reports and four notes on Autonomy raising questions about its accounting and disclosure practices.” At CFRA, he said, “the reaction was not one of surprise but more ’what took so long?’”
-- The Deloitte partner who signed the firm’s audit report on Autonomy’s year-end 2010 financial statements is Nigel Mercer of Cambridge, England. In the U.S., accounting firms at publicly traded companies don’t name the partners responsible for their audit reports. But in some countries, such as the U.K., they do.
The accounting oversight board for years has been floating the idea of requiring U.S. audit firms’ partners to identify themselves by name when they vouch for companies’ financial statements. This is information that investors clearly should be told. But the board’s proposal has gone nowhere, partly because of opposition by the accounting profession.
You can bet there are short sellers and other investors out there checking to see what other audits Mercer may have been in charge of.
-- HP is making a big fuss about how it purportedly got duped by Autonomy’s accounting practices. At the same time, it’s also suggesting that investors disregard the $8.8 billion writedown when they analyze the company’s financial results.
The first number cited in HP’s earnings release yesterday was “fiscal 2012 non-GAAP diluted earnings per share of $4.05.” Translation: earnings before bad stuff. HP had a fiscal 2012 net loss of $12.7 billion, or $6.41 a share, under generally accepted accounting principles. That included a $6.9 billion loss for the fourth quarter.
HP’s earnings spin is so patently ridiculous, you have to wonder: Why bother?
-- Autonomy showed $3.5 billion of total assets as of June 30, 2011, which was the last time it disclosed a balance sheet as a public company. The figure included $1.5 billion of goodwill, which is the bookkeeping entry a company records when it buys another company for a premium. HP, for its part, recorded $6.9 billion of the $11 billion purchase price for Autonomy as goodwill.
What we have here is one serial acquirer blowing up after buying another serial acquirer. It’s a classic roll-up story. HP’s core business has been horrible for years. So it has relied on high-priced acquisitions -- such as Compaq Computer, Electronic Data Systems, and Palm -- to fuel its growth. It made one bad deal after another, repeatedly overpaying. Finally HP hit a wall, just like many roll-ups of the past -- everything from Citigroup and Bank of America during the financial crisis to Waste Management and WorldCom more than a decade ago.
-- Even if HP hadn’t identified any accounting improprieties at Autonomy, writedowns of the magnitude disclosed yesterday were predictable. The need to record them was obvious, as I wrote in an Oct. 4 blog post.
HP finished the fiscal third quarter with $32 billion of shareholder equity. Its balance sheet showed $36.8 billion of goodwill (which isn’t a saleable asset) and $8 billion of other intangible assets. By comparison, HP finished the fiscal fourth quarter on Oct. 31 with a stock-market value of $27.2 billion.
In other words, on paper, HP’s goodwill supposedly was worth more than the company as a whole. The market knew big writedowns were necessary. Investors saw that Autonomy was a disaster. They were just quicker to acknowledge the reality than HP was.
That’s why the company’s market capitalization fell only $3.2 billion yesterday, or 12 percent, on news of a $6.9 billion quarterly net loss. Much of that red ink had been anticipated.
Read more breaking commentary from Bloomberg View at the Ticker.