Writedown sets seal on HP deal from hell

In some parts of the City of London, a sense of disbelief greeted the news last year that Hewlett-Packard had agreed to pay $11bn for Autonomy, a British software company that had traded for half that value barely six months before.

"This deal defies logic," wrote Paul Morland, analyst at Peel Hunt, a UK brokerage. "We believe HP shareholders should be worried."

Quite how much they should have worried has now been revealed. HP on Tuesday wrote down the value of its software business by $8.8bn, with more than $5bn of that due to alleged "serious accounting improprieties, disclosure failures and outright misrepresentations" at Autonomy before the company was acquired.

For an already struggling HP, the massive writedown has set the seal on what has become its deal from hell. The inflated price of the Autonomy acquisition had already helped to sink one HP chief executive and is now set to enmesh the company's directors in another of the seemingly endless succession of boardroom crises that have shaken the company in recent years.

Topping the list of urgent questions they now face: How closely did they dig into a company whose accounting had already prompted several analysts to raise a red flag?

That it has taken six months for HP to uncover the extent of the alleged irregularities, which were first raised in late May by a former senior Autonomy executive, will only add to the discomfort.

Well before HP showed up on the scene, there was already a vocal minority of financial analysts in the City raising questions about the solidity of Autonomy's business – at times drawing an unusually fierce reaction from the company.

Mr Morland at Peel Hunt warned when HP bought the company that "margins have been contracting, profits are growing in single digits and for some reason those profits aren't converting into as much cash as they should".

Despite being one of the few to allege that something was amiss in Autonomy's accounting for years, Mr Morland still seemed surprised that HP had missed a potential $5bn hole. "If I could spot it from going through public accounts, then it's shocking that someone in [HP's] position could not," he said on Tuesday.

There were also warnings that, in hindsight, sound telling. Marc Geall, a former head of investor relations who had gone on to work as an analyst at Deutsche Bank, cautioned that Autonomy had outgrown its controls and systems, becoming a large company with the processes more commonly found in a start-up.

None of this was enough to dissuade HP's then-CEO, Léo Apotheker, from placing a stunning bet on Autonomy, making it the centrepiece of his attempt to rebuild the tattered tech conglomerate around software. A shareholder revolt over the scale of the overpayment played a central part in his dismissal from the company weeks later.

None of this, though, gave any warning of the three accounting charges levelled against Autonomy's former management by HP on Tuesday. The first, and largest, related to the way Autonomy derived a significant slice of its revenue – 10-15 per cent a quarter for the two years before the deal, according to HP – from sales of hardware.

Although the hardware was sold at a loss, some of the costs were booked as marketing expenses, the US company claimed, making it possible for Autonomy to record a gross profit on the sales.

The UK company also reported the sales as having come from software, adding to the impression that its business was derived exclusively from high-margin software, according to HP.

A second claim levelled by HP concerned sales made through intermediaries known as "value-added resellers". Some of these sales had been booked as revenue by Autonomy even though there had been no end customers for the deals, it said – a practice known as "channel-stuffing".

In a third accusation, HP said Autonomy had treated some of its long-term contracts as immediate sales, booking revenue before it should have.

Mr Lynch denied the allegations.

Some $3.5bn of HP's writedown was not related to the disputed accounting but was prompted by a broader review of its assets. HP attributed virtually all of the writedown to the falling value of Autonomy, even though the software business only accounted for a minority of its company-wide goodwill and intangible assets.

While admitting that Autonomy had turned out to be a smaller, lower-margin business than HP had expected, Meg Whitman, chief executive, still defended it as an important part of her company's technology arsenal.

For Ms Whitman, meanwhile, the revelation that accounting irregularities had apparently spread so widely at Autonomy will raise some uncomfortable questions.

"Everybody knows about the 'winner's curse' in tech," said George O'Connor, analyst at Panmure Gordon – a reference to the way bidders willing to pay the highest prices for companies that are considered to be trophy assets often come out as losers.

"For that reason, companies tend to be extra paranoid in terms of going in and doing their due diligence."

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