HPQ – Eggs in flight

The fight between HPQ and Autonomy is going very badly for HPQ.

• It looks increasingly likely that HPQ will have egg all over its face when the Serious Fraud Office and the FBI decline to press charges of fraud against the former management of Autonomy.
• HPQ purchased Autonomy for $10.8bn in 2011 and then followed that up by writing down the acquisition by $8.8bn a year later.
• HPQ has justified this acquisition by saying that it was wilfully defrauded by the former management of Autonomy.
• I love long argued that the real issue here is that HPQ failed to do its due diligence at the time of the acquisition. (see here and here and here).
• This is exactly what is emerging (via the FT) and furthermore it appears that it was aware of many of the contested issues before the deal closed.
  • First: HPQ has claimed that loss making hardware sales were used as a way of making up shortfalls in software revenues.
  • Autonomy often sold hardware as part of its software contracts and while many of the sales booked are questionable, they do not appear to be fraudulent.
  • Autonomy’s auditor Deloitte signed off on these transactions.
  • Finally, HPQ was notified of the existence of these hardware revenues and how they were being recognised, during the seven months after the deal was announced but before it closed.
  • HPQ had every chance to object but appears to have done nothing.
  • Second: Autonomy’s use of resellers is being called into question. Under IAS, a company is allowed to book a sale to a reseller even if there is no end client as long as it is a final sale with no come back.
  • E-mail evidence (via the FT) strongly indicates that:
    • 1) HPQ was aware of these transactions during the seven month period between the announcement and the deal closing.
    • 2) HPQ requested that Autonomy recognise these revenues as deferred revenue as required by US GAAP.
  • Again it appears that HPQ had every opportunity to dig into these issues in more detail before the deal closed but failed to do so.
• These types of transactions may be aggressive and questionable but they are not technically illegal.
• Hence, it looks very much like that both the SFO and the FBI will decline to prosecute this case leaving HPQ’s management looking very foolish again.
• This will leave HPQ’s management with no option but to admit that it failed to fulfil its obligations to shareholders when carrying out its due diligence.
• This is the last thing that management needs as it has done a reasonable job in cutting costs and getting the ship back onto an even keel.
• The eggs are in the air and they look almost certain to hit HPQ squarely in the face.
• Management is fortunate that its shareholders are only focused on the future.