The hits keep coming for Hewlett-Packard, the original Silicon Valley giant. Personal computers, the garage-founded company’s central business, just aren’t cool anymore – not in a world of high-powered smart-phones and touchable tablets. In the second quarter of 2012, HP’s profit fell 31 percent. And on May 23, it announced plans to lay off 27,000 employees. Still, in the third quarter, the losses kept coming – a record $8.86 billion – after the company was forced to write down its disappointing acquisition of Electronic Data Systems, at a charge of $8 billion. In two years, the company has gone through three CEOs. The current CEO, former eBay head Meg Whitman, who is best known to political junkies for a $144 million investment in her failed gubernatorial campaign, is trying to right the ship.
But HP just hit an iceberg. On Tuesday, HP said it will take an $8.8 billion charge against earnings to write down the value of Autonomy, the British software company it acquired for $9.7 billion last year. (The write-down basically erases all the money HP made last quarter.) HP says it is taking the write-down because Autonomy executive fudged the company’s numbers during the acquisition to artificially inflate its value.
On Tuesday’s earnings conference call, Whitman said HP would do all it could to recoup the losses from the acquisition, which was orchestrated under the troubled reign of former CEO Leo Apotheker. Apotheker resigned after seeing HP lose $30 billion in market cap over his tenure. Whitman said that, although the executives responsible for the disastrous acquisition are now long gone, “Most of the board was here and voted for this deal, and we feel terribly about that.” Autonomy’s fake numbers first came to light in May, Whitman said, after a whistle-blowing executive at the British based company leaked the information to HP’s board. The company has referred the case to the Securities and Exchange Commission and the UK’s serious fraud office, and HP plans to sue, Whitman said. The potentially multi-billion dollar fraud case is so much salt in a year-long wound. Year over year, the company’s revenue dropped 5 percent.
As Whitman pointed out, the executives who decided to buy Autonomy are long gone. But the Street isn’t so forgiving. By noon, HP’s stock had fallen over 11 percent, reaching its lowest level in 10 years. While the bungled acquisition wasn’t Whitman’s fault, it certainly throws a wrench in her turnaround project.
Moreover, it raises several troubling questions. The Autonomy deal was a multi-billion-dollar acquisition of a blue-chip British company—not a wild speculation on a Chinese penny stock. How could things go, to use a Britishism, so pear-shaped? Whitman says that the “board relied on audited financials—audited by Deloitte, not ‘Brand X’ accounting firm, but Deloitte.” HP even brought in another Big Four accounting firm, KPMG, to check Deloitte’s work. But why didn’t the “very extensive due diligence process,” as Whitman put it, turn up a whiff of something rotten—especially something sufficiently rotten to prompt an $8.8 billion write-down? Deals of that magnitude usually involve hundreds of auditors, thousands of questions and fact checks, and hundreds and thousands of pages of documentation. And there were warning signs—ones that may raise awkward questions for HP, Deloitte, and KPMG.
Autonomy, a software and institutional services company, was one of HP’s main British rivals before the acquisition—the logic was that HP could expand beyond its ailing hardware business and start competing in the software sector. But even at the time, many investors (and bloggers) slammed Autonomy as overpriced. Moreover, in September 2011, Oracle accused the British company of lying, after it denied approaching the American software giant in an attempt to sell itself. “After the sales pitch was over,” the company said, “Oracle refused to make an offer because Autonomy’s current market value of $6 billion was way too high.” Lest there be any doubt in how much Autonomy had angered Oracle, it even put the company’s sales pitch slides online at Oracle.com/PleaseBuyAutonomy. “[We] hope [Autonomy CEO] Mike Lynch will recognize his slides” and “his memory will be restored,” the company said. According to Forbes’ Daniel Fisher, who quoted a source at the British company, Autonomy allegedly inflated its sticker price through creatively valuing its own acquisitions in pitches to customers. “They would basically give [customers] software for free,” said the source, “but shift the costs around to make it look like they got $3 million in software sales.” Hindsight is always 20-20. But given all the early warning signs, and the reams of “due diligence,” it’s hard to fathom how HP’s deal brokers messed up so badly.
What now for Hewlett-Packard? The numbers are ugly. The market now values this component of the Dow Jones Industrial Average at about $23 billion. In real terms that means that things that are worth more than HP now include: Afghanistan’s GDP, Michael Bloomberg, and three weeks of Wal-Mart sales. In fact, that low and falling market capitalization puts it way at the bottom of the Dow Jones Industrial Average, the index that averages the United States’ 30 largest stocks. According to IndexArb, it now accounts for less than 1 percent of the index. Some observers are openly speculating about who could replace HP in the Dow.
Being removed from the Dow may have more of a symbolic impact than a real one. But that doesn’t mean it doesn’t hurt. Losing a huge chunk of market capitalization to market forces—like the slow decline of personal computing—is just creative destruction. Getting sandbagged through a botched buyout? To use another Britishism, that’s a massive own-goal.