22 Nov 2012 05:13pm

Editors view: Autonomy, HP and the auditors

For some it was the deal of the year, for others simply the latest example of the egregious overvaluation of technology stock. Either way when HP acquired UK tech firm Autonomy for $11bn in 2011, it represented another last throw of the dice for the floundering US tech giant

With its hardware business suffering, and previous major acquisitions of Electronic Data Systems (EDS) and Palm having failed to create value, a move into software and search (the markets Autonomy operates in) seemed like an obvious (if expensive) move. This week’s announcement that HP has had to write down £8.8bn of that £11bn suggests it’s another gamble that failed.

For the moment, Autonomy founder Mike Lynch has resolutely defended the company against the allegations of deliberate accounting “errors” and misrepresentation. For its part HP has taken its case to the SEC in the US and the SFO in the UK. That it has done so suggests its forensic accountants have uncovered some evidence on which to build a legal case.

These allegations against Autonomy are not new. Several analysts raised questions about the company’s ability to achieve the rapid growth in revenues it did from its own acquisitions. 

Several analysts raised questions about the company's ability to achieve the rapid growth in revenues

Lynch claims that this week’s writedown is merely the latest example of poor management from HP and that they are using these allegations to cover up the company’s terrible results. Certainly HP has lurched strategically in recent years, floundering around looking for a clear direction and purpose. And it hasn’t been shy of relying on the odd accounting trick itself, writing down much of the money spent on many of those previous acquisitions.

But this story is fascinating because it raises two of the biggest question in modern business. What is the point of growth by acquisitions, when most mergers or acquisitions fail to add value; and are auditors failing or are audits irrelevant? So what light does the HP/Autonomy row show us about either of these suppositions?

What this story confirms is that when a company is in trouble, trying to buy its way out of the hole rarely works out well. There have been constant warning signs that all wasn’t going well within the new HP-Autonomy arrangement. The firing of Lynch wasn’t a great sign. It is often the case that maverick entrepreneurial figures struggle to get on in larger, more hierarchical power structures. The big, ageing corporate beast swallowing up a dynamic, young, creative hothouse and then stifling the creativity and quickly losing the core team they purchased is a common phenomenon.

But Autonomy was no start-up. It was a FTSE 100 company that had itself grown mostly through acquisition and therefore should have been familiar enough with the challenges of cultural and systems integration.

But culture alone is not the only reason deals so often fail to add value. The motivation or strategic intent, is also often questionable. Former HP CEO who forced the deal through was convinced this was the route the company should head in and ultimately paid the price for paying too high a price for Autonomy. Sometimes such an egotistical CEO or overly aggressive board drives through a deal and sometimes it’s the irrepressible need on the part of analysts and markets to see constant growth. Yet other times (and this was a criticism levelled at HP) it’s a deal done out of desperation. The status quo isn’t an option and only a dramatic gesture will pacify investors. This so-called “burning platform scenario” rarely results in good strategy or clear thinking.

Of course there are always winners from any deal. The list of professional advisors to this deal - all of whom claim their “success fee” when the deal is signed, regardless of the long-term outcome for shareholders and investors- is staggering. The array of bankers, lawyers and accountants involved in this deal, and the millions of pounds they earned, might make for some uncomfortable reading should the charges lead on to a criminal investigation.

The list of professional advisors to this deal is staggering

There is always the suspicion that these fees alone represent the real motivation that keeps a deal moving when the business logic may have faded, or when the price seems to have gone beyond the excessive.

Which brings us neatly to the second issue: the reputation of accountants and auditors. Meg Whitman, HP’s CEO, and a director at the time the deal was done, is right in pointing out that any amount of due diligence (or audit come to that) will not do much good if someone is determined to obscure the truth.

Clever liars will find a way to hide what they want hidden.

The software industry is notorious for somewhat slippery approaches to accounting. Once a software product or service has been developed the cost of rolling it out to a new client might be minimal, while long-term licensing revenues flow steadily. Accounting for guaranteed future revenue can be both a blessing and a curse. In worrying echoes of previous scandals, notably those of the early 2000s such as Enron, those analysts prepared to openly question Autonomy’s revenue growth (and the way it seemed to grow rapidly after each acquisition) found themselves shut out of quarterly presentations and not given access to founder Mike Lynch.

But what of the auditors who regularly gave Autonomy’s accounts a clean bill of health and who were heavily involved in getting the due diligence for the deal done?

Several of the Big Four were involved in the deal or worked with Autonomy, most notably Deloitte and KPMG. The question will again be raised as to the role and effectiveness of audit. Did the auditors not do the job well enough, or is that job, as we currently understand it, simply not up to the task required? Were the auditors complicit in the dubious accounting practices that saw loss-making or low-margin hardware revenue marked down as profitable software deals?

If HP’s allegations prove accurate, questions will be raised over the validity of the Autonomy audit, and the profession as a whole.

If accounting improprieties have occurred and the auditor missed them, it is right and proper that questions are asked. There will once again be questions about how close the Big Four get to their FTSE 100 clients, about the need for mandatory rotation and about the amount of non-audit work carried out by firms for audit clients.

In short, what the HP/Autonomy scandal highlights is how far we are from getting answers to the questions and doubts that stubbornly persist about how high-technology companies are valued; around the sustainability of a business model built solely on growth by expensive acquisitions; and around the robustness of the current audit model. Whether we’ll ever start to get answers to these questions is perhaps the biggest question of all.

Richard Cree 



Richard Cree is the editor of economia