HP Takes $8.8 billion Charge in Autonomy Investment

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HP announced today that they were taking a charge of $8.8 billion on their recent acquisition of Autonomy in the UK.  Read on for details.

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On August 18th, 2011, HP announced that they had completed the acquisition of UK-based software shop Autonomy for $10.3 billion.  At the time, HP lauded the technology used by Automony as a great addition to their business.  Here is how HP describes Autonomy’s technology:

The foundation: Meaning-based Computing

Autonomy’s main technology, Intelligent Data Operating Layer (IDOL), allows search and processing of text taken from database, audio, video, or text files or streams. The processing of such information by IDOL is referred to by Autonomy as Meaning-based Computing.

Autonomy’s technology attempts to “understand” any form of unstructured information, including text, voice and video, and based on that understanding perform automatic operations, for example inferring what the user wants and on that basis finding other information that may be of interest.

The future: integration and scale

The HP Next Generation Information Platform is based on a combination of Autonomy’s unstructured data analytics engine, IDOL 10, and HP Vertica’s fast-loading, real-time analytics database. This strategic move by HP is part of its refocus on enterprise software, and enterprise integration solutions and services. The platform will combine structured data with unstructured information—which comprises about 80 percent of the data on the web such as video, pictures, emails, etc. —and handle them in a unified manner.

In recent years, Autonomy has successfully launched a number of new solutions as a result of extensive research and development, introducing industry-shifting technology into the marketplace. As a testimony to unsurpassed innovation, Autonomy is quickly gaining mainstream adoption and is being established as the standard for all information needs for organizations around the globe.

Today comes the news that $5.0 billion of that investment was based on fraudulent accounting treatment in Autonomy’s financial statements before the sale, leading to an overstatement of the value of the business and an additional $3.8 billion writedown as the original business plan was defective.  Here is HP’s news release from today:

PALO ALTO, Calif., Nov. 20, 2012

HP today issued the following regarding the non-cash impairment charge relating to Autonomy that was announced during HP’s fourth-quarter earnings announcement:

“HP is extremely disappointed to find that some former members of Autonomy’s management team used accounting improprieties, misrepresentations and disclosure failures to inflate the underlying financial metrics of the company, prior to Autonomy’s acquisition by HP. These efforts appear to have been a willful effort to mislead investors and potential buyers, and severely impacted HP management’s ability to fairly value Autonomy at the time of the deal. We remain 100 percent committed to Autonomy and its industry-leading technology.”

Additional background:

HP today announced a non-cash impairment charge of $8.8 billion related to Autonomy in the fourth quarter of its 2012 fiscal year. The majority of this impairment charge, more than $5 billion, is linked to serious accounting improprieties, misrepresentation and disclosure failures discovered by an internal investigation by HP and forensic review into Autonomy’s accounting practices prior to its acquisition by HP. The balance of the impairment charge is linked to the recent trading value of HP stock and headwinds against anticipated synergies and marketplace performance.

HP launched its internal investigation into these issues after a senior member of Autonomy’s leadership team came forward, following the departure of Autonomy founder Mike Lynch, alleging that there had been a series of questionable accounting and business practices at Autonomy prior to the acquisition by HP. This individual provided numerous details about which HP previously had no knowledge or visibility.

HP initiated an intense internal investigation, including a forensic review by PricewaterhouseCoopers of Autonomy’s historical financial results, under the oversight of John Schultz, executive vice president and general counsel, HP.

As a result of that investigation, HP now believes that Autonomy was substantially overvalued at the time of its acquisition due to the misstatement of Autonomy’s financial performance, including its revenue, core growth rate and gross margins, and the misrepresentation of its business mix.

Although HP’s investigation is ongoing, examples of the accounting improprieties and misrepresentations include:

  • 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.
    • This negative-margin, low-end hardware is estimated to have comprised 10-15% of Autonomy’s revenue.
  • The use of licensing transactions with value-added resellers to inappropriately accelerate revenue recognition, or worse, create revenue where no end-user customer existed at the time of sale.

This appears to have been a willful effort on behalf of certain former Autonomy employees to inflate the underlying financial metrics of the company in order to mislead investors and potential buyers. These misrepresentations and lack of disclosure severely impacted HP management’s ability to fairly value Autonomy at the time of the deal.

HP has referred this matter to the US Securities and Exchange Commission’s Enforcement Division and the UK’s Serious Fraud Office for civil and criminal investigation. In addition, HP is preparing to seek redress against various parties in the appropriate civil courts to recoup what it can for its shareholders. The company intends to aggressively pursue this matter in the months to come.

The techniques allegedly used by Autonomy are well-known in the revenue recognition field, and audit techniques are usually employed to find these.  HP has referred the matter to the SEC in the USA and to the Serious Fraud Office in the UK; I would expect jail time for those involved if HP’s assertions can be supported by facts.

Here is a timeline for the Autonomy deal; note that the former CEO was let go on May 23rd for failing to meet performance metrics, which is what would happen if the business was fraudulently booking transactions before the acquisition.

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It seems that HP just can’t cut a break lately, and the massive due diligence failure highlighted in this deal will raise serious questions about its acquisitions going forward.  For now, it looks like the fallout will hit former Autonomy management, but the SEC will likely want to ensure that HP did not continue these deceptive practices after the deal was closed last October.  We’ll keep you posted on this story as more information becomes available.

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