From H.P., a Blunder That Seems to Beat All

The dubious title of worst corporate deal ever had seemed to be held in perpetuity by AOL’s acquisition of Time Warner in 2000, a deal that came to define the folly of the Internet bubble. It destroyed shareholder value, ended careers and nearly capsized the surviving AOL Time Warner.

The deal was considered so bad, and such an object lesson for a generation of deal makers and corporate executives, that it seemed likely never to be repeated, rivaled or surpassed.

Until now.

Hewlett-Packard’s acquisition last year of the British software maker Autonomy for $11.1 billion “may be worse than Time Warner,” Toni Sacconaghi, the respected technology analyst at Sanford C. Bernstein, told me, a view that was echoed this week by several H.P. analysts, rivals and disgruntled investors.

Last week, H.P. stunned investors still reeling from more than a year of management upheavals, corporate blunders and disappointing earnings when it said it was writing down $8.8 billion of its acquisition of Autonomy, in effect admitting that the company was worth an astonishing 79 percent less than H.P. had paid for it.

And it attributed more than $5 billion of the write-off to what it called 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,” adding, “These misrepresentations and lack of disclosure severely impacted H.P. management’s ability to fairly value Autonomy at the time of the deal.”

In an unusually aggressive public relations counterattack, Autonomy’s founder, Michael Lynch, a Cambridge-educated Ph.D., has denied the charges and accused Hewlett-Packard of mismanaging the acquisition. H.P. asked Mr. Lynch to step aside last May after Autonomy’s results fell far short of expectations.

But others say the issue of fraud, while it may offer a face-saving excuse for at least some of H.P.’s huge write-down, shouldn’t obscure the fact that the deal was wildly overpriced from the outset, that at least some people at Hewlett-Packard recognized that, and that H.P.’s chairman, Ray Lane, and the board that approved the deal should be held accountable.

A Hewlett-Packard spokesman said in a statement: “H.P.’s board of directors, like H.P. management and deal team, had no reason to believe that Autonomy’s audited financial statements were inaccurate and that its financial performance was materially overstated. It goes without saying that they are disappointed that much of the information they relied upon appears to have been manipulated or inaccurate.”

It’s true that H.P. directors and management can’t be blamed for a fraud that eluded teams of bankers and accountants, if that’s what it turns out to be. But the huge write-down and the disappointing results at Autonomy, combined with other missteps, have contributed to the widespread perception that H.P., once one of the country’s most admired companies, has lost its way.

Hewlett-Packard announced the acquisition of Autonomy, which focuses on so-called intelligent search and data analysis, on Aug. 18, 2011, along with its decision to abandon its tablet computer and consider getting out of the personal computer business. H.P. didn’t stress the price — $11.1 billion, or an eye-popping multiple of 12.6 times Autonomy’s 2010 revenue — but focused on Autonomy’s potential to transform H.P. from a low-margin producer of printers, PCs and other hardware into a high-margin, cutting-edge software company. “Together with Autonomy we plan to reinvent how both structured and unstructured data is processed, analyzed, optimized, automated and protected,” Léo Apotheker, H.P.’s chief executive at the time, proclaimed.

Autonomy had already been shopped by investment bankers by the time H.P. took the bait. But others who examined the data couldn’t come anywhere near the price that Autonomy was seeking. An executive at a rival software maker, Oracle, a company with many successful software acquisitions under its belt, told me: “We looked at Autonomy. After doing the math, we couldn’t make it work. We couldn’t figure out where the numbers came from. And taking the numbers at face value, even at $6 billion it was overvalued.” He didn’t want to be named because he was criticizing a competitor.

A former Autonomy executive laughed this week when I asked if even Autonomy executives thought H.P. had overpaid. “Let’s put it this way,” this person said. “H.P. paid a very full price. It was certainly our duty to our shareholders to say yes.” (Former Autonomy executives declined to be named because of the continuing investigation.)

Wall Street’s reaction to Hewlett-Packard’s announcement was swift and harsh. Mr. Sacconaghi wrote, “We see the decision to purchase Autonomy as value-destroying.” Richard Kugele, an analyst at Needham & Company, wrote “H.P. may have eroded what remained of Wall Street’s confidence in the company and its strategy” with “the seemingly overly expensive acquisition of Autonomy (cue the irony) for over $10B.”

Mr. Apotheker addressed the issue two days later, at a Deutsche Bank technology conference. “We have a pretty rigorous process inside H.P. that we follow for all our acquisitions, which is a D.C.F.-based model,” he said, in a reference to discounted cash flow, a standard valuation methodology. “And we try to take a very conservative view.”

He added, “Just to make sure everybody understands, Autonomy will be, on Day 1, accretive to H.P.,” meaning it would add to earnings. “Just take it from us. We did that analysis at great length, in great detail, and we feel that we paid a very fair price for Autonomy. And it will give a great return to our shareholders.”

But few seem to have seen such an analysis. At least one large shareholder asked Mr. Lane, the chairman, if the company had performed such an analysis and asked what growth assumptions were used in the model. Mr. Lane seemed unfamiliar with any discounted cash flow analysis but contended the price was justified because Autonomy was unique and critical to H.P.’s strategic vision.

At least one high-level Hewlett-Packard executive, Catherine A. Lesjak, the former acting chief executive and currently the chief financial officer, was implacably opposed to the deal and spoke out internally. According to an account in Fortune magazine, which H.P. hasn’t disputed, Ms. Lesjak made an impassioned presentation to the board and argued that the deal wasn’t in the best interests of shareholders. One person who spoke to her the day the deal was announced said she was afraid she’d be fired for being so outspoken. The week after the deal was announced, she canceled an appearance at a road show meant to defend the deal and its terms.

In the days after the announcement, Mr. Lane heard from a chorus of disgruntled major shareholders. According to Mr. Sacconaghi, who said he spoke to many of them, “Not one person thought H.P. should do this deal. There was so much bitterness. They were begging Ray Lane to find a way out to get out of the deal, but he said they were stuck.”

The Hewlett-Packard spokesman said Ms. Lesjak and Mr. Lane declined to comment. Mr. Apotheker couldn’t be reached, but he had earlier told The Wall Street Journal that H.P.’s due diligence was “meticulous and thorough” and that although the latest allegations were a “shock,” he still believed in Autonomy’s potential.

Mr. Apotheker was fired by H.P. on Sept. 22, less than a month after the announcement. Mr. Lane “did listen to shareholders, and his reaction was to fire Léo,” Mr. Sacconaghi said. “But he should also have hired a team of forensic accountants to scrutinize Autonomy’s accounting and find an excuse to get out of the deal. There were rumors swirling then that the accounting was fishy.”

The former Autonomy executive said: “There was chatter they were trying to get out of the deal. But we were never presented with anything concrete.”

The Autonomy acquisition was a disaster almost from Day 1. Mr. Lynch and other former Autonomy executives said this was entirely H.P.’s fault. “We tried really hard to make this work,” the former Autonomy executive said. “Instead of doing it the Autonomy way, which is to sweep problems out of the way and move full steam ahead, we got bogged down in H.P. process.” Far from increasing revenue at the forecast double-digit rates, Autonomy’s revenue started to drop precipitously.

H.P.’s current chief executive, Meg Whitman, who inherited the mess but was on the board when it approved the deal, went from glowing comments in November 2011 — “I am really excited about this acquisition,” which would be “priority No. 1, 2 and 3 for 2012” — to announcing just six months later, in May 2012, that Autonomy “had a very disappointing license revenue quarter, with a significant decline year-over-year resulting in a shortfall to our expectations.”

Still, no one was prepared for a write-down of the magnitude H.P. announced last week, let alone allegations of fraud. Far from being “accretive,” as promised by Mr. Apotheker, the acquisition pulled Hewlett-Packard down. The company announced a loss of $6.9 billion for the latest quarter, largely because of the Autonomy mess. H.P. shares were trading at just over $31 when the deal was announced. This week, they were nearly $13, a drop of 58 percent.

Is the Autonomy deal really worse than the legendary AOL fiasco? “Worst” is a subjective standard, and H.P. contends that Autonomy remains a uniquely valuable asset that will someday prove its worth. It’s also true that Autonomy is only one of several blunders that have hurt H.P.’s performance. It has no tablet in the market for this holiday season, and its personal computer division is still reeling from the aborted possibility of getting rid of it.

Still, the AOL deal was never alleged to be a huge fraud. And based on the impact on shareholders, a case can be made that Autonomy is worse. At the time the AOL-Time Warner deal was announced in January 2000, the combined value of the two companies was more than $300 billion. By the time Gerald Levin announced that he was stepping down as chief executive of AOL Time Warner in December 2001, the value of the company was about $159 billion, down nearly 50 percent. H.P.’s value has declined by an even higher percentage since the Autonomy deal was announced, to $25 billion from over $61 billion.

Moreover, Time Warner’s decline occurred during the collapse of the Internet bubble, when the broad Standard & Poor’s 500 dropped nearly 50 percent. During Mr. Lane’s tenure, the S.& P. 500 has gained nearly 19 percent. Adjusted for relative performance to the broad market, H.P.’s shareholders have suffered far more than Time Warner’s did.

And whatever else might be said, Time Warner survived, spun off AOL to shareholders, and today is a profitable company with a market capitalization of $45 billion. Hewlett-Packard has a market value of just over $25 billion, and vulture investors are rumored to be circling it as a candidate for a takeover or dismemberment.

Autonomy “will arguably go down as the worst, most value-destroying deal in the history of corporate America,” Mr. Sacconaghi asserted.

Whichever deal turns out to be worse, what they have in common may prove to be a more enduring legacy. Just as Autonomy was supposed to transform H.P. into a software powerhouse, AOL was meant to transform old-media Time Warner into an Internet darling. So-called transformative thinking by some board members and top management rendered traditional valuations irrelevant and silenced critics.

In both cases, that thinking proved delusional.