Boy, you talk about having a run of really bad luck. Over the last decade, HP has had the most incredible run of questionable decisions by ex-CEOs, board members and top executives, most of which are long gone from the company and yet the firm still is experiencing the fallout.
From Mark Hurd cutting the company so deep it was barely viable and then allegedly using it as an extramarital dating service, to the most recent allegation that Autonomy was fraudulently presented to the company, the prior two CEOs stand out as doing more damage to the firm than any competitor or economic problem. And that says a lot since HP has had Oracle and the last market crash to deal with on top of everything.
I doubt Meg Whitman had any idea things would be so bad. But this latest Autonomy problem showcases an exposure that could happen to any acquiring company and there are deep lessons here.
Let’s cover them.
The importance of a good CFO can’t be understated when making a major acquisition and Cathy Lesjak, HP’s CFO, is considered one of the best. What is little known is she was outspoken in her objection to the Autonomy acquisition but was overridden by then-CEO Leo Apotheker, who said the due diligence for Autonomy was meticulous.
But when your CFO throws her, or his, body in front of a deal, it is either time to reconsider the deal or reconsider the CFO. In this case, the former would appear to have been the better path and I know HP has increased Cathy Lesjak’s authority over acquisitions to assure something like this never happens again.
So the cause of the mistake, at least part of it, was the lack of authority by the CFO over a process she should mostly own. It has already been corrected to help assure this doesn’t happen again.
It is hard to protect against someone intentionally falsifying financial documents. As an ex-internal auditor, if there is enough collusion to disconnect the financial documents from reality, unless you go in knowing they are false, you are unlikely to discover the issue. An acquiring company, until it consummates the purchase, isn’t allowed even an auditor’s level of access. It can request documents, but if the source documents sampled agree with the financial statements presented, there is no foundation, unless someone got sloppy, to assume they are inaccurate.
The reason why we don’t have a lot of fraud during acquisitions is that falsifying financial statements for public companies is a criminal and career-ending offense against the investors, and for both a private and public company it is fraud. And given the dollar value of the fraud, the prison time, if found guilty, can be several years on top of returning the money stolen, not to mention a significant amount for punitive damages and potential fines.
Like robbing a bank, unless you went to a country that doesn't offer extradition, you’d end up with far less money, far less freedom and no career at the end of the process. Now the sellers could argue they weren’t aware of the problem, but they remain liable nonetheless.
Now, minor omissions are common and the likelihood of the purchasing company going ballistic for them is slight because the acquiring firm doesn’t want to appear incompetent. But if the misrepresentation, as HP alleges, is in the billions, it has an obligation to its own stockholders to report the problem and move aggressively to recover what was illicitly taken.
Now given all of that, I really doubt the sellers of Autonomy were aware, as a group, what shape it was in. It is also clear that HP believed it was in some kind of bidding war that it was desperate to win, which is likely why the views of the CFO were disregarded.
For Autonomy, which had been formed through acquisitions that, I’m told, hadn’t gone well, there likely was a huge amount of pressure to show success where there wasn’t by the executive team and this kind of panic often leads to significant financial misstatements in order to cover up the widening financial problem, betting that things will eventually turn around (they seldom do) and that the misstatements age out.
So you had Autonomy, which desperately wanted to cover up massive execution problems, issuing false financial statements to its investors; executives who likely knew this was a huge problem and hoped for a quick fix that a sale might provide; and a buyer that desperately wanted to show major progress down a software path to validate two questionable CEO moves: the firing of Hurd, whom the financial analysts liked, and the hiring of Apotheker, whom they didn’t.
This appears to be the formula for a catastrophe.
Wrapping Up: Acquisition Method
Now that the mistake is in HP’s history, process changes have been put into place to assure this same mistake is less likely to occur, and the CEOs who were responsible are both gone from the acquired and acquiring companies. However, one final lesson stands out: HP’s acquisitions have been going very badly and so had Autonomy’s. Both firms appear to have used the integration merger process, which appears to have a better than 80 percent failure rate.
While this showcases an ongoing problem of doing things the way they have always been done, regardless of how badly they work out, it should also showcase that firms like EMC and Dell have been following a very different path far more successfully of late and that it is their example, not the historical failed process, that should now be followed.
Had Autonomy executed a better acquisition process, it would likely have been worth what HP paid and, even if it wasn’t, the company likely wouldn’t have been under near as much pressure to allegedly alter the financials. Had HP followed the different process, it would have focused on the value of the assets more and would have more accurately valued the property. And not to mention other catastrophic recent acquisition failures like Palm would have been avoided.
As an ex-auditor, I realize that while a lot of the focus will be on finding people to blame for this, I think that more focus should be put on making sure this kind of thing doesn’t happen again at HP or to you. We can learn from the mistakes of others. HP has been an excellent teacher, though I think it is well past time it passed this responsibility on to another firm.