Compliance Evangelist

Last week, former Autonomy Corporation PLC founder Mike Lynch was found to be extraditable to the US by a UK court for his alleged fraud in the company’s acquisition by Hewlett-Packard Company (HP). The BBCreported, “HP and US prosecutors allege that Dr Lynch and other former Autonomy executives artificially inflated the software company’s revenues and earnings between 2009 and 2011, causing HP to overpay for the firm.” This is just one more development in perhaps one of the most disastrous mergers in this century. It led HP, which paid some $12 billion for Autonomy in August 2011, to write down the deal off its books some 15 months later wiping out some $8.8 billion in company value.

The extradition ruling continues the story of the Department of Justice (DOJ) bringing a criminal complaint against Lynch in 2020. The DOJ wants to try him in San Francisco, the home of HP. Lynch “has argued that HP used the allegations to cover up its own mismanagement of Autonomy after the 2011 deal.” Lynch was quoted that “I don’t think that we did anything wrong at Autonomy, but let me remind you that HP, of its own free will, decided to pay 70% more for Autonomy than its price on the London stock market. It was an astronomical amount of money, but it was their choice – not ours.”

Left unanswered at this point, are whether the actions of HP allowed any misevaluation to occur, failed to engage in a reasonable level of due diligence or even tried to make the deal work in the first place. As reported by Ben Worthen and Justin Scheck in the Wall Street Journal (WSJ) article “Inside H-P’s Missed Chance To Avoid a Disastrous Deal”, HP did not follow its own internal protocol for acquisitions during the time that led up to its purchase of the British company Autonomy. Additionally, HP’s actions and decisions before and after the acquisition probably steered the deal in to, at a minimum, a very difficult path to success.

New Leadership

In 2010, HP made the decision to bring in someone, who was little known in Silicon Valley, to run the company, that person being Leo Apotheker, who had headed the German company, SAP. However, little noted at the time was the change in the Board of Directors, where “HP simultaneously got a new board chairman, also a software specialist: Ray Lane, a venture capitalist and former president of Oracle Corp. Soon after, four HP board members didn’t stand for re-election, and five new members arrived.” In other words, a majority of the top leadership positions in the company changed in a very short time.

Apotheker immediately made clear his desire to purchase one or more software companies. However, the Board of Director’s “finance committee scotched one, and negotiations to buy the other fell apart over price. A frustrated Mr. Apotheker told Mr. Lane, “I’m running out of software companies,” said a person familiar with the conversation.” This led HP to take a look at Autonomy.

Board Protocol 

Another change for HP in the pre-acquisition process regarding the Autonomy deal related to Board of Director oversight. It came about because Apotheker had two major initiatives early in his tenure. One was to divest the company of its PC-manufacturing business. The second was to purchase Autonomy. These initiatives were considered so large and complex that the Board of Directors split itself into two separate groups to evaluate each proposal. So only half the Board was looking into the details of the Autonomy deal. Further, “H-P’s normal procedures require the board’s finance committee to review and approve deal proposals before they reach the full board. That didn’t happen with the proposal to acquire Autonomy, said people familiar with how the board proceeded.” While the split of the Board of Directors provided some ease of coordinating some logistical issues such as scheduling meetings, it provided Apotheker, with “more opportunities to lobby for a deal, said people familiar with the board’s activities.”

Red Flag Raised (or not)

One of the things that HP’s Board of Directors were surprised about during the due diligence process was “how little detail about the target firm’s finances became available. Autonomy allowed a review of financial statements and about 25 sales contracts. H-P also wanted the “working papers,” or original financial material, underlying Autonomy’s audits. Autonomy declined to provide them, citing U.K. corporate-takeover rules that require companies to disclose the same documents to all potential suitors.” While understanding that it is never the case that an acquiring company gets to review everything that it wants to during due diligence, reviewing only 25 sales contracts for a company that you are about to spend over $8 bn on does seem a bit of an under-representation of financial data to review. Moreover, some of the members of the HP due-diligence team “said they were reassured, to some extent, by Autonomy’s being a public company that had been audited for years.” Autonomy’s UK audit firm was Deloitte.

But even Deloitte raised red flags with HP, however weakly. At one point, people from HP and KPMG, HP’s audit team in the acquisition of Autonomy, spoke by telephone with the Deloitte team. Someone at Deloitte “mentioned that about a year earlier, an Autonomy finance executive had alleged improper accounting at Autonomy, according to people familiar with the call. Three of these people, said Deloitte mentioned the issue briefly and added that a review had found the allegation to be baseless. The HP team didn’t investigate further, one of the people said, and didn’t share the information with either Mr. Apotheker or HP’s board.” The articles claims that “Neither Mr. Apotheker nor the directors ever heard such an allegation during negotiations, according to several people either close to the CEO or knowledgeable about the board. Said one: “There were zero red flags raised about this company during the whole process.””

Loss of Steam

There was a decided lack of enthusiasm by some members of the HP senior management team over the Autonomy transaction. For instance, “Chief Financial Officer Cathie Lesjak said an acquisition would batter H-P’s balance sheet, using up its cash and incurring debt, said people familiar with the conversations.” Pretty profound when you think about it now. But beyond simply the Autonomy debacle, the Board of Directors was becoming equally uneasy with Apotheker’s desire to cut the heart out of the company by getting rid of the PC-manufacturing business. So just after the Autonomy purchase, the Chairman of the Board, Lane “spoke to senior HP executives and found a near-universal view that their CEO wasn’t right for the job. In late September 2011, 35 days after the agreement to buy Autonomy and 11 months into Mr. Apotheker’s tenure, the board dismissed him.”

This meant that the person who had shepherded the deal through the company was gone. Apotheker had not only pushed for the deal but said he had plans on how to integrate Autonomy into HP and make it work. He was quoted in the WSJ article as saying, “”We had concrete and ambitious plans on how to integrate and leverage the Autonomy acquisition,” Mr. Apotheker said. “But I was gone by the time the deal closed.”” This led to claims by the head of Autonomy, Mike Lynch to claim that the intention for HP to integrate and sell Autonomy software after the transaction never came to pass. “Within weeks, Mr. Lynch told the new HP CEO, Ms. Whitman, in an email that when he discussed with HP’s server unit the idea of selling Autonomy software along with HP hardware, he received a “very negative response.””

Join us tomorrow for Part 2 where we look at post-closing, allegations to and from across the Atlantic and the civil trial.

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