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It’s too late for HP – but analysts and accountants say they had doubts about how Autonomy was able to grow its business so quickly
The explosive result of Hewlett-Packard’s claim that the British software company Autonomy had indulged in “outright misrepresentation” of its financial results has hit the markets – and HP’s stock – hard. Autonomy had been one of the leading lights of British software, and its co-founder Mike Lynch one of the most luminous names.
Yet after HP’s announcement, many were quick to say that they had told everyone so – but held back for one reason or another. And in some cases, they could even point to doubts expressed long before HP’s shock writedown – and even before the takeover was completed.
As the deal was announced in August 2011, Leslie Owens of Forrester blogged that she had “a few issues with the narrative of the company”, and suggesting that the idea that its software could “manage unstructured information for competitive advantage” wasn’t quite right: “Here’s the wrinkle – Autonomy hasn’t solved that problem,” Owens wrote, querying the value of its IDOL (Intelligent Data Operating Layer) system. The blogpost asked rhetorically “What is Autonomy without its marketing?”
Similar doubts are expressed by Charlie Hull of Flax, an open source search company. “Autonomy’s ability to market its technology has never been in doubt: aggressive and fearless, it painted IDOL as unique and magical, able to understand the meaning of data in multiple forms. However, this has never been true; computers simply don’t understand ‘meaning’ like we do. IDOL’s foundation was just a search engine usingBayesian probabilistic ranking; although most other search technologies use the vector space model there are a few other examples of this approach.” He adds: “It’s important to remember though that Bayesian ranking is only one way to approach a search problem and in many cases, simply unnecessary. It certainly isn’t magic.”
But it’s the accountancy – or the way that the company recorded its revenues and hence profits – that has exercised analysts for years. Because Autonomy’s share ticker symbol was “Au”, the chemical shorthand for gold, many sceptics liked calling the shares “fools’ gold”.
At Forbes, Daniel Fisher was brutal: “With Autonomy, HP bought an old-fashioned accounting scandal,” said the headline.
Fisher said he had been told Autonomy “was vaporware writ large: an $11 billion software company with an overhyped flagship product that was literally being given away because customers didn’t have a use for it.”
He says that his sources told him there was “really sketchy accounting going on” and that the tactic used by Autonomy was to book all the revenue in the present from contracts that would be continuing for years.
Fisher explains: “Here’s what my source observed personally. Autonomy grew through acquisitions, buying everything from storage companies like Iron Mountain to enterprise software firms like Interwoven. They’d then go to customers and offer them a deal they couldn’t refuse. Say a customer had $5 million and four years left on a data-storage contract, or “disk,” in the trade.
“Autonomy would offer them, say, the same amount of storage for $4 million but structure it as a $3 million purchase of IDOL software, paid for up front, and $1 million worth of disk. The software sales dropped to the bottom line and burnished Autonomy’s reputation for being a fast-growing, cutting-edge software company a la Oracle, while the revenue actually came from the low-margin, commodity storage business.”
Autonomy’s former management, including Mike Lynch, have said they were not told of the charges made on Tuesday by HP, and have rejected suggestions of wrongdoing. No charges have been laid against any former or current directors of Autonomy or HP.
There had been murmurs – some very loud – before. Richard Windsor, formerly at Nomura Securities, says it was a case of caveat emptor (buyer beware): “Autonomy’s detractors have been writing about this for years and there has been the occasional obvious sign that things were not quite right. The most common red flag was that cash flow in some quarters often did not match profit. This is quite unusual in a software company. The balance was often made up in subsequent quarters but critically, this and other issues caused people to wave the red flag.” He adds: “To any reasonably prudent person, this would have made him doubly cautious when looking into the financial position of Autonomy.”
And those flags – once you start looking – looked like a parade. John Hempton, founder of Bronte Capital Management says that he was extremely suspicious of the company, and that on 25 October he made a presentation at the Santangels conference in New York. There he gave a presentation about how to spot misleading accounts – in order to educate his investor listeners.
The example Hempton used: Autonomy.
Deferred and receivable
Hempton pointed to the disparities between Autonomy’s sales ($870m {$545m} for the whole of 2010), its “receivables” (money that it is owed) and its “deferred revenue” (money that will be paid in the future).
The “receivables” of $330m equated to four and a half months’ revenues. The deferred revenue – $177m – was only half the receivables.
“This is really perverse for a software company,” Hempton writes. “Software companies sell stuff that is barely tangible – they sell it up front and for cash. They have very few receivables. They do however have an obligation to service that software for a long time after they sell it – so the unearned income is relatively large (usually a multiple of receivables.”
But that wasn’t happening, he argues. In Autonomy’s case, it was the other way round. “Autonomy was booking as income lots of cash it had not received (which is why the receivables were large) and not booking any obligation to provide future services for that income.
“This is prima-facie suspect (and you could tell simply by looking at the balance sheet). All it required was basic applied accounting.”
HP’s management told the Guardian on Tuesday that the alleged malfeasance had been going on “for at least eight quarters” before the takeover. That would go back to the third quarter of 2009 . Meg Whitman, HP’s CEO, said that if the figures had been reported correctly then the operating margins would have been “28 to 30%, rather than 45%.”
Intriguingly, until the second quarter of 2008, Autonomy’s operating margins wavered from 28% to 37% – but after that they took off, hitting a peak of 50% in the fourth quarter of 2009. The operating margin reflects the profit on activities, ignoring tax and other non-operational expenses.
HP management takes flak
And there’s been plenty of blame for HP’s management too. At Bloomberg, Jonathan Well suggests that “the numbers don’t make sense”, pointing out that HP says “more than $5bn of the writedown” against Autonomy is linked to the alleged accounting improprieties: “One reason the previous number seems odd is that Autonomy showed only $3.5bn of total assets as of June 30, 2011. That was the date of the last balance sheet Autonomy publicly disclosed before it was bought by HP in November 2011,” he says, adding:
“Perhaps it’s true that Autonomy somehow committed more than $5bn of financial-reporting improprieties with only a $3.5bn balance sheet. I’m not sure how this is possible. But if it is, HP should explain. So far the company hasn’t.” He points to the $6.9bn of “goodwill” – the premium a suitor pays to win a company over and above its tangible asset value – that HP paid: the $11bn purchase consisted of $4.3bn of intangibles and others, with the rest in goodwill.
http://www.guardian.co.uk/business/2012/nov/22/autonomy-hp-warnings-analysts
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