5 Warning Signs HP Missed When It Bought Autonomy

Danger Ahead?

Hewlett-Packard stunned the IT world Tuesday when it disclosed plans to take an $8.8 billion "impairment" charge for its $11.1 billion acquisition of Autonomy last year. In a statement, HP said some former members of Autonomy's management team "used accounting improprieties, misrepresentations and disclosure failures" to inflate Autonomy's value prior to the acquisition.

But should HP have known better? There were warning signs at the time the deal was struck -- and before -- that HP might not be getting what it was paying for.

Here are five warning signs that, in hindsight, HP might have paid more attention to.

Autonomy's Financials

Autonomy certainly has some cool technology, but in the years leading up to the HP acquisition there were some storm clouds on the horizon in terms of the company's finances.

True, for fiscal 2010 the company reported 18 percent growth to $870 million in revenue. But a story on the Daily Telegraph website dated Oct. 31, 2009 –- two years before Autonomy was acquired by HP –- raised concerns about the company's growth rate. The story specifically questioned Autonomy's ability to turn earnings into cash and said the company's cash conversion rate "should ring alarm bells for investors."

British analysts often seemed skeptical of Autonomy's financial results. "There is always something of concern with Autonomy, whether it is poor cash conversion or increased research and development capitalization," said Paul Morland, an analyst at KBC Peel Hunt, quoted in a Daily Telegraph story after the software company reported worse-than-expected second quarter results in July 2010.

Close Scrutiny

HP executives might have paid close attention to Deutsche Bank analyst Marc Geall's 2010 skeptical, 26-page report on Autonomy. Why? Because Geall worked at Autonomy until June of that year, running a software division for several years and then serving as head of investor relations and corporate strategy.

Geall, who today is head of corporate strategy for SAP, was highly critical of Autonomy's management and business model. The management structure, control and systems at Autonomy, he said, were "more representative of a start-up than a major global player." Senior management, while talented, lacked "bandwidth," he wrote. "This can lead to some decision paralysis as middle management is sometimes limited in its autonomy." Geall's report went on to say that Autonomy's investment in the business had lagged revenues, a problem that "could affect customer satisfaction towards the product and the value it delivers." He also described the company's service business as "too lean" and "risk[ed] falling short of standards demanded by customers."

Did Autonomy CEO Lynch "Doth Protest Too Much?"

Autonomy co-founder and CEO Mike Lynch (pictured) had developed a reputation for being combative with financial analysts who were bearish on Autonomy's financial performance.

When Autonomy execs held a call with financial analysts in October 2009 about third-quarter results, analysts with a "sell" rating on Autonomy stock were prevented from asking questions, according to a Daily Telegraph story. Autonomy denied those allegations.

Nine months later The Telegraph published another story, under the headline "Autonomy boss Mike Lynch attacks bearish analysts as shares tumble," in which Lynch was quoted as saying that U.K.-based analysts had difficulty understanding the complexities of software.

HP's CFO Opposed The Autonomy Acquisition

In what was perhaps the biggest red flag of all, Hewlett-Packard CFO Catherine Lesjak (pictured) spoke out against the acquisition deal before HP's board of directors in the summer of 2011, according to a story published in Fortune in May.

"I can't support it," she told the directors, the story said, quoting a person who was present. "I don't think it's a good idea. I don't think we're ready. I think it's too expensive. I'm putting a line down. This is not in the best interests of the company."

The board ultimately backed the acquisition as it had been engineered by then-HP CEO Leo Apotheker -- who was reportedly furious with Lesjak for her opposition. But Apotheker was fired little more than a month later, and some HP board members are undoubtedly wishing they had listened to the CFO.

Oracle Rejected Autonomy's Price Tag As "Absurdly High"

After Hewlett-Packard announced its plans to acquire Autonomy, Oracle CEO Larry Ellison (pictured) claimed that Autonomy had been shopped to Oracle, but Oracle decided against bidding for the company.

"Autonomy was shopped to us," Ellison said during an earnings call in September 2011. "We looked at the price and thought it was absurdly high. We had no interest in making the Autonomy acquisition."

Autonomy CEO Mike Lynch issued a denial that he had shopped the company to Oracle. That set off some dueling press statements between both parties (one Oracle press release was headlined "Another Whopper from Autonomy CEO Mike Lynch"). For good measure Oracle posted the presentations Autonomy sent to Oracle president Mark Hurd and they're still available online today.