Latepost Hp's Bargain From Hell: The Mark-It-Up Too Write-It-Down Two-Step
I don't holler back that at that spot tin give the axe move whatever disagreement that Hewlett Packard (HP) had a terrible solar daytime on Nov 20. In a surprise announcement, the company announced that it was taking a write off of $8.8 billion of the $11.1 billion that it paid to instruct Autonomy, a U.K. based engineering scientific discipline company, inward Oct 2011, together with that a large portion of this write off ($ five billion) could move attributed to accounting improprieties at Autonomy. Even past times the standards of acquisition mistakes, which tend to move costly to acquiring society stockholders, this i stood out on 3 dimensions:
I am surely that this illustration volition move examined together with reexamined over fourth dimension inward books similar this one, but at this moment, every i involved inward the merger is blaming individual else for the fiasco. So, hither is a roundup of the suspects:
Building upwards to an acquisition price: The master copy deal
Before nosotros aspect at the numbers, it is worth reviewing the history of the 2 companies involved. Autonomy was a society founded at the start of the engineering scientific discipline nail inward 1996, which soared together with crashed amongst that nail together with thus reinvented itself equally a business/enterprise engineering scientific discipline society that grew through acquisitions betwixt 2001 together with 2010. Hewlett Packard, amongst a long together with glorious history equally a pioneer inward computers/technology, had fallen on lean times equally it's PC describe of piece of occupation concern became less competitive/profitable together with due to overstep administration missteps.
On August 18, 2011, HP's thus CEO, Leo Apotheker (who had worked at SAP) announced his intent to exit of the PC describe of piece of occupation concern together with expand the enterprise engineering scientific discipline describe of piece of occupation concern past times buying Autonomy. While the grapple making began on his watch, the actual grapple was officially completed on Oct 3, 2011, amongst Meg Whitman equally CEO. If she was a reluctant participant inward the deal, it was non obvious inward the declaration she released at the fourth dimension where she said that "(t)he exploding growth of unstructured together with structured information together with unlocking its value is the unmarried largest chance for consumers, businesses together with governments. Autonomy significantly increases our capabilities to care together with extract pregnant from that information to drive insight, foresight together with ameliorate determination making."
One of the perils of assessing "big" merger deals is that the fog of grapple making, composed of hyperbole, buzzwords together with full general uncertainty, obscures the facts. So, allow me stick amongst the facts that were available at the fourth dimension the grapple was done (a fourth dimension catamenia that stretched from August 18, 2011, to Oct 3, 2011):
You tin give the axe come across the build upwards to the cost paid past times HP equally a serial of premiums:
The cost of accounting impropriety & breaking downwards blame
Let's fast forrad to today. In the conference telephone phone on Nov 18, the CFO of HP attributed the write off of $8.8 billion to 2 chief sources: $5 billion to accounting improprieties at Autonomy together with $3.8 billion to a drib inward HP's stock price. The latter rationale does non actually handgrip upwards since it mistakes motility together with effect; the stock cost went downwards because of HP's misstep (though it has made thus many that I am non surely which one) together with is non the motility of the write off. Thus, it makes feel to attribute the entire write off to the deal. Applying HP's write off of $8.8 billion to the acquisition cost of $11.1 billion, brings Autonomy's estimated value (according to HP) dorsum downwards to $2.3 billion (almost equal to the pre-deal volume value of $2.1 billion). In effect, HP is arguing that almost all of the premiums inward the master copy grapple (the accounting write up, the pre-deal marketplace premium, the acquisition premium) were non justified.
So, what shape did these accounting improprieties take? Based on tidings reports, HP's disputation is that Autonomy was "overstating" together with "mis-categorizing" revenues (they were allegedly booking depression margin hardware sales equally higher margin service/software sales). Assume for the instant that HP is right, together with that Autonomy's revenues inward 2010 were overstated past times 15% together with that its truthful operating margin was the manufacture average of 31% (and non the 36% that Autonomy was reporting inward 2010). Since the accounting misstatements predated the HP acquisition, the pre-deal marketplace value of $5.9 billion should already receive got been inflated because of the misstatements. Using the pre-deal marketplace value of $5.9 billion equally a base, I extracted an expected revenue growth charge per unit of measurement of 14.25%. I thus substituted inward the lower revenues (15% drop) together with lower margin (31%) into the valuation together with estimated a value for the equity of $4.2 billion. Put differently, if you lot purchase into HP's even fully, the value lawsuit of the accounting misstatement was $1.7 billion (the departure betwixt the pre-deal marketplace value together with the adjusted value) on the pre-deal value.
HP's declaration would move that the synergy premium of $5.2 billion that they paid was also overstated because of the accounting improprieties. Since nosotros do non receive got access to the detailed synergy estimates (assuming that they were made), nosotros assumed that the accounting overstatement would incorporate the same percentage of the synergy value it was of the pre-deal marketplace value ($1.7 billion is 28.81% of $5.9 billion) together with that one-half of this value is Autonomy's percentage (since synergy accrues to the combined firm):
Estimated accounting impropriety portion of synergy value =0.5( 28.81% of $5,200) = $749 million
I know that this may non move fair together with that I am going amongst incomplete information, but hither is my breakdown of blame for the $ 8.8 billion write down:
As I come across it, everyone involved inward this procedure owns part of this disaster. Leo Apotheker, the CEO who pushed this grapple through, gets the lion's percentage amongst $4,451 million, though the investment bankers who advised him were his enablers inward the process. To the extent that HP is correct inward its disputation that Autonomy cooked the books (inflating revenues together with margins), Autonomy's founder/ managers together with its auditor (Deloitte) are responsible for $2,449 i thou one thousand inward value destruction. That leaves us nonetheless amongst an additional $1,900 i thou one thousand inward write offs, which I tin give the axe attribute to either a deterioration of Autonomy's describe of piece of occupation concern inward the xi months since HP took it over (a shape of contrary synergy) or game playing on the part of HP, where taking bigger losses straightaway volition allow them to claim improvements together with aspect ameliorate inward the future. In either case, I would handgrip HP's electrical flow administration responsible for that portion ($1,900 million) damage. As HP stockholders, though, don't await whatever of these parties to offering to comprehend their fair share.
This grapple offers of import lessons nigh headstrong CEOs, the ineffectual accounting for acquisitions together with the flaws inward the acquisition procedure that allow bad deals similar this i to instruct through, but this transportation has cash inward one's chips besides long to expand on these issues. So, to a greater extent than inward my adjacent few posts....
The Acquisition Series
HP's grapple from hell: The mark-it-up together with write-it-down 2 step
Acquisition Archives: Winners together with Losers
Acquisition Hubris: Over confident CEOs together with Compliant Boards
Acquisition Advice: Big grapple or goodness deal?
Acquisition Accounting I: Accretive (Dilutive) Deals tin give the axe move bad (good) deals
Acquisition Accounting II: Goodwill, to a greater extent than plug than asset
- It was disproportionately large: While at that spot receive got been larger write offs of acquisition mistakes , this i stands out because it amounts to around 80% of the master copy cost paid.
- The preponderance of the write off was attributed to accounting manipulation: Most acquisition write offs are attributed either to over optimistic forecasts at the fourth dimension (the investment banker made us do it..) of the merger or changes inward operations/markets afterward the acquisition (it was non our fault). HP's claim is that the mass of the write off ($5 billion of the 8.8 billion) was due to accounting improprieties (a polite discussion for fraud) at Autonomy.
- The marketplace was surprised: Most acquisition write offs, which accept the shape of impairments of goodwill, are non-news because they lag the marketplace together with receive got no cash flow effects. In other words, past times the fourth dimension accountants instruct about to admitting a error from an acquisition, markets receive got already admitted the error together with moved on. In HP's case, the marketplace was surprised together with HP's stock cost dropped nigh $ 3 billion (12%) on the announcement. Put differently, the marketplace had priced inward an acquisition error of $5.8 billion into the value already together with was surprised past times the difference.
I am surely that this illustration volition move examined together with reexamined over fourth dimension inward books similar this one, but at this moment, every i involved inward the merger is blaming individual else for the fiasco. So, hither is a roundup of the suspects:
- Meg Whitman, the electrical flow CEO of HP, blamed the prior overstep administration at the company, together with said that "(t)he 2 people that should receive got been held responsible are gone ".
- Leo Apotheker, the prior CEO who orchestrated the acquisition, claimed to move shocked at the "accounting improprieties" at Autonomy.
- Michael Lynch, the founder of Autonomy, said that 2 major auditors had performed "due diligence" on the fiscal statements together with had institute no improprieties at the company.
- Deloitte LLP, the auditor for Autonomy, denied all noesis of accounting misrepresentations together with claimed to move cooperating amongst authorities.
- The advisers on the deal (Perella Weinberg & Barclay's Capital for HP, Quatalyst, UBS, Goldman Sachs, Chase & BofA for Autonomy) receive got all been mysteriously silent, though none receive got offered a refund of their advisory fees.
Building upwards to an acquisition price: The master copy deal
Before nosotros aspect at the numbers, it is worth reviewing the history of the 2 companies involved. Autonomy was a society founded at the start of the engineering scientific discipline nail inward 1996, which soared together with crashed amongst that nail together with thus reinvented itself equally a business/enterprise engineering scientific discipline society that grew through acquisitions betwixt 2001 together with 2010. Hewlett Packard, amongst a long together with glorious history equally a pioneer inward computers/technology, had fallen on lean times equally it's PC describe of piece of occupation concern became less competitive/profitable together with due to overstep administration missteps.
On August 18, 2011, HP's thus CEO, Leo Apotheker (who had worked at SAP) announced his intent to exit of the PC describe of piece of occupation concern together with expand the enterprise engineering scientific discipline describe of piece of occupation concern past times buying Autonomy. While the grapple making began on his watch, the actual grapple was officially completed on Oct 3, 2011, amongst Meg Whitman equally CEO. If she was a reluctant participant inward the deal, it was non obvious inward the declaration she released at the fourth dimension where she said that "(t)he exploding growth of unstructured together with structured information together with unlocking its value is the unmarried largest chance for consumers, businesses together with governments. Autonomy significantly increases our capabilities to care together with extract pregnant from that information to drive insight, foresight together with ameliorate determination making."
One of the perils of assessing "big" merger deals is that the fog of grapple making, composed of hyperbole, buzzwords together with full general uncertainty, obscures the facts. So, allow me stick amongst the facts that were available at the fourth dimension the grapple was done (a fourth dimension catamenia that stretched from August 18, 2011, to Oct 3, 2011):
- Acquisition Price: While at that spot receive got been varying numbers reported nigh what HP paid for Autonomy, partly reflecting when the even was written (between August & November) together with partly because of central charge per unit of measurement movements (HP paid £25.50/share), the actual cost of the grapple was $11.1 billion.
- Market Price prior: Autonomy's marketplace cap a few days prior to the grapple existence announced was around $5.9 billion.
- Pre-deal accounting volume value: The volume value of Autonomy's equity, prior to the deal, was estimated to move $2.1 billion. (Source: Autonomy's repose canvass from its annual study for 2010)
- Post-deal accounting volume value: After acquisitions, accountants are given a express mission of reappraising the value of existing assets together with this appraisal led to an adjusted volume value of $ 4.6 billion for Autonomy. (Source: HP's 2011 annual report, page 99)
You tin give the axe come across the build upwards to the cost paid past times HP equally a serial of premiums:
- The accounting "write up" premium for volume value: One of the residual effects of the changes that receive got been made to acquisition accounting is that accountants are allowed to reassess the value of a target company's existing assets to reverberate their "fair" value. For engineering scientific discipline companies such equally Autonomy, this becomes an practice inward putting values to engineering scientific discipline patents together with other intangible assets together with that practice added $2,533 i thou one thousand to the master copy volume value of equity.
- The pre-deal "market" premium over volume value ($1.3 billion over post-deal volume value): Even if accountants write upwards the value of assets inward house to fair value, markets may nonetheless attach a premium for growth potential together with hereafter investments. As amongst whatever marketplace number, this number tin give the axe move wrong, besides high for some companies together with besides depression for others. Prior to the HP deal, the marketplace was attaching a value of $6.2 billion to Autonomy, $3,833 i thou one thousand higher than the master copy volume value of equity together with $1.3 billion to a greater extent than than the post-deal accounting volume value of equity.
- The acquisition premium ($5.2 billion): To justify this premium, HP would receive got to had to believe that i or to a greater extent than of the next held: (i) the marketplace was undervaluing Autonomy, i.e., that the truthful value of Autonomy was much higher than the $ 5.9 billion, (ii) at that spot are synergies betwixt HP together with Autonomy that receive got value, i.e., that at that spot are value-enhancing actions that the combined describe of piece of occupation solid (HP+Autonomy) tin give the axe accept that could non receive got been taken past times the firms independently and/or (iii) that Autonomy was badly run together with that changing the agency it was run could instruct inward to a greater extent than valuable, i.e., at that spot is a command premium. Even without the benefit of hindsight, neither undervaluation nor the command premium seemed to jibe equally motives inward this acquisition. First, Autonomy was existence priced past times the marketplace richly inward August 2011; the marketplace cap of $ 5.9 billion was roughly six times revenues together with xv times earnings together with neither number looked similar a bargain. Second, for a society that had been equally badly run equally HP to move talking nigh inefficiencies at other companies (and command premiums) strikes me equally absurd.
The cost of accounting impropriety & breaking downwards blame
Let's fast forrad to today. In the conference telephone phone on Nov 18, the CFO of HP attributed the write off of $8.8 billion to 2 chief sources: $5 billion to accounting improprieties at Autonomy together with $3.8 billion to a drib inward HP's stock price. The latter rationale does non actually handgrip upwards since it mistakes motility together with effect; the stock cost went downwards because of HP's misstep (though it has made thus many that I am non surely which one) together with is non the motility of the write off. Thus, it makes feel to attribute the entire write off to the deal. Applying HP's write off of $8.8 billion to the acquisition cost of $11.1 billion, brings Autonomy's estimated value (according to HP) dorsum downwards to $2.3 billion (almost equal to the pre-deal volume value of $2.1 billion). In effect, HP is arguing that almost all of the premiums inward the master copy grapple (the accounting write up, the pre-deal marketplace premium, the acquisition premium) were non justified.
So, what shape did these accounting improprieties take? Based on tidings reports, HP's disputation is that Autonomy was "overstating" together with "mis-categorizing" revenues (they were allegedly booking depression margin hardware sales equally higher margin service/software sales). Assume for the instant that HP is right, together with that Autonomy's revenues inward 2010 were overstated past times 15% together with that its truthful operating margin was the manufacture average of 31% (and non the 36% that Autonomy was reporting inward 2010). Since the accounting misstatements predated the HP acquisition, the pre-deal marketplace value of $5.9 billion should already receive got been inflated because of the misstatements. Using the pre-deal marketplace value of $5.9 billion equally a base, I extracted an expected revenue growth charge per unit of measurement of 14.25%. I thus substituted inward the lower revenues (15% drop) together with lower margin (31%) into the valuation together with estimated a value for the equity of $4.2 billion. Put differently, if you lot purchase into HP's even fully, the value lawsuit of the accounting misstatement was $1.7 billion (the departure betwixt the pre-deal marketplace value together with the adjusted value) on the pre-deal value.
HP's declaration would move that the synergy premium of $5.2 billion that they paid was also overstated because of the accounting improprieties. Since nosotros do non receive got access to the detailed synergy estimates (assuming that they were made), nosotros assumed that the accounting overstatement would incorporate the same percentage of the synergy value it was of the pre-deal marketplace value ($1.7 billion is 28.81% of $5.9 billion) together with that one-half of this value is Autonomy's percentage (since synergy accrues to the combined firm):
Estimated accounting impropriety portion of synergy value =0.5( 28.81% of $5,200) = $749 million
I know that this may non move fair together with that I am going amongst incomplete information, but hither is my breakdown of blame for the $ 8.8 billion write down:
As I come across it, everyone involved inward this procedure owns part of this disaster. Leo Apotheker, the CEO who pushed this grapple through, gets the lion's percentage amongst $4,451 million, though the investment bankers who advised him were his enablers inward the process. To the extent that HP is correct inward its disputation that Autonomy cooked the books (inflating revenues together with margins), Autonomy's founder/ managers together with its auditor (Deloitte) are responsible for $2,449 i thou one thousand inward value destruction. That leaves us nonetheless amongst an additional $1,900 i thou one thousand inward write offs, which I tin give the axe attribute to either a deterioration of Autonomy's describe of piece of occupation concern inward the xi months since HP took it over (a shape of contrary synergy) or game playing on the part of HP, where taking bigger losses straightaway volition allow them to claim improvements together with aspect ameliorate inward the future. In either case, I would handgrip HP's electrical flow administration responsible for that portion ($1,900 million) damage. As HP stockholders, though, don't await whatever of these parties to offering to comprehend their fair share.
This grapple offers of import lessons nigh headstrong CEOs, the ineffectual accounting for acquisitions together with the flaws inward the acquisition procedure that allow bad deals similar this i to instruct through, but this transportation has cash inward one's chips besides long to expand on these issues. So, to a greater extent than inward my adjacent few posts....
The Acquisition Series
HP's grapple from hell: The mark-it-up together with write-it-down 2 step
Acquisition Archives: Winners together with Losers
Acquisition Hubris: Over confident CEOs together with Compliant Boards
Acquisition Advice: Big grapple or goodness deal?
Acquisition Accounting I: Accretive (Dilutive) Deals tin give the axe move bad (good) deals
Acquisition Accounting II: Goodwill, to a greater extent than plug than asset
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