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Should takeovers come with a health warning?

Roger Barker, director of corporate governance and professional standards, Institute of Directors

Guest post by Roger Barker*

When it comes to whistle-blowing over alleged accounting irregularities, they don't come much bigger than this. In recent months, a massive whiff of scandal has surrounded the purchase of UK software company Autonomy by Hewlett Packard (HP) in 2011.

It's reported that the takeover was prompted by HP looking for something more exciting than its current product mix of computer hardware and printing inks. High margin software offered them a way out.

But, the $11bn sale of Autonomy in October 2011 to HP was followed a year or so later by a shock write-down relating to the transaction of an eye-watering $5bn (source: Financial Times, 18 February 2014).

According to HP, a whistleblower from Autonomy had decided to step forward and tell their new bosses about alleged financial irregularities in the newly-acquired business.

The allegations centred around Autonomy's practice of not only selling its own software but also discounted third party computer hardware to large financial institutions.

This practice has been described by HP investigators as a means by which Autonomy artificially inflated software revenues. HP thought it was buying a software company with massive software revenues - but according to HP these revenues were apparently not all they seemed.

HP has since informed both the FBI and Securities and Exchange Commission about its allegations. It is, it claims, the victim of a multi-billion-dollar scam.

To add fuel to the fire, EY, HP's auditors, recently republished Autonomy accounts, which show half the previously declared revenues and 81 per cent less profit.

Autonomy meanwhile, counter-claims that HP was well aware of the accounting practices relating to the booking of software revenues. They claim to have evidence that such practices were being discussed by HP executives long before the emergence of any whistleblower.

The losses it made on the hardware were apparently fully recognised in the result for the period, and they were accounted for as a Sales and Marketing expense in a report by Deloitte in October 2009.

Far from being a victim, Autonomy claims that HP has been the architect of its own misfortune, destroying the value created by the acquisition through overwhelming bureaucracy, internal disruption and mismanagement.

HP shareholders are far from impressed, and have sued HP for the cost of the write-down and the fact the board allegedly ignored financial irregularities before the sale went through.

So, is HP the victim here? Investigators will need to look into the allegations of accounting malpractice, disclosure failures and misrepresentation, which would amount to a massive scandal.

But there is also the question of governance- did the HP board overpay for Autonomy as shareholders claim? There was scepticism voiced by some analysts about Autonomy before the sale. So what on earth was happening during due diligence?

Was HP blinded by the opportunity in front of it? Did the prospect that Autonomy offered, including entering new and lucrative markets and acting as a catalyst for a more entrepreneurial culture, prove simply too tempting for proper checks and balances to be in place? And were decisions subject to appropriate independent scrutiny?

There are so many questions yet to be answered. Autonomy's external auditors, Deloitte, it has to be said, strenuously deny any wrongdoing.

It's hard to know at this point in the investigation if whistleblowing acted as the wake-up call to the HP board that they have claimed, alerting them to practices they say they had no prior knowledge of. But the fact that a whistle-blower was prepared to speak up might have wider ramifications for future deals, if, as this suggests, there is only limited protection that can be afforded through established accounting principles and rules.

There is no doubt how hard it can be for boards to make decisions - often based on partial information - in a complex world. The lesson, once again, has to be proceed with caution when it comes to takeovers, particularly in view of the finding of some academic studies that up to 70% may be value-destroying rather than value enhancing.

Caveat emptor.

*Dr Roger Barker is director of corporate governance and professional standards at the Institute of Directors


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