Hewlett-Packard rocked investors when it claimed UK firm Autonomy had sold it a pup. Katherine Rushton reports on a transatlantic technology battle .
When British entrepreneur Mike Lynch is not obsessing about software, he likes to stride around his Suffolk estate taking potshots at rabbits.
He often gives them names, calling them after the analysts, investors and journalists who have questioned whether his technology business, Autonomy, is as financially robust as he claims.
Today, he will have a few more targets, led by Meg Whitman, chief executive of Hewlett-Packard. The American computer giant – which rattled investors by buying Autonomy for an eye-watering $11.1bn (£7.1bn) last August– last week rattled them again as it turned on the company it formerly loved and wrote off $8.8bn.
Whitman accused the Cambridge software firm of using serious accounting improprieties to wilfully misrepresent the business, which specialises in searching unstructured data such as texts, voice mails and video. It was this, she claimed, which prompted HP’s huge payment.
Whitman delivered the news – to investors, America’s Securities and Exchange Commission and the UK’s Serious Fraud Office – without a word to Lynch. The bombshell shocked HP’s long-suffering shareholders and the share price fell once again, to its lowest point in a decade.
Lynch came out fighting , denying any wrongdoing and accusing HP of trying to make a “scapegoat” of him to distract from its own “flip-flopping” strategy. “They were trying to silence me with one killer blow, but they couldn’t silence me with that one,” he told The Sunday Telegraph this weekend.
His approach will not have surprised long-time Autonomy observers. After all, this is a man who last year had a public row with Larry Ellison, the multi-billionaire founder of Oracle, over whether Lynch had tried to sell his software company to the Silicon Valley titan.
Lynch is also reputed to have exacted revenge on bear analysts, such as Peel Hunt’s Paul Morland, who has been raising red flags over Autonomy’s accounting methods for years, by blocking them from investor meetings.
That rod-of-iron approach was also apparent within Autonomy. The company, which grew out of Mr Lynch’s work as a PhD student at Cambridge, would sack 5pc of its sales force every quarter to weed out the weakest.
The best would be treated “like rock stars”, according to senior sources who used to work there, but there was zero tolerance for even mediocre performers. “The attitude was that you were lucky to be part of it,” says one former senior executive.
When Lynch brokered the deal to sell to HP, he made certain that its then chief executive, Leo Apotheker, and its chief technology officer, Shane Robison, would allow him to keep this driven entrepreneurial spirit.
“What Leo and Shane realised was that Autonomy had a different culture, that it needed to be left alone and built around,” he says. “Instead, what we got was a tank driver being put in charge of a Formula 1 car.”
Before her arrival, the three men shared a vision of using Autonomy to help HP to abandon the old world of hardware and focus exclusively on software.
The margins for hardware were being squeezed, and although HP still ranked as the biggest PC maker in the world, it was steadily ceding ground to cheaper players in emerging markets. Indeed, China’s Lenovo finally overtook HP last month.
Meanwhile, the software giants HP once counted as allies, such as Oracle, Cisco and EMC, were marching ahead in higher-margin areas such as networking, servers, storage and virtualisation.
The move to abandon hardware was controversial, but not so far-fetched. IBM had already effected a similar turnaround, such that executives used to joke that HP sold its kit to tech workers in the basement while IBM was on the top floor talking to chief executives.
Mr Lynch thought he could ensure HP’s long-term survival by reshaping the company as a “more high-value, high-margin business, selling to the people with the budget”, he explains. According to colleagues, his long- term ambition was even bigger.
“Mike and the team genuinely thought that they were taking over HP in order to transform the IT industry. The attitude was that we were a Trojan horse within HP,” said a source.
Apotheker announced the massive shift in HP’s strategy at the same time as the Autonomy deal.
It was a lurching change of direction and after previous mishaps it sealed his fate as far as investors were concerned. Both Apotheker and Robison were ousted in the following months.
But when Whitman, a former chief executive of eBay, took the helm, she was also quick to endorse Autonomy.
The two companies had “shared hundreds of sales leads”, she claimed, as she vowed that increasing the size of Lynch’s business would be her “priority one, two and three”. Meanwhile, Lynch said that Ms Whitman understood Autonomy and was giving it room to breathe.
The honeymoon period did not last long. It dawned on Lynch that the writing was on the wall at 6pm on November 1, 2011. Whitman was on a conference call with Autonomy’s senior management team in Cambridge, discussing an internal argument with the rest of HP’s software division.
“[That’s] the day I knew we were in trouble,” Lynch said. “She said, 'Autonomy, you’ve had your fun as a start-up. Now it’s time for you to grow up.’ This was a start-up that was a FTSE 100 company. We put the phone down and that’s when we knew that the Leo and Shane plan wasn’t working.”
Autonomy was already locked in a culture clash with “bureaucratic” HP, which was being damaged by “internecine wars”.
“Divisions within HP didn’t [help]. It was like boarding a plane, realising the engine is on fire, and then going up to the cockpit only to find that the pilots are having a fight,” Lynch said.
Lynch said that departments would fight over which of them was able to claim credit for bundled deals, while HP’s sales people poured their efforts into selling rivals’ software over and above Autonomy’s.
“You could get commission if you sold an Autonomy competitor, but not if you sold Autonomy,” Lynch said.
“Sales people are coin-operated, so you can imagine the results.” In some cases, they undermined Autonomy by telling customers that HP computers were not certified to use Autonomy’s software, Lynch claims.
Meanwhile, the British outfit was also lumbered with responsibility for several “low-margin, negative-growth” firms.
One of these, Tower Software in Australia, was “a real dog of a business and brought in a lot of bureaucracy”, Lynch said. “They kitchen-sinked us.”
Morale suffered, sparking an exodus of talent. The majority of Autonomy’s senior managers had already abandoned ship by the time Lynch left the following May. He did not part on amicable terms. “I didn’t quit, I was fired,” he said.
As far as he is concerned, HP has ridden rough-shod over his reputation since.
Whitman has been careful not to name names, telling analysts simply that the executives who should be held to account had already left the company, and that HP should have been able to rely on Deloitte’s accounts.
“It is a little challenging to go in and say, 'Gee, we need to double-check Deloitte’,” she said.
The company has yet to publish full details of the alleged anomalies in Autonomy’s books, but it has accused the company of recording revenues from its relatively slow-growing hardware business as faster-growing software sales, and of counting sales to wholesalers, whether or not that wholesaler had sold the product on to the end customer.
Lynch is adamant that HP is stirring up a “PR war” as a distraction technique to mask its disastrous performance in recent years. The way he paints it, the issue turns on different interpretations of accounting standards, and he insists in any case that HP was made fully aware of everything that was going on.
Autonomy might have used some of the accounting practices HP now claims are irregular, he admits, but it complied with International Financial Reporting Standards at all times.
Certainly Autonomy had some decent brains on the case. The year before the HP deal, its chief financial officer Sushovan Hussain was crowned FTSE 100 finance director of the year, and the “FD’s FD”.
But even if HP is right and $100m of Autonomy’s revenues were wrongly classified as software sales, there is still a big leap between that figure and last week’s colossal write-down.
Aswath Damodaran, a professor of finance at New York University’s Stern School of Business, told a US newspaper that of the $8.8bn, “I’d be very surprised if more than a couple of billion was due to accounting improprieties”.
As Mr Lynch is keen to point out, HP has form with massive write-downs. It booked an $8bn charge in August for EDS, the services business it bought for $13.9bn in 2008. Last year, it recorded impairments for handset maker Palm and PC company Compaq.
“At the end of the day, it’s caveat emptor, buyer beware. HP rushed into it and paid a crazy premium,” says Jim Chanos, whose $6bn hedge fund Kynikos has a short position on HP. “This is a board that has agreed to a number of disastrous deals. It’s one of the most dysfunctional boards in America. They should be ashamed of themselves.”
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