Inside H-P’s Missed Chance to Avoid a Disastrous Deal

 

The following appears on online.wsj.com

Days before Hewlett-Packard Co. HPQ +0.11% dived into an $11 billion software deal it almost instantly regretted, it missed a chance to back away.

During a call with an H-P delegation, outside auditors for British software maker Autonomy Corp. mentioned that an executive there had raised an allegation of improper accounting at the firm, according to people familiar with the call, who said the auditors added that the allegation was found to be groundless.

The H-P executives never passed this mention on to their board or chief executive, one of the people said.

Within days of agreeing to buy Autonomy, in the summer of 2011, H-P was looking for a way to get out of it. Before the deal even closed, H-P canned the CEO who pushed it. Then last fall, H-P wrote down the value of the software firm by $8.8 billion, blaming more than $5 billion of that on what it said was improper accounting at Autonomy designed to inflate its revenue and profit. Autonomy’s founder denied any wrong accounting.

Of a series of H-P fumbles in recent years, the Autonomy acquisition ranks among the costliest. An examination of how the technology giant got into the deal—draining its cash to pay top dollar—finds a confluence of factors: a new chief executive bent on a high-impact acquisition; a refusal by the target firm to provide certain financial data H-P sought; and an H-P board, populated with several new members, that had to wrestle simultaneously with another far-reaching proposal.

While weighing the software acquisition, directors also faced a wrenching hardware decision: whether to jettison H-P’s $40 billion-a-year personal-computer manufacturing business. To juggle two transformative initiatives at once, the board divided itself into two separate teams and skirted some standard company procedure. Meanwhile, eight of the board’s 13 members had served for less than a year and had little experience overseeing the huge company and collaborating with one another.

The board set a limit on how much to bid for Autonomy. But with the firm demanding more, and a target date for H-P to announce the deal already set, directors dialed into a conference call and approved a higher price.

Recently, H-P has received feelers about buying Autonomy from it but so far isn’t interested in selling, The Wall Street Journal reported last week. CEO Meg Whitmanconceded H-P overpaid for a company that “turned out to be smaller, slower-growth and somewhat less profitable than we anticipated,” but said the idea of the acquisition was correct and “we’re still investing in” it.

This account of H-P’s costly 2011 decision to buy Autonomy is based on conversations with a wide range of people involved with the acquisition and due-diligence process, others familiar with the deliberations of H-P’s board, and internal documents reviewed by The Wall Street Journal.

The stage was set in 2010 when H-P’s board needed a new CEO, following the departure of Mark Hurd amid a flap over whether he had violated standards of business conduct, which he said he hadn’t. Cost-cutting had been a big part of Mr. Hurd’s formula for raising profits. The company sought a CEO who could mastermind a growth strategy. Its surprise pick was Leo Apotheker, who had headed German software company SAP AG SAP.XE -0.99% for a short time but was little known in Silicon Valley.

H-P simultaneously got a new board chairman, also a software specialist: Ray Lane, a venture capitalist and former president ofOracle Corp. ORCL -1.45% Soon after, four H-P board members didn’t stand for re-election, and five new members arrived.

Mr. Apotheker proposed buying two midsize software companies. The board’s finance committee scotched one, and negotiations to buy the other fell apart over price. A frustrated Mr. Apotheker told Mr. Lane, “I’m running out of software companies,” said a person familiar with the conversation.

Autonomy, in Cambridge, England, had been on H-P’s radar screen for years but was seen as too expensive. Its name came up again at a retreat for H-P executives at the Rosewood Sand Hill hotel in Menlo Park, Calif., a month after Mr. Apotheker arrived.

Autonomy’s software, which helps businesses find relevant information in text files, video and other corporate documents, was well-positioned, and the firm was reporting steady growth. Mr. Apotheker met with its founder and CEO, Michael Lynch, at H-P headquarters in Palo Alto, Calif., in April 2011 and afterward told H-P chairman Mr. Lane he planned to propose acquiring the firm. “Now you’re talking” was the chairman’s response, according to someone familiar with the exchange.

Mr. Apotheker mentioned the idea to directors the next month and got their OK to look into it. By this time, directors were into other issues. H-P had missed financial projections two quarters in a row. Directors were aware their new CEO was at odds with some of his lieutenants.

And the board had a major decision to make. H-P had the largest PC-manufacturing business in the world. Mr. Apotheker wanted to get rid of it.

With two major proposals to weigh, involving PCs and Autonomy, the board decided to divide itself up to deal with them. One group focused on a PC-business spinoff or sale, a plan code-named Hermes; the other looked into a possible deal with Autonomy, code-named Tesla.

The Tesla team, aided by bankers from Perella Weinberg Partners and BarclaysBARC.LN -0.45% PLC, evaluated ideas ranging from a technology partnership to a full acquisition. Several senior H-P executives expressed reservations. Chief Financial Officer Cathie Lesjak said an acquisition would batter H-P’s balance sheet, using up its cash and incurring debt, said people familiar with the conversations. Ms. Lesjak declined to comment through a company spokesman.

Because only half of the directors were focused on Autonomy, it became easier to coordinate schedules for meetings with Mr. Apotheker, giving him more opportunities to lobby for a deal, said people familiar with the board’s activities.

H-P’s normal procedures require the board’s finance committee to review and approve deal proposals before they reach the full board. That didn’t happen with the proposal to acquire Autonomy, said people familiar with how the board proceeded.

Whether it would have made a difference is impossible to say. The finance committee chairman was among directors most skeptical of the Autonomy idea, said several people familiar with the board’s deliberations, but ultimately he joined in a unanimous vote to buy it. The committee chairman, McKesson Corp. MCK -0.43% CEO John Hammergren, didn’t respond to a request for comment.

The full board discussed an acquisition at a meeting July 20. Some members bristled at the likely cost. Others, including Mr. Lane and venture capitalist Marc Andreessen, wanted to push forward, said people familiar with the meeting. These people said the board authorized the CEO to bid up to a maximum of £25 a share, about $40.

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