HP Turnaround Hits Autonomy Wall

NEW YORK ( TheStreet) -- Hewlett-Packard's ( HPQ) says it is the victim of an accounting fraud related to its $11.1 billion Aug. 2011 acquisition of British software giant Autonomy, a poor performing unit at the heart of turnaround efforts at the world's largest personal computer maker.

In earnings released before the opening bell on Tuesday, HP also recorded a $8.8 billion fourth quarter writedown of its Autonomy unit, erasing most of the software analytics unit's value to shareholders, and casting in doubt the company's efforts to remake itself into the mold IBM ( IBM).

"The majority of this impairment charge is linked to serious accounting improprieties, disclosure failures and outright misrepresentations at Autonomy Corporation plc that occurred prior to HP's acquisition of Autonomy and the associated impact of those improprieties, failures and misrepresentations on the expected future financial performance of the Autonomy business over the long-term," HP said in a statement released with earnings, that indicates $5 billion of the writedown is related to the alleged fraud.

The Palo Alto, Calif.,-based company also said it has referred the Autonomy fraud charges to Britain's Serious Fraud Office and the U.S. Securities and Exchange Commission for civil and criminal investigation. HP also said that fraud charges relate to Autonomy's recognition of revenue and that the company opened an investigation when an Autonomy executive came forward with the fraud.

The writedown and fraud charges couldn't come at a worse time. HP's fourth quarter earnings reflected weaker than expected revenue of $30 billion, and adjusted earnings per share of $1.16 came in slightly better than expected. Still, an alleged accounting fraud sent HP shares tumbling over 12% to new five-year lows below $12 a share in late afternoon trading.

HP's full year 2013 EPS guidance of $3.60 - $4.00 unveiled on Tuesday was in line with previous forecasts, according to Shaw We of Sterne Agee.

HP's slowing results and weak outlook match poor earnings from Dell ( DELL) earlier in November and underscore why turnaround bets hinge on software businesses like Autonomy.

Still, with HP now having spent its "last" mega-deal dollars on Autonomy, the acquisition is yet to propel the company into IBM ( IBM) and Accenture ( ACN)-like territory of data and software services, as it tries to strategically reposition.

As TheStreet noted in August, HP was already bracing for the prospect of a writedown at Autonomy, after the unit's growth failed to impress and profit margins fell far below expectations.

In August, HP took a $8 billion writedown related to its $13 billion-plus acquisition of business services and hardware giant EDS in 2008, and indicated billions more in M&A related charges could by year-end. Overall in 2012, HP has taken over $18 billion in writedowns, but the company still holds $35.6 billion of goodwill on its balance sheet.

HP's chief executive said on an earnings call and in media interviews that she regretted completing the Autonomy transaction, and the executives involved in the fraud have left the company. She also indicated that the fraud had gone undetected to Autonomy's auditor Deloitte and to HP's advisers on the acquisition, Barclays, Perella Weinberg and KPMG.

Autonomy -- HP's third largest acquisition ever at $11.1 billion - was seen as a key but uncertain piece of CEO Whitman's restructuring efforts. Second and third quarter results, showed a serious slowdown in Autonomy's earnings, which stunted growth expectations of HP's wider software businesses.

In the third quarter, Whitman restructured HP's software unit to bring Autonomy closer to HP's existing operations and ousted celebrated Autonomy founder Mike Lynch with Bill Veghte, HP's chief strategy officer, in a move to bolster the unit's performance.

Whitman cited Autonomy's poor results as reason to remove Lynch and further integrate the software specialist within HP's global sales force, where the business could scale faster. It's to be see if revelations of an alleged accounting fraud change HP's story.

When HP first took control of Autonomy it planned to run the company independently, keeping Lynch, who founded the firm in 1996, at the helm. The drastic second quarter management change for Autonomy, a maker of software analytics that search unstructured data like emails, phone calls and social media, was a troubling sign for investors worried about whether HP will get a bang for its buck on the acquisition.

Under new unit head Veghte, HP expected to tie Autonomy to the company's existing services, server storage, networking businesses and its sales force, in an "organizational structure to support a $1 billion company," according to May comments from Whitman.

Fourth quarter earnings did show a reversal in a trend of trend of falling profit margins and a growth slowdown at HP's software and services units, integral to any transformation.

HP's software revenue growth grew 14% year-over-year, driven by 48% growth in its services business. The unit's operating margins rose to 27.2% in the quarter, after falling below 20% for much of 2012.

In August, UBS analyst Steven Milunovich said HP has so far assembled a mediocre set of assets that's unlikely to pull business from entrenched enterprise players IBM and EMC ( EMC).

"HP lacks the pure enterprise focus of IBM and EMC yet will have trouble competing for consumers without strong tablet and phone businesses like Apple and Samsung," wrote Milunovich.

"We question whether HP is 'better together' and that it might be 'smart to be apart,' specifically spinning off printers and PCs," he added.

In a decisive call, Whitman retained HP's PC unit -- contrary to an audacious plan by former CEO Leo Apotheker -- and cast high expectations on the benefits of Autonomy.

HP chairman Ray Lane said in September that Autonomy's software and analytics revenue could grow from present levels of $1 billion to $5 billion or even $10 billion. "Hopefully, we'll see a bigger software portfolio and we'll see more value-added services at HP, but we have $120 billion of hardware business that we care dearly about," said Lane in September.

Since then, HP has enacted other turnaround efforts under Whitman, including a merger of its PC and printers divisions in a move to cut costs.

For more on tech sector M&A and turnaround efforts, see why a BMC Software ( BMC) deal is caught between a cloud boom and tech gloom.

Interested in more on HP? See TheStreet Ratings' report card for this stock.

Check out our new tech blog, Tech Trends.

-- Written by Antoine Gara in New York

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