Tag: HP

Hewlett Packard Confusion and Berkshire Hathaway Stake

The Investors Chronicle (IC) published an article last week entitled “What does Buffett see in HP?”. I read it with interest as I used to do a lot of business with HP and its customers before I retired from a proper job. But I think the article might have confused more people than it enlightened.

The article referred to the acquisition of a “large stake in printer manufacturer and software company Hewlett Packard (US:HPE)” by Berkshire Hathaway. But the latter actually acquired a stake in HP Inc (US:HPQ).

The Hewlett Packard company split into two companies in 2015 these being HP Inc (HPQ) focussed on printers and PCs, and HP Enterprise (HPE) focussed on software and services. The latter made the disastrous acquisition of Autonomy although they did win a legal case on the issue of misleading accounts in January this year.

The printer/PC business was seen as being slower growth and of course as being in a highly competitive sector and hence achieved a relatively low market rating. It’s now on a historic P/E of 7 but as the IC article indicated the free cash flow of HPQ has been improving greatly. Return on assets has improved to 17% as well so one can see why Buffett might be attracted to this business.

The IC article also talked about the management in-fighting at HP not prevented by weak management at the top of the company. In fact the company want through a series of top management changes after the founders departed and the worst of them was the appointment of Carly Fiorina as CEO. To quote from Wikipedia “Fiorina’s predecessor at HP had pushed for an outsider to replace him because he believed that the company had become complacent and that consensus-driven decision making was inhibiting the company’s growth. Fiorina instituted three major changes shortly after her arrival: replacing profit sharing with bonuses awarded if the company met financial expectations, a reduction in operating units from 83 to 12, and consolidating back-office functions. Fiorina faced a backlash among HP employees and the tech community for her leading role in the demise of HP’s egalitarian “The HP Way” work culture and guiding philosophy which she felt hindered innovation. Because of changes to HP’s culture, and requests for voluntary pay cuts to prevent layoffs (subsequently followed by the largest layoffs in HP’s history), employee satisfaction surveys at HP—previously among the highest in America—revealed widespread unhappiness and distrust, and Fiorina was sometimes booed at company meetings and attacked on HP’s electronic bulletin board.”

The company’s record of investing in software was also abysmal when hardware was becoming ever cheaper and generic. This cumulated in the disastrous acquisition of Autonomy.

But the fact that the company has survived (albeit it in two parts) is no doubt due to its strong historic reputation for well-engineered quality products and strong brand name.

But there are two key lessons to learn from the history of HP: 1) Changing the culture of an organisation is always exceedingly difficult and is likely to fail unless done very sensitively; and 2) Management incompetence can damage even the most admired businesses, as Hewlett Packard used to be.

To quote from my book Business Perspective Investing: “One of the key factors that affect the outcome of any investment is the competence of the management and how much they can be trusted to look after your interests rather than their own. Incompetent or inexperienced management can screw up a good business in no time at all, although the bigger the company, the less likely it is that one person will have an immediate impact. But Fred Goodwin allegedly managed to turn the Royal Bank of Scotland (RBS), at one time the largest bank in the world, into a basket case that required a major Government bail-out in just a few years”.

At Hewlett Packard it was not quite so disastrous and the company certainly faced challenges as the computer technology market changed but the damage done to a once great company was unhappy to see.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Record Fine on Deloitte, But It’s Not Enough

 The Financial Report Council (FRC) has fined accounting firm Deloitte £20.6 million (including costs) for its defective auditing of Autonomy. Deloitte is the largest of the big four audit firms and this is what the head of the firm said when talking about their 2019 results: “Our FY 2019 results are a validation of Deloitte’s strategy to deliver high-quality, globally consistent service to our clients while continuing to serve the public interest and working to restore trust in capital markets”.

Revenue of the firm in 2019 was $46.2 billion. The average payout to UK partners was £882,000 and there were 699 partners (i.e. a total paid of £616 million). That size of fine therefore will not worry them much. The fine should surely have been much greater!

The fine is the biggest yet issued by the FRC which at least means it’s a step in the right direction, but still not far enough.

This is some of what the FRC said about the case:

“The Tribunal found that each of Deloitte, Mr Knights and Mr Mercer [the two responsible audit partners] were culpable of Misconduct for failings in the audit work relating to the accounting and disclosure of Autonomy’s sales of hardware during FY 09 and FY 10.  They failed to exercise adequate professional scepticism and to obtain sufficient appropriate audit evidence.  Deloitte should not have issued unqualified audit opinions in these years based on the audit evidence obtained. Deloitte, Mr Knights and Mr Mercer fell seriously short of the standards to be expected of a reasonable auditor.

Similarly, in relation to certain of Autonomy’s sales to VARs, the Tribunal found that Deloitte, Mr Knights and Mr Mercer were culpable of Misconduct for failing to obtain sufficient appropriate audit evidence and for a lack of professional scepticism in relation to the nature of these sales.  Deloitte and Mr Knights should not have issued an unmodified audit opinion in FY 09 without obtaining further audit evidence.

The Tribunal commented that ‘…it is the wholesale nature of the failure of professional scepticism in relation to the accounting for the hardware sales and the VAR transactions as well as our findings of Misconduct and of breaches of Fundamental Principles that make this case so serious’.

The Tribunal also made findings of Misconduct in relation to the consideration by Mr Knights and Mr Mercer of Autonomy’s communications with its regulator, the FRC’s Financial Reporting Review Panel (FRRP), in January 2010 and March 2011 respectively.  Mr Knights acted recklessly and thus here with a lack of integrity. Mr Mercer failed to act with professional competence and due care”.

Autonomy was acquired by HP who relied partly on the audited accounts no doubt but subsequently had to write off $8.8 billion related to the acquisition. Both criminal and civil law suits over the accounts of Autonomy are still live.

Altogether a disgraceful example of how the auditing profession is being brought into disrepute of late.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson  )

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Good News – Autonomy CFO Jailed

Good news – former CFO of public company jailed for fiddling the accounts. Oh to see that happen more often so as to deter manipulation of accounts that is so prevalent and so damaging to investors.

Sushovan Hussain, the former CFO of software company Autonomy, was sentenced to 5 years imprisonment by a US Court yesterday plus he was fined $4 million and ordered to forfeit $6.1 million he made from the sale of the company to Hewlett-Packard. He won’t even be spending time in a cushy minimum-security prison as he is a foreign national. He was found guilty some months ago on 16 counts of security fraud and other counts. In essence the allegation was that sales were inflated in the accounts and the result was that when HP bought the company, they had to write off much of the $11 billion they paid for it.

Although Autonomy was a UK public company, and the Serious Fraud Office did look at the case they decided to do nothing. However a civil action against Mr Hussain and the former Autonomy CEO, Mike Lynch is still being pursued in the English courts, and the latter also faces criminal charges in the USA.

Mr Hussain is planning to appeal the verdict. Let us hope he does not succeed because such cases provide a good deterrent to future malefactors.

These were some of the allegations against Autonomy:

  • Booking transactions to resellers as revenue when there was no end-user license (i.e. “channel stuffing” as it is sometimes called).
  • Engaging in “round-trip” transactions where purchases were invented so it could pay money to companies which then returned it to Autonomy to cover fictitious sales.
  • Backdating sales transactions so they fell into a previous accounting period.

There was also a claim that bundles of hardware/software sales were treated as solely software in the accounts. Why does this matter? Because software sales are valued in company valuations much more highly than hardware sales.

The above are some of the things that investors in IT companies need to look at although abuse can be difficult to spot in the published accounts of a public company. High accounts receivable and apparent lengthy payment delays can be clues. There were some questions raised about Autonomy’s accounts even before the takeover.

Hussain and Lynch have claimed that some of the disputed differences were simply down to different accounting standards (US GAAP versus IFRS) and I said when originally commenting on the case that I was unsure that this stood up to scrutiny. The US Court judge clearly rejected that argument.

But the sad thing is of course that we rarely see such cases pursued to criminal convictions in the UK, whether they are large or small companies.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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