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The news broke last week: Hewlett-Packard (NYSE: HPQ ) appears to be following in the footsteps of such giants of industry as Monsanto (NYSE: MON ) , IBM (NYSE: IBM ) , and General Electric (NYSE: GE ) (during its 2004 acquisition of InVision), in the worst possible way. At one point or another, all those companies have been ensnared in the tightly woven legal loopholes of the American Foreign Corrupt Practices Act.
Like its predecessors in technical misfeasance, HP has been accused of paying bribes to foreign officials in an effort to win foreign government contracts -- specifically, a computer-supply deal in Russia. But there's one significant difference in this case: The scale.
Simply put, the bribery allegations leveled against HP today are piddling to the point of laughability, and pose no real threat whatsoever to investors in the company today.
Tempest in a Russian tea glass
Here's a quick rundown of the allegations against HP. Back in 2003, Russia's Prosecutor General's office put up for bid a contract for sophisticated computer equipment. HP won the $48 million deal, but in order to do so, it allegedly had to pay out $11 million in bribes, parceled out through bills for nonexistent services, and paid to middlemen through an extended series of shell companies ranging from Belize to Latvia to Switzerland.
Confused? Ignore the details of how the scheme worked. Focus instead on the numbers: HP supposedly paid $11 million to win a $48 million contract. Does that sound right to you?
I mean, HP makes a nice profit off its business. It beats out peer Dell (Nasdaq: DELL ) by several percentage points of gross margin on its sales. But by the same token, HP's no Apple (Nasdaq: AAPL ) or IBM, gross margin-wise. Both of those companies generate margins beyond the 40% range, well beyond HP's own 23% haul. It only ordinarily grosses about $11 million on $48 million in sales. Thus, paying an $11 million bribe would eat up every single bit of gross margin HP would ordinarily earn on this sale. Tack on HP's operating costs, and the transaction would put HP deeply in the red. This suggests that in any logical world, bribing Russians to win the contract makes no economic sense...
Which doesn't mean it didn't happen, of course. You probably have to have lived in Russia for a while to guess at what did happen. But I have.
How Russia is different
If HP did bribe Russian officials in order to win the contract -- remember, this is all alleged! -- it did so at a vastly inflated profit margin, and the idea likely originated with the Russians, rather than at HP.
For a bribery transaction like this to work, you see, the people buying the HP computers would propose to pay HP an inflated cost for its equipment. Presumably, the fair market value of the equipment in question was somewhere on the order of $37 million or less. As for the balance, that all would go to the corrupt officials -- part of their attempt to bilk their own government, and steal from their own taxpayers, to line their own pockets.
What this means to investors
Despite occasional indications to the contrary, I suspect that U.S. Department of Justice and SEC officials (and their counterparts in Russia and Germany, also investigating the matter), are capable of interpreting basic mathematics and understanding that there was essentially no "upside" in this deal for HP.
Of course, this doesn't excuse HP's alleged participation in the bribery scheme. But it does suggest that the bulk of the blame resides with the corrupt officials, not with HP. For this reason, I suspect that any punishment ultimately meted out to the company will be along the lines of the fine IBM had to pay to settle investigations into its own Argentinean shenanigans.
If IBM got off with a mere $300,000 fine for paying $25 million in bribes to win $250 million in contracts back then, HP's punishment for an offense just a fraction of that size should be de minimis in the extreme. On the scale of international criminal masterminds, HP's violation amounts to little more than petty theft.
In short, I think this is a non-issue. No matter how many headlines the Wall Street Journal gives to this story of "corruption at Hewlett-Packard," it won't affect your portfolio in the least.
But if it does, rejoice! Consider any drop in stock price on the news a bona fide buying opportunity.