HP: Accounting Fraud Isn't the Worst of It

Stocks are giving back some of yesterday's rich gains this morning, with the Dow Jones Industrial Average (INDEX: ^DJI  ) and the broader S&P 500 (INDEX: ^GSPC  ) down 0.37% and 0.26%, respectively, as of 10:10 a.m. EST.

The micro view
On Sunday, I wrote of Dow component Hewlett-Packard (NYSE: HPQ  ) that while it "has beaten expectations at least four times consecutively prior to [today's] earnings report ... the company has otherwise systematically crushed investors' hopes and dreams for some time now." Today, HP keeps the investor nightmare alive by simultaneously missing expectations and announcing an $8.8 billion charge on its $10.3 billion acquisition of U.K. software company Autonomy due to accounting fraud by the latter prior to its acquisition.

If fraud took place, that is something HP should pursue vigorously. However, investors should keep their eye on the ball: The acquisition of Autonomy was probably ill-advised, regardless of any current allegations of accounting fraud -- and it was certainly overpriced. Note that while $5 billion of the Autonomy-related charge is due to accounting practices, that still leaves roughly a $3.8 billion charge that has nothing to do with the alleged fraud -- more than one-third of the acquisition price.

The Autonomy deal smacked of desperation, a situation in which a chief executive sought to paper over decline and mismanagement of core activities by buying growth or pursuing "transformational" acquisitions. Thankfully for CEO Meg Whitman, that chief executive happened to be her predecessor, who announced the deal roughly a month before he was jettisoned.

What's next for HP investors? Today, they're down another 12.6% as of 10:15 a.m. EST. At this stage, one should only consider owning or buying these shares as an outright speculation. If you want to own a tech stalwart that is turning things around, you're better off looking at Cisco Systems (Nasdaq: CSCO  ) , for example. Click here to receive our premium report on the shares, which includes 12 months of ongoing coverage.


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  • Report this Comment On November 20, 2012, at 10:38 AM, cbglobal wrote:

    All well and good, but Autonomy is a teeny tiny part of HP. If they never bought the company, HP would be doing $120 Billion of business, which is currently being valued at $23 Billion. For reference, IBM does $105 Billion of business and is valued at $215 Billion. Dollar for dollar is IBM really 11 times more valuable, when you consider IBM is by no means overvalued? If HP had IBM's value it would be trading at $123. Projected depressed 2013 earnings for HP is $3.50 giving you a 33% return on your investment if they paid it as a dividend; which they could because cash flow is about $5.

  • Report this Comment On November 20, 2012, at 12:57 PM, TzingerToo wrote:

    I would like to see a good cash flow analysis of HP now. I sold out of my position some time ago when I noticed their failure to write down goodwill at a reasonable rate.

    I have often observed that friendly mergers take 3-5 years to be profitable but unfriendly ones are often profitable from the start.

    HP's acquisition of Compaq was suspect and so too was the acquisition of Autonomy. They were both right in principle but HP paid far too much. You can't carry >$8B in phony assets on your balance sheet forever.

  • Report this Comment On November 20, 2012, at 2:17 PM, Tibbyracers wrote:

    To discount or count out HP is definitely foolish. Sure, margins are declining and volume of PCs aren't what they used to be, but HP still has potential. Look at IBM, their stock price has barely moved. The problem with HP is that there's so much negative attention with them that any hope of turnaround will skyrocket the price to $20!!

  • Report this Comment On November 20, 2012, at 2:26 PM, TheDumbMoney2 wrote:

    Jeff Matthews has been pounding the table on HPQ's own questionable accounting for over two years now. A review of his past pieces is what originally caused me to reevaluate my HPQ holding, and that along with strategic concerns ultimately led me to sell out entirely at around $22 early this year for a small loss, as my "TheDumbMoney" account documents.

    I agree the Autonomy issue is really about a company trying to justify a spectacularly stupid acquisition, but I will reserve judgement, not having really looked into it, as to whether Autonomy committed any fraud. This acquisition was always going to get written down, the only question was by how much. I think a lot of this is HPQ face-saving.

    Likewise, I think we can safely say FB will eventually write down Instagram, and MSFT will eventually write down Skype, etc., etc. Those are not at this level (particularly the Instagram purchase), but it will likely happen and one can't analyze shares in those companies without making at least a broad attempt at such a calculation. This relates to Meuller's recent excellent piece on merger accounting. While I agree with him based on the law, and accounting rules, there is an argument to be made that legal merger accounting provides a sort of legal pathway for companies to disguise how bad such transactions are for some time, don't you think?

  • Report this Comment On November 21, 2012, at 6:55 AM, AndrewBaker14 wrote:

    HP has messed up badly, but it's now a very cheap company, and is not going to fail any-time soon, so at the current share price, this is a buy: for the longer term, certainly; but never-the-less, a buy.

    Disclosure: long HPQ.

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