Six Autonomy Red Flags That HP Missed

15 january 2013

In 2011, Hewlett Packard (HPQ) bought big data software maker, Autonomy, for $10 billion and last week it wrote off $8.8 billion of that. Since Meg Whitman, who spent $140 million of her own money on a failed gubernatorial bid in 2010, took over at HP’s CEO on September 21, 2011, its stock has lost 46% of its value to $12.44 — 84% below its April 2000 all-time high of $77.

After writing about how HP’s Autonomy deal failed most of the four tests of a successful acquisition, I received emails from two people who highlighted six red flags that should have warned HP away from buying Autonomy.

1. Autonomy CEO, Mike Lynch, would be out of HP fast.

It is quite common for an acquiring company to adopt a conqueror’s mentality — meaning that HP would have wanted to get rid of all the top people at Autonomy and replace them with HP people. But in so doing, there is a question about whether it would have been losing the people who made Autonomy worth $10 billion.

That’s why HP should have paid more attention to whether Lynch would stick around. A venture capitalist who contacted me said that when the Autonomy deal was announced, he told the CEO of one of his portfolio companies, “I doubt Mike Lynch will remain at HP more than 6-9 months.  Sure enough, within 9 months he was out.”

The venture capitalist also noted: “Talk about a culture class. The HP Way and Mike Lynch’s Way (CEO of Autonomy) couldn’t be any more different.”

2. Track record of destroying acquired companies.

Lynch has been widely quoted as saying that HP destroyed Autonomy. That’s something the venture capitalist who contact me found the most ironic. As he wrote, “What is really funny to me is the fact that Mike Lynch and all of these ex-Autonomy executives are stating how HP destroyed Autonomy.”

The venture capitalist gave me an example of a company that Autonomy bought and then destroyed. He noted, “As my friend, Brian Baird, who sold his company Meridio to Autonomy, told me 12 months after his acquisition, Autonomy lost almost every executive from every company they acquired (including his) because of Autonomy’s slash and burn style of dealing with acquisitions.”

3. Amazing revenue growth that’s really artificial.

The venture capitalist sent me a quote noting that “Autonomy’s amazing revenue growth (55% YoY) has largely been a result of acquisitions rather than organic growth.”

He also told me that Autonomy’s growth looked to him like it was too good to be true. He pointed out that “Endeca, one of the stars of the Boston enterprise software technology ecosystem, was always whiter than white with its accounting and business practices.”

And yet an Endeca competitor, Fast Search and Transfer (FAST), was growing much faster. As the venture capitalist wrote, ”We couldn’t understand why FAST grew as much as it did and then was bought in 2008 for $1.2 billion by Microsoft (MSFT), until the news came out about fraud accounting for as much as 1/3 of FAST’s revenue.”

The venture capitalist had a similar view on Autonomy. As he said, ”We similarly could not believe the Autonomy numbers that the UK stock analysts (other than 1-2 true analysts) accepted without question.”

This venture capitalist has a dim view of Autonomy and HP. As he wrote, “There will be a big PR battle over the next few weeks on this, and those who are Autonomy fans will rightly point out that HP overall had poor results, but Autonomy itself was in my view a case of perpetual low-level fraud on the UK investing public where management had hoped an HP sale would prevent an eventual disclosure and stock crash of their own.”

4. Low deferred income and high accounts receivable.

Jon Tseng of Uneasy Empires is an analyst who did not drink the Autonomy Kool-Aid. Tseng pointed out that Autonomy’s cash collection and accounting policies were unusual.

Most software companies have high deferred revenues — money received for services not yet rendered and booked as revenue — and low accounts receivable – money owed for services already rendered and booked as revenue.