Apotheker’s Folly: H-P Should Have Bought Back Stock Instead Of Autonomy

15 january 2013

Anger and frustration are the two emotions pulsing through my veins as I write this.  Hewlett-Packard, once the symbol of innovation, is being dismantled by its high-pedigreed board and the CEO of the hour (I truly hope his tenure will be measured in hours, not years).

I vividly remember the early 2000s, when Carleton Fiorina, then CEO of HP, engineered the HP merger with Compaq.  She argued that the merger was a must for HP’s future to be bright.  Walter Hewlett, the son of one of the founders, was publicly opposed to it, and I remember the drama of the proxy fight, the TV interviews and arguments from both sides, and the finale: Walter Hewlett lost and the merger went through.

But it was not the finale, because nine years and two CEOs later, HP has announced that the PC business, the one it so desperately wanted just a decade ago, is too hard a business and that it will look for ways to get rid of it.  Almost in the same breath HP announced that it will kill WebOS devices, a business it acquired in April 2010 for $1 billion; and management, possibly missing the irony in those two announcements, went ahead and announced another acquisition, which this time will for sure transform the company.

HP will buy Autonomy, a UK software company, for $10 billion. I understand $10 billion doesn’t sound like a lot of money in today’s post-trillion-dollar-bailout world, but it is plenty for HP, especially considering what that money bought.  There are many ways to illustrate how expensive and meaningless to HP’s future this acquisition is: $10 billion is about a fifth of HP’s market capitalization, while Autonomous will contribute 0.7% to HP’s revenues, and 2.7% to its earnings; and HP paid 10x revenues and about 25 times earnings.

Leo Apotheker, HP’s CEO, bragged about Autonomy:

“Autonomy has grown its revenues at a compound annual growth rate of approximately 55% and adjusted operating profit at a rate of approximately 83% over the last 5 years.”

Keith Backman, a sell-side analyst from BMO Capital, asked a very pertinent question about Autonomy:

“… metrics that you threw out for Autonomy, particularly on top-line growth, included a lot of acquisitions for Autonomy. What’s the organic growth rate that Autonomy has achieved lately?”

Leo did not have an answer, whereupon HP’s stock started to drop.  HP had reported an OK quarter, expectations were already low (its stock was at about 6x times 2011 estimates, which remain intact), and Dell had already lowered guidance a day before; so no one was surprised when HP lowered its revenue guidance for 2011 by a few percentage points.

Management said that since it will pay for Autonomy from cash on the balance sheet, it will not be buying much of its stock in the near future, and then they mentioned that this acquisition will be accretive.  Yes, accretive!  Nothing to worry about.  This transaction is accretive only for illiterates in economics and those short on common sense.