Hewlett-Packard’s Acquisition of Autonomy Corporation, Mending a Broken Acquisition Process

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011TimelineHewlett-Packard

Acquisitions

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Mercury Interactive$4.5 billion

3Com$2.7 billion

Vertica Systems

$0.35 billion

TimelineHewlett-Packard

Acquisitions

Compaq$25 billion

EDS Systems

$13.9 billionPalm

$1.2 billion


Acquisitions

Autonomy$11 billion


Acquisitions

CharteredAccountant

Solutions LLC®

Hewlett-Packard’s Acquisition of Autonomy CorporationMending a Broken Acquisition Process

Presented by Chartered Accountant Solutions LLC® –Yassine Benidir, Caroline Carrière, Jesse Dunn, Brandon Graham,

Brenda Lim, and Alexandre Sauvé

Presentation delivered on Wednesday, December 9, 2015

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Environmental Analysis

(Slides 5 to 12)

Engagement Mandate

(Slides 13 to 16)

Basis for Autonomy Valuation

(Slides 17 to 26)

Accounting Issue Analysis

(Slides 27 to 35)

Due Diligence Process

(Slides 36 to 42)

Closing Points(Slides 43 to 45)

Agendaa. What We’ll Be Discussing Today

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Environmental Analysisa. Porter’s Five Forces Analysis: Information Technology...............................................

6b. Key Trends Analysis: Information Technology............................................................ 7c. Internal v External Environment Analysis: H-P............................................................

9d. Portfolio Analysis.........................................................................................................

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Force Weight Scope DescriptionBuyer Power High Consumers • High volume needed, low switching costs

• Historical preference for specialist producersSupplier Power Medium Intel, AMD,

etc.• Low entry barriers, vertical integration trend• Preference for long-term relationships

Threat of Substitute Low Scientific

calculators• There exists few actual substitutes to

information technologyThreat of New Entry Low Xiaomi,

etc.• Initial need for capital, particular expertise• Incumbent firms possess cost advantages

Rivalry High IBM, Dell, etc.

• Increasing trend towards specialization as a competitive advantage

Environmental Analysisa. Porter’s Five Forces Analysis: Information Technology

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Key Takeaways• The information technology market is saturated with

competitors possessing similar capabilities• Firms must specialize to distinguish themselves

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b. Key Trends Analysis: Information Technology

1960sLarge Calculators

1970sPersonal

Computing

1980sData Networks

and Data Mining

1990sWorld Wide Web

NowSoftware and

Services

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Environmental Analysis (cont’d)

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b. Key Trends Analysis: Information Technology

1960sLarge Calculators

1970sPersonal

Computing

1980sData Networks

and Data Mining

1990sWorld Wide Web

NowSoftware and

Services

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Environmental Analysis (cont’d)

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ess Environmental Analysis (cont’d)

b. Key Trends Analysis: Information Technology (cont’d)

Cloud StorageOffer a new way of storing data

Mobile and ApplicationsAccess and create data in new ways

Big Data and ConsumerizationAdd value to data, and make IT simple

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ess Environmental Analysis (cont’d)

b. Key Trends Analysis: Information Technology (cont’d)

Cloud StorageOffer a new way of storing data

Mobile and ApplicationsAccess and create data in new ways

Big Data and ConsumerizationAdd value to data, and make IT simple

8

Key Takeaways• Demand in the information technology industry

today is shifting away from hardware, especially PCs• Consumers want software and service solutions

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Internal

External

What’s Working What Needs Work

Watch out For Where to Grow

Environmental Analysis (cont’d)c. Internal v External Environment Analysis: H-P

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Internal

External

What’s Working• Strong financial situation• Solid brand, market share• Strategy: end-to-end

solutions

What Needs Work



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Internal

External


solutions

What Needs Work• Poor strategy execution• Late to act on key

software and service trends



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Internal

External


solutions



Watch out For• Risk losing market share

to better-branded rivals

Where to Grow


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Internal

External


solutions





Where to Grow• Renew focus on high-

growth/margin segments• Improve control to better

leverage acquisitions


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Internal

External


solutions





Where to Grow• Renew focus on high-

growth/margin segments• Improve control to better

leverage acquisitions


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Internal

External


solutions





BCG Matrix• Renew focus on high-

growth/margin segments


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Estimated Market ShareHigh Low

Projected Gro

wth

High

Build: the Bright Stars• IT Services (13.83%)• Storage and Networks (10.68%)

Hold: the Question Marks• Software (20.12%)• Financial Services (8.77%)

Low

Harvest: the Cash Cows• Hardware: PCs (5.21%)• Hardware: Printers (15.90%)

Divest: the Dead Dogs• None

Environmental Analysis (cont’d)d. Portfolio Analysis (H-P, Operating Margin)

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Projected Gro

wth

High

Build: the Bright Stars• IT Services (11.41%)• Storage and Networks (14.43%)

Hold: the Question Marks• Software (6.26%)• Financial Services (2.38%)

Low

Harvest: the Cash Cows• Hardware: PCs (13.24%)• Hardware: Printers (33.77%)

Divest: the Dead Dogs• None

Environmental Analysis (cont’d)d. Portfolio Analysis (H-P, Return on Investment) (cont’d)

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Projected Gro

wth

High

Build: the Bright Stars• IT Services• Storage and Networks• Software

Hold: the Question Marks• None

Low

Harvest: the Cash Cows• None

Divest: the Dead Dogs• Hardware: PCs

Environmental Analysis (cont’d)d. Portfolio Analysis (IBM) (cont’d)

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Projected Gro

wth

High

Build: the Bright Stars• IT Services• Storage and Networks• Software

Hold: the Question Marks• None

Low

Harvest: the Cash Cows• None

Divest: the Dead Dogs• Hardware: PCs

Environmental Analysis (cont’d)d. Portfolio Analysis (IBM) (cont’d)

12

Key Takeaways• H-P is a related-diversified firm, and would like to

differentiate similar to IBM – however, H-P has a lot of ground to make up for

Engagement Mandatea. Summary of Key Takeaways........................................................................................

14b. Gap Analysis: Key Success Factors and Decision Criteria............................................

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ess Engagement Mandate

a. Summary of Key Takeaways

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Competitive Environment• S

pecialization-differentiation is necessary for H-P

Key Market Trends• Y

our customers want software and services

Strategic Execution at H-P• I

BM is an example to follow, but H-P is behind

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Internal

External

What’s Working• Strong financial situation• Solid brand, market share• Strategy: end-to-end solutions

What Needs Work• Poor strategy execution• Late to act on key software and

service trends

Watch out For• Risk losing market share to better-

branded rivals

Where to Grow• Renew focus on

high-growth/margin segments• Improve control to better leverage

acquisitions

Environmental Analysis (cont’d)b. Gap Analysis: Key Success Factors

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Internal

External

Key Success Factors• Strong financial situation• Solid brand, market share• Strategy: end-to-end solutions

What Needs Work• Poor strategy execution• Late to act on key software and

service trends

Watch out For• Risk losing market share to better-

branded rivals

Where to Grow• Renew focus on

high-growth/margin segments• Improve control to better leverage

acquisitions

Environmental Analysis (cont’d)b. Gap Analysis: Key Success Factors

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ess Engagement Mandate (cont’d)

b. Gap Analysis: Key Success Factors (cont’d)

KSF Current State Desired StateStrong Financial Position

• Depleting resources on questionable acquisitions

• Improve acquisition process and maximize shareholder value

Solid Brand, Market Share

• Sizeable market share in low-growth/margin segments (e.g., PCs)

• Sizeable market share in high-growth/margin segments (e.g., software)

Strategy: End-to-End Solutions

• Constant executive turnover and shifts in strategy

• Strategic stability and a coherent approach to growth

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KSF Current State Desired StateStrong Financial Position

• Depleting resources on questionable acquisitions

• Improve acquisition process and maximize shareholder value

Solid Brand, Market Share

• Sizeable market share in low-growth/margin segments (e.g., PCs)

• Sizeable market share in high-growth/margin segments (e.g., software)

Strategy: End-to-End Solutions

• Constant executive turnover and shifts in strategy

• Strategic stability and a coherent approach to growth

Key Takeaways• Problem: pressures, a lack of control, and an

incoherent strategy have led to poor acquisitions• Mandate: to propose process recommendations

based on a discussion of the Autonomy acquisition

Engagement Mandate (cont’d)b. Gap Analysis: Key Success Factors (cont’d)

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Basis for Autonomy Valuationa. Assessing the Price Tag...............................................................................................

18b. Proposing a New Stock Range.....................................................................................

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Rapid Growth Autonomy was founded in the late 1990s

Innovative Enhanced offerings to become a market leader

Highly Regarded Autonomy was subject to public praise

No Red Flags Autonomy’s appeared to be a strong performer

Basis for Autonomy Valuation (cont’d)a. Assessing the Price Tag (Qualitative Considerations)

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Valuation Methods Used

• Discounted cash flow (“DCF”) method

• Multiplier method – EBITDA and revenue multipliers

Multiplier Method Formula

• EDITDA Multiplier • Equity or deal value / EBITDA• Revenue Multiplier • Equity or deal value / revenue

Basis for Autonomy Valuation (cont’d)a. Assessing the Price Tag (Quantitative Considerations) (cont’d)

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Financial Projections (in Millions of USD) (from 2011 to 2015) Year 2011 2012 2013 2014 2015

Add, Revenues 1,151.47 1,544.43 2,075.70 2,809.56 3,825.87 Less, Total Cost of Revenues 213.97 297.90 448.16 728.37 1,271.63

Gross Profit 937.50 1,246.53 1,627.54 2,081.19 2,554.23 Less, Total Operating Expenses 535.85 751.77 1,051.16 1,472.23 2,063.19 Less, Depreciation / Amortization 1.23 2.11 3.62 6.21 10.65

EBIT 400.42 492.65 572.77 602.75 480.39 Less, Tax Expense 156.16 192.13 223.38 235.07 187.35

NOPAT 244.25 300.52 349.39 367.68 293.04 Add, Depreciation / Amortization 1.23 2.11 3.62 6.21 10.65 Less, Increase in Accounts Receivable 41.21 45.41 50.04 55.15 60.77 Less, Increase in Inventory 0.12 0.14 0.16 0.19 0.22 Less, Increase in Other Current Assets 18.83 20.50 22.31 24.29 26.44 Add, Increase in Current Liabilities 42.51 68.18 109.36 175.41 281.36

Cash Flow from Operations 227.83 304.76 389.85 469.68 497.63 Less, Increase in Gross PPE 15.00 15.00 15.00 15.00 15.00

Free Cash Flow 212.83 289.76 374.85 454.68 482.63 Terminal Value (perpetuity) - - - - 8,110.04 Total Free Cash Flows 212.83 289.76 374.85 454.68 8,592.67

Basis for Autonomy Valuation (cont’d)a. Assessing the Price Tag (DCF Method) (cont’d)

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ess Basis for Autonomy Valuation (cont’d)

a. Assessing the Price Tag (DCF Method) (cont’d)

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Discounted Cash Flows (in Millions of USD)• Year 2011 2012 2013 2014 2015• Total Free Cash Flows 212.83 289.76 374.85 454.68 8,592.67 • Discount Factor 96.82% 89.59% 82.90% 76.71% 70.98%• Present Value 206.06 259.59 310.74 348.77 6,099.07

Price per Share Enterprise Value 7,224.23 Less, Value of Debt 1,213.00 Add, Net Cash 1,061.00 Value of Equity 7,072.23 Share Outstanding 269 Price per Share 26.29

Important Rates• Tax Rate 39.00%

• Terminal Growth Rate 2.00%

• WACC 8.07%

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Company Equity Value Revenue EBITDA EV/EBITDA EV/Revenue• Ansys 5,267.63 691.45 334.15 15.79 7.63• CDS 2,744.48 1,149.84 259.37 10.58 2.39• Computa. 893.15 4,408.51 114.36 7.81 0.20• DSTS 825.44 2,388.70 450.90 1.83 0.35• FleetCor 2,407.82 519.59 260.43 9.25 4.63• Igate 911.40 779.65 177.27 5.14 1.17• NI Corp. 3,165.20 1,024.17 161.03 19.66 3.09• NeuStar 2,493.52 620.46 261.57 9.53 4.02• Rackspace 5,673.45 1,025.06 317.69 17.86 5.53• Sapient 1,736.13 1,062.45 136.61 12.71 1.63• Averages 2,612.71 1,366.99 247.34 11.02 3.06

Basis for Autonomy Valuation (cont’d)a. Assessing the Price Tag (Multiplier Method) (cont’d)

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Company Deal Value Revenue EBITDA DV/EBITDA DV/Revenue• Sybase 5,958.70 1,197.00 411.90 14.47 4.98• Hewitt Ass. 4,804.30 3,092.10 613.30 7.83 1.55• DD 3,448.86 4,503.72 251.46 13.72 0.77• McAgee 7,828.20 2,002.90 430.80 18.17 3.91• Novell 2,206.80 811.90 117.50 18.78 2.72• Savvis 3,064.70 973.40 232.10 13.20 3.15• Skype 8,508.73 922.43 283.62 30.00 9.22• PAETEC 2,228.10 1,840.20 314.30 7.09 1.21• Averages 4,756.05 1,917.96 331.87 15.41 3.44

a. Assessing the Price Tag (Multiplier Method) (cont’d)Basis for Autonomy Valuation (cont’d)

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Multiples Selected Companies

Other Companies

Average

• EV/EBITDA 11.02 15.41 13.21• EV/Revenue 3.06 3.44 3.25

b. Proposing a New Stock Range (Industry Comparison)Basis for Autonomy Valuation (cont’d)

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Autonomy Value (in Millions of USD), Ent. Value Multiple

• EBITDA 758.00• Multiplier 13.21• Value of Autonomy 10,014.42

Autonomy Value (in Millions of USD), Revenue Multiple

• Revenues 870.00

• Multiplier 3.25

• Value of Autonomy 2,828.89

b. Proposing a New Stock Range (Multipler Method) (cont’d)Basis for Autonomy Valuation (cont’d)

Average of the Values (in Millions of USD)• Average 6,421.65

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Comparison of the Values (in Millions of USD)• Method DCF Method Multiplier Method

• Result 7,071.83 6,421.65

• Result/Share 26.29/share 23.87/share

b. Proposing a New Stock Range (Method Comparison) (cont’d)Basis for Autonomy Valuation (cont’d)

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Accounting Issue Analysisa. Summary-Level View of Accounting Improprieties.....................................................

28b. Accounting Issue Analysis...........................................................................................

29c. Impact of the Improprieties on the Valuation.............................................................

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Overview of Accounting ImproprietiesAllegation 1:

HardwareAllegation 2:

VARsAllegation 3: Reciprocal

Allegation 4: Hosting

Allegation 5: OEM

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Relevant Policies

Relevant Policies

Relevant Policies

Relevant Policies

Relevant Policies

Proposed Treatment

Proposed Treatment

Proposed Treatment

Proposed Treatment

Proposed Treatment

Impact of Accounting Improprieties on Autonomy Valuation

Accounting Issue Analysisa. Summary-Level View of Accounting Improprieties

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Allegation 5: OEM

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Relevant Policies

Relevant Policies

Relevant Policies

Relevant Policies

Relevant Policies

Proposed Treatment

Proposed Treatment

Proposed Treatment

Proposed Treatment

Proposed Treatment



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Allegation 5: OEM

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Relevant Policies

Relevant Policies

Relevant Policies

Relevant Policies

Relevant Policies

Proposed Treatment

Proposed Treatment

Proposed Treatment

Proposed Treatment

Proposed Treatment



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VARsAllegation 3:

ReciprocalAllegation 4:

HostingAllegation 5:

OEMAutonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Relevant Policies

Relevant Policies

Relevant Policies

Relevant Policies

Relevant Policies

Proposed Treatment

Proposed Treatment

Proposed Treatment

Proposed Treatment

Proposed Treatment



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Allegation 5: OEM

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Relevant Policies

Relevant Policies

Relevant Policies

Relevant Policies

Relevant Policies

Proposed Treatment

Proposed Treatment

Proposed Treatment

Proposed Treatment

Proposed Treatment



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ess Accounting Issue Analysis (cont’d)

b. Accounting Issue Analysis (Issue 1, Hardware Sales)

Accusation Description

Autonomy’s Rebuttal

Relevant Policies Proposed Treatment

• Concealed pure hardware sales

• Divided hardware costs between sales/marketing expenses and cost of goods sold

• Hardware sales not significant enough to warrant separate classification

• Cost allocation better reflects economic substance

• IAS 18, Revenue, and IFRS 8, Operating Segments

• Separate operating segment was not necessary

• Note disclosures• Appropriate cost

allocation, wrong percentage was used

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b. Accounting Issue Analysis (Issue 2, Value-Added Resellers)




• Premature recognition of revenue and fabricated sales

• VARs bared no risk, and were not liable for paying balances outstanding

• Sales to VARs were valid transactions

• Under IFRS, VARs are an end user

• VARs did bare risk, and cash on these deals was usually collected

• IAS 18, Revenue • Recognize sales once IAS 18 criteria are met

• Improper/early recognition on some deals, as economic substance was ignored

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b. Accounting Issue Analysis (Issue 3, Reciprocal Transactions)




• Capitalizing goods acquired

• Recognizing revenue on “reciprocal sale” to overstate income

• Deals involved dissimilar goods, had commercial substance, and the fair value could be measured reliably

• In respect of IFRS

• IAS 16, Property, Plant, and Equipment (Non-Monetary Transactions)

• Reciprocal sales should not be classified as barter transactions

• Autonomy appears to have correctly capitalized costs

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• Intentionally changed hosting arrangements with new/existing clients

• Deceived shareholders

• Correctly accounted for the license revenues

• Each component had a separate fair value

• Residual method

• IAS 18, Revenue • Autonomy appears to have respected IFRS (generally)

• Autonomy recognized some revenue prematurely

Accounting Issue Analysis (cont’d)b. Accounting Issue Analysis (Issue 4, Hosting Sales)

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• IDOL OEM sales inappropriately included revenue from various sources

• No royalties on some deals

• H-P must distinguish between an OEM sale and an OEM-derived revenue

• Professional judgment

• IAS 18, Revenue – note, there exists no specific standard for OEM revenue

• There needs to be more transparent note disclosures

Accounting Issue Analysis (cont’d)b. Accounting Issue Analysis (Issue 5, OEM Revenue)

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b. Accounting Issue Analysis (Summary)

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Allegation 5: OEM

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Autonomy Rebuttal

Relevant Policies

Relevant Policies

Relevant Policies

Relevant Policies

Relevant Policies

Proposed Treatment

Proposed Treatment

Proposed Treatment

Proposed Treatment

Proposed Treatment


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b. Accounting Issue Analysis (Summary)

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VARsAllegation 3:

ReciprocalAllegation 4:

HostingAllegation 5:

OEM

Immaterial Amounts

VARs Are End Users

Dissimilar Goods Dealt

Separate Fair Values

Professional Judgment

IAS 18 and IFRS 8 IAS 18 IAS 16 IAS 18 IAS 18

Note Disclosures

Avoid Early Recognition

Capitalize Costs

Avoid Early Recognition

Note Disclosures


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Deficiencies Purchase price did not consider US GAAP and IFRS differences

Write-OffHow the write-off was calculated remains unclear

DCF ImpactAccusations mainly involve aggressive revenue recognition No cash impact

ConclusionProfessional opinion: improprieties could not justify a $5 billion write-off

Accounting Issue Analysis (cont’d)c. Impact of the Improprieties on the Valuation

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Due Diligence Processa. Board Composition: Strengths and Weaknesses.........................................................

37b. Governance Failure.....................................................................................................

39c. Due Diligence Process.................................................................................................

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ess Due Diligence Process

a. Board Composition: Strengths and Weaknesses

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Meg WhitmanInformation Technology

Marc AndreessenVenture Capital

Shumeet BanerjiConsulting

G. Kennedy Thompson

Insurance

Rajiv GuptaInformation Technology

Ann LivermoreInformation Technology

John HammergrenPharmaceuticals

Gary ReinerPrivate Equity

Patricia RussoTelecomm-unications

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Strengths• Appropriate proportion of external

governors to ensure independence• Sufficient presence of industry

expertise

Weaknesses• Lack of CPA-designates, general

accounting expertise• Need for more governance expertise

Due Diligence Process (cont’d)a. Board Composition: Strengths and Weaknesses (cont’d)

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Board Responsibilities

Information should have been communicated

Need to seek out information from external audits

Due Diligence Process (cont’d)b. Governance Failure (Communication Breakdown)

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Board Failure

CFO opposed the deal

Emergency Board meeting in attempt

to stop the deal

Board not firm in opposing the deal –

CEO decidedBoard needs to exercise their

voting power to ensure due

diligence

Due Diligence Process (cont’d)b. Governance Failure (Decision Opposition) (cont’d)

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Internal due diligence was only a 3-week process

H-P hired KPMG for a limited-scope engagement

Team was limited to Autonomy’s public records and 25 sales contracts

Requirement for the finance committee to review all M&A deals

Due diligence team reported to the CSO, not the CFO

Due Diligence Process (cont’d)c. Due Diligence Process (Internal Perspective)

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Due Diligence Responsibilities

Engagement Limitations

KPMG’s Key Findings

• Procedures were limited in nature, extent

• KPMG’s duty to report material errors was stated in the report

• Team was limited to Autonomy’s public records and 25 sales contracts

• Limited process: only reviewed Deloitte’s audits of Autonomy

• Accounting issues (i.e., hardware sales, sales to VARs, etc.) were highlighted in the report

• KPMG identified differences between IFRS and U.S. GAAP

Due Diligence Process (cont’d)c. Due Diligence Process (KMPG Perspective)

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Closing Pointsa. General Recommendations.........................................................................................

44b. Summary of the Presentation.....................................................................................

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Reducing Acquisition-Related Risks

• Shorten DCF forecasting period, perform sensitivity analysis• Create a specific M&A committee as part of the Board of Directors• Involve relevant stakeholders in aspects of the M&A process• Demand more director governance and accounting experience• Tie compensation to M&A performance, emphasize accountability• Ask due diligence teams to report directly to the CFO• Increase the scope of M&A reviews for large targets in the future• Ensure post-acquisition operational independence of targets

Closing Pointsa. General Recommendations

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H-P wants to differentiate with software/servicesExecution has been a problem for H-P (e.g., Autonomy)

Your Strategy

Accounting issues might have overstated some of Autonomy’s valueProblems with valuation and due diligence

The Problem

H-P must improve governance processes H-P must maintain independence with acquisition targetsConsider adjusting valuation/DCF assumptions

Our Solution

Closing Points (cont’d)b. Summary of the Presentation

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Documents

Hewlett-Packard’s Acquisition of Autonomy Corporation, Mending a Broken Acquisition Process