How Is Hewlett-Packard Reinventing Itself?

Jay is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

From its humble beginning and throughout the proud history, Hewlett-Packard (NYSE: HPQ) has always tried to project the inventor image onto the consumer’s mind. After all, “hp invent” is the company’s motto and its corporate logo. But now it seems that the once distinctive slogan is gradually losing its old persuasiveness, as the long-held personal-computer invention is giving away to the mass mobile-computing revolution. To reinvent itself, HP needs a corporate strategy that is not only reflective of the current computing technology, but also well-executed by an able management team.

So far this year HP stock has lost more than half of its market value amid ongoing business repositioning, questionable acquisitions and purchase writedowns in the billions. During its latest fiscal quarter ended Oct. 31, the company saw its total book equity decrease by almost 30 percent, largely due to a writedown of more than $9 billion in connection with its earlier acquisition of Electronic Data Systems, the enterprise data processing software company that HP had counted on to help it break into the business software service segment. Its most recent purchase of Autonomy, a British business software company specializing in data searches crossing multiple platforms such as an organization’s emails and its social media accounts, cost HP another $8.8 billion in valuation write-off. Investors will likely see further decline in its reported total book equity when the next quarterly results come out.

Other computer makers have also scrambled to rework their corporate strategies mostly by venturing into business software and services to make up the foreseeable losses in personal computing hardware. For example, Dell (NASDAQ: DELL) bought a series of business software makers in 2012 alone, including AppAssure, Clerity Solutions and Quest Software. It’s been a shopping spree to say the least for these traditional computer makers trying to buy front-line software developers. As one can imagine, amid all the excitement but potentially careless use of shareholders‘ money, the execution of a deal could go widely wrong sometimes. HP’s purchase of Autonomy has been proven to be a disaster as the result of overvaluation. This is in turn a refection of the incompetence of management including its board, as they did not understand Autonomy’s particular business practice and accounting reporting, which were quite different from what normally works at a computer maker like HP.

The central issue related to HP’s Autonomy purchase debacle is around the target company’s reported software license revenue. While HP now claims that Autonomy inappropriately recorded its so-called software license revenue, many accountants may disagree, including this author, who has a master’s degree in accounting. In addition to software sales revenue earned directly from clients, Autonomy also recorded certain other proceeds from the same clients under software license revenue, which probably prompted more interests from HP as it likely believed that the license revenue could be more of a long-term earnings stream. Well, as Warren Buffett would always say, it’s all in the footnotes. But apparently, the HP management and its board did not carefully read the footnotes of Autonomy’s financial reports for detailed disclosures on how its license revenue was categorized.

For Autonomy, the software license revenue was intended to show its clients’ commitment to buying and using Autonomy’s software after a client having first purchased a discounted hardware in a promotional offer by Autonomy. Per agreements, the specific hardware bought by the client from Autonomy would be subsequently used in the installation of Autonomy’s software. So the discount hardware proceeds received by Autonomy seemingly works the same way a license fee would in that the selling of the initial hardware helps secure the software sale later. The entire hardware sale maneuver by Autonomy was nothing more than a promotional effort of marketing to eventually sell the company’s software, and the negative margin from the hardware sale was appropriately recorded as a marketing cost, which HP probably didn’t catch either. With an overly optimistic view on revenue but potentially an under calculation on cost, HP might have twice inflated the valuation on Autonomy.

HP may have also misinterpreted Autonomy’s total software sales value, given that many of the Autonomy’s software sales were done through third-party resellers including IBM (NYSE: IBM), which is itself a classic example of successfully transitioning from a consumer hardware maker to a leading enterprise software and service provider. Using more reputable software providers as representatives, Autonomy was able to introduce its software to more business clients. However, when a client buys an Autonomy software on a reseller’s recommendation, revenue is split between Autonomy and the reseller. Therefore, Autonomy’s actual software sales revenue is likely only a portion of the aggregate value of the software sold to clients. Becoming aware of the situation only recently, HP now essentially admits having over priced Autonomy’s revenue generating capability.

HP is reportedly referring the issues of sales and accounting practices at Autonomy to both the U.S. and UK authorities and intends to file civil lawsuits against previous owners of Autonomy. But can HP investors really count on that when the allegations seem to all point back to HP’s own lack of due-diligence? It was simply a bad business deal by HP. The only recourse would be for investors to take actions to force some management overhaul.

 


JJtheArdent has no positions in the stocks mentioned above. The Motley Fool owns shares of International Business Machines. Motley Fool newsletter services recommend Dell and International Business Machines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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