The ultimate blame for problems at Hewlett-Packard has yet to be attributed but, wherever responsibility is finally deemed to lie, the saga has revealed some uncomfortable truths about the operation of financial markets – not least with regard to UK software company Autonomy.

Among the claims and counterclaims flying around are allegations – strongly refuted by Autonomy co-founder and former CEO Mike Lynch – that senior people within the group booked low-margin hardware sales as higher-margin software sales to flatter profit figures. Some eagle-eyed analysts have suggested this showed up in the group’s cashflow numbers, which were not as strong as its high profits would suggest.

Much though various people would like to blame the ‘anti-establishment’ figure of Lynch, this type of fraud would have had to go much deeper than the CEO. There must have been a widespread agreement among staff to ‘cook the books’, presumably to boost the share price or make the company more attractive as a takeover target. If this is the case, it perhaps suggests the limitations of employee share ownership – long-heralded as the solution to incentivising staff and creating alignment of interests between senior management and shareholders.

Whether or not it is found to have been ‘duped’, the role of Hewlett-Packard in all this also deserves some scrutiny. Its due-diligence was inadequate. Rumours had been in the market for some time and, while the senior management of the day say they fully investigated them, for the issues to come to light in exactly the same form as the rumours seems suspiciously coincidental. The tie-up smacks of a deal railroaded through to the benefit of a number of advisers and senior executives – but to the detriment of Hewlett-Packard shareholders.

Hewlett-Packard now has ‘new broom’ management in the form of Meg Whitman. Lynch has argued poor incentive structures have ensured Autonomy has been run into the ground while Whitman claimed there had been “serious accounting improprieties” and wrote off £5.5bn from the value of the acquisition. Neither side emerges from this looking good.

There is one further side to this story. A number of analysts and fund managers have emerged to say ‘we told you so’ over Autonomy – and indeed it looks as if their analysis of the company may be proved correct. Nevertheless, as a short position in a portfolio, it was a spectacularly bad one as Autonomy was ultimately taken over by Hewlett-Packard at a significant premium to its then share price.

It shows both the limitations of shorting on the basis of company fundamentals alone and the danger of assuming that the market – or indeed trade buyers – are ultimately rational. It may be a sad end for a once-great UK company but there need to be some lessons learned.

NOVEMBER 2012