Autonomy: challenger to Silicon Valley captivated the City
Until this week the company Mike Lynch founded in Cambridge in 1996 was considered the closest thing Britain had produced to a business that could challenge the giants of Silicon Valley. Lynch was Britain's answer to Bill Gates, and the City was largely captivated by the success he claimed for Autonomy, the corporate information storage and search business sold for $10bn last year to America's Hewlett-Packard.
Not everyone was a believer, but questioning the claims of one of the UK's most flamboyant entrepreneurs was considered a little unpatriotic.
Now the senior management of Autonomy stands accused by HP of cooking the books on a scale that recalls the scandals at Japanese electronics group Olympus and NHS supplier iSoft. HP is alleging "serious accounting improprieties, misrepresentations and disclosure failures", saying the group's financial performance was exaggerated in order to deceive financial analysts and its acquirer – allegations flatly denied by a spokesperson for Lynch and his management team.
In the offices of Autonomy's headquarters, where the conference rooms are named after Bond villains, from Dr No to Goldfinger, a tightly knit group of senior managers led by Lynch, who boosted his own fortune by an estimated £500m by selling to HP, are alleged to have presided over accounting and sales practices that are of such concern they have been referred to the Serious Fraud Office and US financial regulator the Securities and Exchange Commission.
From analysts and former employees, a picture is emerging of a company where short-term results may have been pumped up at the expense of long-term, stable revenues, to the extent that a financial performance that had seen 55% a year growth could have flatlined unless Lynch found a buyer.
"We will seek redress against those parties we think we need to go after," warned HP chief executive Meg Whitman in a conference call, as she announced $8.8bn (£5.5bn) had been slashed from HP's book value as a result of the acquisition. HP said it was likely to go after not just employees, but some of the many advisers involved.
Speaking to the Wall Street Journal on Tuesday, Lynch laid Autonomy's woes at the door of its new owners.
"There was a series of mismanagement steps," he said. "They lost hundreds of the talented people at Autonomy. The whole management team basically went out of the door. Sadly they are left with the results of having destroyed all that value. Now they are trying to cover it up with this big write off."
He said the announcement was timed to coincide with the "worst set of results" in HP's history, and that it had written down other big acquisitions including technology groups Palm and EDS.
Whitman was at pains to stress her team had been surprised by what they uncovered, and that dubious practices only came to light after Lynch's dismissal from the company in May. At that point, a "senior member of Autonomy's leadership team" came forward, and gave an account that included "numerous details" of which HP previously had no knowledge.
But the discovery that all was not as it seemed within Autonomy did not come as news to everyone. Attempts to blow the whistle go back as far as 2010, when Marc Geall, Autonomy's former head of strategy investor relations, published a highly critical analysis after leaving to join Deutsche Bank.
A UK based technology consultant called Alan Pelz-Sharpe has told the Guardian that he reported alleged suspicious practices at Autonomy to the Serious Fraud Office a week before the completion of its sale on 3 October 2011.
His information was based on research widely circulated to journalists, analysts and HP insiders as the deal was being negotiated, and he was one of a number of bloggers who raised concerns publicly."Autonomy wasn't a place where you spoke up, it wasn't a happy place," he said.
Questions are now being raised about the thoroughness of auditors, advisers and the HP board itself in scrutinising the company. Whitman was not the architect of the acquisition. That dubious honour falls to Léo Apotheker, who stepped down after just 10 months with a $25m severance and stock payment. But Whitman, who took over from him 12 days before the deal closed on 3 October, was a member of the board that approved the transaction.
"We tried to generate whatever awareness we could around improprieties but there was no pickup," says a former employee who tried to blow the whistle at theat time of the deal. "It was all right there for someone willing to dig into it. HP simply assumed that what the investment bankers and the auditors were telling them was true. The analysts were captivated by the story."
If there was a problem within Autonomy it may have been in part one of accountability. Former employees, including Geall, say Lynch held the reins tightly with a small group of trusted lieutenants including marketing director Nicole Eagan, who has since left, head of global operations Ian Black, who remains at the company, and the head of US operations Stouffer Egan, who left last week.
The accusations made by HP allege several dubious practices. Loss-making hardware sales were allegedly being reported as software revenues. The cost of that hardware was then booked as a marketing expense which inflated revenue and gross margins. These sales are estimated to have comprised 10 to 15% of overall revenues.
It is claimed that licensing of Autonomy products to resellers was booked as revenue even when products had not been sold on to end users – long term hosting deals, for example information storage, were converted into short term licensing deals to inflate revenues. In the quarters before its sale, employees say sales agreements frequently involved offering firms discounts on licensing deals if they paid upfront. The revenue was booked, but said to have been made to look as though it was normal recurring licensing revenue rather than a one-off payment.
A series of what Autonomy liked to call "mega-deals" were announced – software licensing agreements with the world's largest banks. In July 2007 Autonomy bought a company called Zantaz, an email archiver with a number of large banking clients. Zantaz had long life service and maintenance agreements with these clients, and over the following two years it is claimed Autonomy offered to rewrite those contracts with a discount, again in exchange for large upfront payments, which again are said to have been made to look like ongoing revenues.
"Autonomy was raiding its piggy bank," said the unnamed employee. "They were misclassifying revenue and making it seem that revenue was larger than it was. It was not sustainable. The problem was, no one had the full picture except in the UK."
The investment banker hired to help sell Autonomy was Frank Quattrone. The former Credit Suisse high flyerhad been cleared over charges of "spinning" to inflate the value of companies during the dotcom boom and was beginning a rehabilitation. Oracle was one of the potential buyers targeted by Lynch and Quattrone, but they were rebuffed, with Oracle chief executive Larry Ellison later ridiculing the price paid by HP as "absurdly high".
Whitman confirmed investigations were concentrating on the eight quarters preceding the deal. Analysis shows that around then Autonomy's profit margins fattened visibly, from an average of about 30% to 40% or more.
She still believes some of that value was real. "We think Autonomy can still be a very important part of HP's future software growth," she said yesterday. But the hopes that Lynch would be able to use his rewards from the UK's largest ever technology company sale to fund a new generation of entrepreneurs have been somewhat shaken.
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