Accounting Fraud or Not, Hewlett Packard Has Proven to Be A Huge "Value Trap"

Accounting Fraud or Not, Hewlett Packard Has Proven to Be A Huge "Value Trap"

Hewlett Packard asserted on November 20, 2012 that it was the victim of massive accounting fraud in its October 2011 $10 billion acquisition of Autonomy. The issue of whether fraud occurred is fascinating, but secondary to the reality that Hewlett Packard - like no other stock in recent history - demonstrates the danger of chasing dividends and looking at PE ratios. Does the stock represent value here?

When David Faber on CNBC broke the news of a massive accounting fraud allegation by Hewlett Packard at 7:30 AM on November 20, 2012, Andrew Ross Sorkin, the CNBC/NY Times anchor/finance editor who is in a class by himself in terms of understanding of accounting in financial journalism, seemed completely nonchalant.  Sorkin explained that Hewlett Packard overpaid by 70% for Hewlett Packard under any circumstance and they had previously written the value of the acquisition down to $5 billion (see the video here).

Sorkin of course is correct.  The Autonomy acquisition was such a ridiculous overpayment by what at the time was still a leading technology company and was recognized as such almost instantly throughout the financial services industry and the technology industry.   It was the single biggest reason why institutional hunting for high dividends and low PE ratios avoided the stock even as its dividend moved above 4% and its PE fell to single digits.  Noted short-seller Jim Chanos, in the summer of 2012, with the stock still at 19 issued a dire warning on Hewlett Packard calling it the ultimate fallen technology angel and said it was masking its decline in revenues through overpaying for acquisitions.

Hewlett Packard announced earnings of $1.14 for the last quarter and guided towards full year earnings over $4.  It is estimated to earn 90 cents in the first quarter of 2013 and full year 2013 estimates are as low as $3.  The stock today now trades below $12.  Its dividend rate is close to 5 and it is one of the highest paying dividend stocks in the Dow (see the complete list of Dow dividend payers).   Even with the lowest analyst targets, it is trading at 4 times earnings.

The actual allegations of fraud seem to be quite dubious.  Autonomy was a software company and Hewlett Packard is asserting that it showed unrealistic margins through sales of hardware.  There is a caveat emptor, and Hewlett Packard should now and understand the hardware and the software industries both very well.

The accounting fraud assertion has real consequences.  If it occurred, it could involve Anderson-like liabilities for Deloitte, Autonomy’s accounting firm, and liabilities for Autonomy's bankers.   The fraud assertion could protect Hewlett’s board and its former CEO Leo Apotheker from significant liabilities resulting from the overpayment. More importantly, however, regardless of whether fraud occurred, the ultimate question is whether the same board that remains largely the same as it was a year ago can engineer a turn around that would stabilize the company and avoid the deterioration in all of its businesses, even with Meg Whitman at the helm.  When framed in that context, investors would be foolhardy to rush into a stock with a dividend close to 5 and a PE around 4.

Editor's Note: The author has no position in Hewlett Packard securities.

Reviews

  • Abe

    November 20, 2012

    From the HP release:

    "HP recorded a non-cash charge for the impairment of goodwill and intangible assets within its Software segment of approximately $8.8 billion in the fourth quarter of its 2012 fiscal year. The majority of this impairment charge is linked to serious accounting improprieties, disclosure failures and outright misrepresentations at Autonomy Corporation plc that occurred prior to HP's acquisition of Autonomy and the associated impact of those improprieties, failures and misrepresentations on the expected future financial performance of the Autonomy business over the long-term."

    That sounds a bit different from dubious allegations. Can you cite your source?

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