Overvalued By, Oh, 400% Or So

Posted on Nov 21, 2012 | No Comments

A word of friendly advice: Always look closely before acquiring a software company for $11 billion.

Otherwise, you might find you’ve bought a dud like Autonomy. That’s what Hewlett-Packard did, and now CEO Meg Whitman has conceded the point. H-P has written down more than 80% of the purchase price and accused Autonomy’s erstwhile executives of “accounting improprieties, misrepresentations and disclosure failures.”

Over at Forbes, Daniel Fisher has what may be the skinny on what happened. Autonomy had a product called IDOL, an acronym for Intelligent Data Operating Layer, which it sold in conjunction with other basic stuff like data storage—but switched around the official prices to make IDOL look like software that people valued. By analogy, imagine you purchase a Bel Air mansion plus one chocolate chip cookie for a total price of $8 million. To mask the true values of what you were paying for, the seller notes in his accounts that he sold the Bel Air mansion for $3 and the cookie for $7,999,997. Thus, is he able to claim that he makes a highly sought-after cookie.

Whether this describes what Autonomy was up to will come out in the months ahead. In any case, Peter Drucker would have seen much of the problem as tied to accounting conventions that, even when not fraudulent or unethical, at the very least are outdated and likely to give misleading pictures of the businesses in question.

“Managers must emphasize increasingly the responsibility for earning the costs of risk, of change, of innovation and of tomorrow’s jobs for today’s young people and the new entrants in to the work force,” Drucker wrote in his 1980 bookManaging in Turbulent Times. “They cannot do sounless they first make sure that the accounting figures of their own enterprises, by which they themselves manage, reflect reality rather than the delusion of ‘profit.’”

By the time he wrote Management Challenges for the 21st Century, in 1999, things at most companies didn’t look a whole lot better. “Accounting was originally created, at least 500 years ago, to provide the data a company needed for the preservation of its assets and for their distribution if the venture were liquidated,” he explained. “And the one major addition to accounting since the 15th century—cost accounting, a child of the 1920s—aimed only at bringing the accounting system up to 19th century economics, namely, to provide information about, and control of, costs.”

What do you think? Are the accounting practices at most companies badly outmoded?

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