This morning, Hewlett Packard (HPQ) took a $8.8 billion accounting charge to mark down the value of Autonomy, a company HP acquired last year for $13.5 billion. Predictably, this sent HP shares down over 10% as a huge chunk of shareholder value was wiped out. Not too noteworthy if it weren't for the fact that the same exact thing had happened this August when HP took a $8 billion charge for EDS. One would have thought that most shareholders would have scrutinized HP's books more carefully and not get caught with their pants down again. However, it is apparent this is not the case as a lot of shareholders just saw several billion in shareholder equity wiped out overnight (for the second time in a year).
Which brings me to my point, all too often, mark to market risk is overlooked by long term investors. In short, a company's profits/earnings, and ultimately its value (and stock price) is measured in large part, by its cash flow and its books. In this case, HP had on its book, the Autonomy unit with a nominal value of $13.5 billion. Turns out, Autonomy isn't worth $13.5 billion anymore, not even close. By HP's own reckoning, it is worth $8.8 billion less. And fortunately (or unfortunately depending on how you look at it), corporate accounting standards require that corporations report the true value of their assets.
So, due to the decrease in the value of Autonomy, HP was required to take a $8.8 billion charge, which is bad for HP investors, but good for the market as a whole as now HP's books more accurately reflect its true value (unlike say, corporations like Enron and Worldcom). While $8.8 billion seems huge (especially for the now smaller HP), it pales in comparison to the $40 billion charge Time Warner (TWC) took on AOL. In that situation, Time Warner had purchased AOL at the peak of the dotcom bubble and discovered several years later, no surprise, that it had grossly overpaid.
In hindsight, today's outcome for HP is not all that surprising either and should have been something many investors were able to capitalize on. At the time of the Autonomy acquisition (during the midst of the 'cloud' bubble), HP was widely panned for having overpaid. To put it in perspective, weeks before HP paid $13.5 billion, Oracle walked away from the table because it considered Autonomy's $6 billion market cap to be excessive. And judging by HP's performance over the last year, it is quite apparent to all that Autonomy has not delivered the growth to HP that it promised, and is not nearly as valuable as HP was led to believe. Viewed from that perspective, even a less sophisticated investor could have anticipated today's accounting charge had they been paying attention.
Luckily for HP investors, with the Autonomy charge, there are no longer any major charges that are potentially waiting in the sidelines. However, additional mark downs for Autonomy are possible in the future if HP doesn't rapidly turn that business around and this is something to keep in mind. Similarly, long term investors might want to closely scrutinize their holdings to see if they are holding other corporations with large potential mark to market risks. Some candidates include:
Alpha Natural Resources (ANR): Acquired Massey Energy for $8.28 billion.
Duke Energy (DUK): Acquired Progress Energy for $25.52 billion.
Express Scripts, Inc (ESRX): Acquired Medco for $34.3 billion.
Sanofi (SNY): Acquired Genzyme for $19.64 billion.
Texas Instruments (TXN): Acquired National Semiconductor for $6.5 billion.
All of these deals closed in 2011 and are sizable enough that even a 20% mark to market can significantly drop stock prices. As HP's disaster today illustrates, the adage buyer beware applies to both corporations and stock investors.