The H-P Affair: What Stockholders Need to Know

For nearly a week the scandal at Hewlett-Packard (HPQ) has dominated the headlines. Each day has brought progressively worse news. What began as news that George Keyworth had been identified as the source of a leak and would not stand reelection, quickly escalated with the revelation that investigators hired by board Chairwoman Patricia Dunn had obtained information about directors and reporters illegally.

Subsequent reports brought news that Tom Perkins had resigned from the board in May in objection to this unethical act, that the California Attorney General was investigating criminal charges, and that the FCC, FBI, US Attorney, and Congress were also conducting investigations.

Despite this, Dunn has maintained that there is no need for her to resign, though she has said she will do so if asked by the board.

What is most interesting to me about this is the market’s reaction. Hewlett Packard stock has deflected each piece of news, closing Monday at $36.36, just short of its 52 week high. So while the headline writers and journalists (particularly those who had their phone records illegally obtained by Dunn’s henchman) have determined that this is a serious matter, investors have decided it’s immaterial.

What are the possible impacts that investors should be concerned with?

Impact to Business
Hewlett Packard is a well-established vendor it is hard to imagine this having a material impact on revenues. Purchasers will view this is an internal company matter, irrelevant to their purchasing decisions

Impact to Mark Hurd
Since taking the CEO position at Hewlett Packard, Hurd has been credited with vastly improving the company’s performance. Any indication that Hurd were involved that might jeopardize Hurd’s future role at the company would be viewed as a negative by the street. There has been no suggestion that Hurd played a role in this, and in fact, the investigation began during his predecessor, Carly Fiorina’s tenure. I view it as unlikely that Hurd will be adversely impacted by this.

Criminal Charges or Lawsuits against the Company
With the number of investigations underway now, criminal charges against one or more individuals seem likely. I suspect that the investigators are the most likely target. From what is currently known, it would seem difficult to make a case against Patricia Dunn and even more difficult to make one against other board members. Lawsuits against the company by those journalists whose records were illegally obtained seems possible, but of uncertain outcome.

Patricia Dunn’s Job Status
While it is unclear what Dunn knew when about the illegal activity, she ultimately should be held responsible by the board for the investigation that she ran. Dunn hired the investigators, managed communications with them, and received reports from them. Proof that Keyworth was the leak source must have included phone records. If she didn’t ask how they were acquired, she certainly should have. And if Tom Perkins knew what had happened in May, she certainly did, yet there is no evidence that she did anything at that time to rectify the situation. She may not have done anything illegal, but she has failed utterly at her job an ought to be fired.

Bottom line, the market has weighed these and other factors, and yawned. If I owned HPQ though, I would view this as an opportunity to sell. The stock has moved up significantly both over the last month and the last year, there remains risk of additional revelations, and I don’t want to own a company whose board allows this Chairwoman to remain.

Update: HPQ announced this morning that Dunn will be stepping down as chairwoman effective January 18 but remain on the board. Mark Hurd will become Chairman. This is puzzling to me. If Dunn isn’t fit to serve as Chairwoman after January, she isn’t fit now, and she isn’t fit to be a director. There had been some speculation that Tom Perkins might be brought back to replace her, but with Dunn remaining on the board seems unlikely. It would seem to me that as long as Dunn and those board members who allowed her to stay remain, HPQ should be approached with caution.

Disclosure: I do not own HPQ

Related: More opinion and analysis of Hewlett-Packard

Comments

[David Segelov:]

HPW's announcment to make the CEO Hurd also the Chairman reverses the trend of the past five years where every investor wanted the roles split.

Did the investment community learn anything from Enron and other corporate debacles?

2006 Sep 12 11:53 AM

[Paul Meisel:]

Several things that seem to bear witness to a serious corporate governance issue:

1. George Keyworth says, and apparently some internal HP sources confirm, that he was authorized on many occasions to give background information to business journalists. Assuming this is so, why the sudden interest in preventing leaks? Or wasn't there any guidance on what was to be leaked?

2. Perkins resigned in protest in May and had significant correspondence with HP in June and July regarding their need to publicize the reason for his resignation, yet they did not until recently. This by itself is a troubling ethical issue and a failure by Dunn to fulfill her responsibilities.

3. The employment of an investigator without guidance to methods is certainly poor judgment at a minimum.

4. Combination of the CEO and Chairman role when there is an in-process governance problem is troubling if not just plain dumb. Hurd may be an outstanding executive but there is no good reason to split his priorities between running the company and cleaning up a boardroom mess.

5. It would be very interesting to see what other outside directors say, although it could well be argued that their remaining in the background is wise.

2006 Sep 13 01:50 PM