What do you think of this?

Meanwhile, the most controversial banker involved in the HP-Autonomy deal, Frank Quattrone of Qatalyst, represented Autonomy and played a key role in getting HP to pay a high price. … Analysts almost uniformly deemed the $11.1 billion he got HP to pay for Autonomy as overly rich – a compliment to him at the time, but possibly a hollow success if HP’s allegations prove true.

True or false, re: “hollow success”? The article is about how the eight zillion bankers and lawyers and auditors and, I dunno, PR firms swarming around the HP-Autonomy deal failed to notice that Autonomy was a giant fraud due to (1) it not being a giant fraud, (2) it not being their job to notice that it was a giant fraud, and/or (3) their not being good at their jobs.1 Was it Quattrone’s job?2 The capital-markets gatekeeping function, whether in sell-side M&A or in IPOs, exists in irresolvable tension between “getting the best possible price for your client” and “maintaining some credibility with the buy side.” If I were selling my company – fraud or otherwise! – I’d be pretty psyched to hire someone talented enough to get $11 billion for a giant fraud; on the other hand, once you get a reputation for getting top dollar for giant frauds, it becomes hard for you to get any dollar for anything.3

A while back we talked about a sort of amusing article saying that M&A lawyers provide no value because (1) their job is to negotiate the conditions in which a merger will and will not close, (2) mergers always close, so (3) their job is purely decorative. You could take issue with that for a number of reasons; at the time I suggested that one of those reasons would be “well they also add value by doing due diligence” and, heh, so much for that.

To add back some value, the authors recommended changing the role of lawyers from negotiating closing conditions to negotiating variable consideration: instead of just “you close the deal for $40 unless there’s a material adverse change, in which case everyone freaks out,” it’s “you close the deal always, but you pay $40 ± ($1 x percentage change in revenues)” or whatever. This too has some dubiousness in terms of lawyer-value-adding: it requires lawyers to do math, for one thing, which in turn I guess requires a mean joke about lawyers’ math ability here4.

Would that have helped HP with Autonomy? In theory, kind of, yes? If you’re an acquirer bound to close unless there’s a material adverse effect, and if you know that proving that sort of thing is close to impossible, then you spend your time between signing and closing congratulating yourself on what a good deal you’ve gotten. What else are you going to do? If you find a small or medium or medium-large problem with the target, it’s your problem now, so best for your peace of mind not to look for problems. (If you find a giant problem, you can call a MAC, but what are the odds.)

If on the other hand you get a dollar-for-dollar (or whatever) discount for every problem you find, then a good use of your time is to look for problems. In some loose sense this is true before you sign the deal – your diligence helps you find reasons to argue for a lower valuation, the target tries to argue for a higher valuation, you argue, minds meet – but market prices and auction dynamics and negotiating leverage and various other whatnots interfere. If you’ve got a contract, and the contract says “$1 off for every $1 of accounting fraud you find,” then your incentives to find fraud are at their highest.

Meh, it’s a theory. But it also shows you why this wouldn’t work. HP signed its deal to acquire Autonomy in mid-August 2011, went out with a fixed-price offer to shareholders, and closed in early October. Building in more time to dig into Autonomy’s performance, and turning the consideration from a fixed price to “fixed price minus whatever fraud we find,” might in hindsight have helped out HP. But why would Autonomy agree to it? If you want to be exposed to price risk for a long time, just don’t sell yourself.

The whole point of M&A, for the target, is to use all your negotiating power and auction dynamics and competitive pressures and whatever else to get the acquirer to overpay by as much as possible and to close as quickly and certainly as possible. Autonomy’s advisors did a great job for Autonomy, if for no one else. You can question whether Frank Quattrone did himself any favors by maximizing the price, but it’s hard to argue with its lawyers for maximizing certainty and speed.

In HP-Autonomy debacle, many advisers but little good advice [Reuters]

1. Who am I to say which, but I find this compelling:

Software companies sell stuff that is barely tangible – they sell it up front and for cash. They have very few receiveables. They do however have an obligation to service that software for a long time after they sell it – so the unearned income is relatively large (usually a multiple of receiveables). Autonomy was booking as income lots of cash it had not received (which is why the receiveables were large) and not booking any obligation to provide future services for that income. This is prima-facie suspect (and you could tell simply by looking at the balance sheet). All it required was basic applied accounting.

2. Narrowly/legalistically no, right? The sell-side banker probably has even less of a diligence obligation than the buy-side one: his obligation is to get the highest price, not find problems. Unless I guess he actually knew about fraud? One assumes that even if Autonomy was a giant fraud they wouldn’t bother to make Quattrone aware of it at the org meeting. “Well, Frank, let’s talk about our strategy for addressing the fact that our entire company is built on recognizing revenue that we haven’t earned,” etc. Or maybe?

3. Does this prove too much? If you get a reputation for getting top dollar even for non-frauds, people should be less willing to give you top dollar.

4. For the record, I don’t buy it. Corporate equity derivatives, where I used to work, is pretty much lawyers doing math. Also mathematicians doing securities law.

43 comments (hidden to protect delicate sensibilities)
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Comments (43)

  1. Posted by Guest | November 21, 2012 at 12:28 PM

    Didn't realize Borat was a banker.

  2. Posted by Guest | November 21, 2012 at 12:34 PM

    It's nice what Matt can do with a little autonomy

  3. Posted by guest | November 21, 2012 at 12:39 PM

    Frank Quattrone is the hotel mini bar of tech M&A.

  4. Posted by Quant Humor | November 21, 2012 at 12:39 PM

    Why did the M&A lawyer (who was a math genius) name his dog "Cauchy"?

    Because he left residue at every pole!!

  5. Posted by Guest | November 21, 2012 at 12:41 PM

    Matt, a couple things: First, there already are purchase price adjustment structures to reconcile the expected value of the purchased company to actual value based on closing and post-closing balance sheets. Second, the majority of transaction documentation consists of reps and warranties and indemnification rights. This is a risk allocation and damage recovery mechanism that, while not usually expressed mathematically, has much the same effect.

  6. Posted by DingALing | November 21, 2012 at 12:41 PM

    Great mustache, or greatest mustache?

  7. Posted by Bejujular | November 21, 2012 at 12:42 PM

    Did one man fool the world's second largest accounting firm, and subsequently the world's fourth largest accounting firm checking the second's work?

    Is that their defence?

    1. Admittedly it's not their "job" but by the same token Arthur Andersen's conviction was overturned, these failures ruin your credibility going forward.

  8. Posted by BORДT | November 21, 2012 at 12:46 PM

    The rubber fist was this big!

  9. Posted by sme | November 21, 2012 at 1:02 PM

    that's Quack-tastic!…

  10. Posted by qwestion | November 21, 2012 at 1:03 PM

    Nice rug. Plays a nice supporting role to that porn 'stache.

  11. Posted by Puck It | November 21, 2012 at 1:10 PM

    Not even close to the legendary Lanny McDonald's 'stache.

  12. Posted by Unfrozen Caveman | November 21, 2012 at 1:15 PM

    You know what’s more useless than lawyers?


  13. Posted by PermaGuestII | November 21, 2012 at 1:18 PM

    I'll see your Lanny McDonald, and raise you Thurman Munson.

  14. Posted by guestivus | November 21, 2012 at 1:27 PM

    "Let me be Frank with you", said Mr. Quattrone…

  15. Posted by lucas | November 21, 2012 at 1:37 PM

    But suing (and collecting) for breach of reps and warranties isn't easy. There's room to make post-closing adjustments more predictable and useful.

  16. Posted by craig of craigslist | November 21, 2012 at 1:40 PM

    First we bitch slapped her at EBAY and now they get her at HP
    Score 2 for the good guys!!!

  17. Posted by Guest | November 21, 2012 at 1:43 PM

    Ideally, yes. Though I would expect any major dispute over purchase price to be resolved by a court or arbitral panel. Even if you have a well-defined adjustment mechanism, unless you put a huge part of the purchase price in escrow (and maybe even if you do), neither party will relinquish their purported claim to it without a fight.

  18. Posted by Robin Olds | November 21, 2012 at 1:46 PM

    I'll see your Thurman Munson and raise you Frida Kahlo! http://www.biography.com/people/frida-kahlo-93594

  19. Posted by Guest | November 21, 2012 at 2:06 PM

    Bros it's Thanksgiving eve alright, relax.

  20. Posted by Guest | November 21, 2012 at 2:09 PM

    I'm going with Lanny McDonald. Frida would have won if the mustache could be located on the eyebrows, however, I have ruled it out of the field of play.

    – Unoffical DB Mustache Arbiter

  21. Posted by Guest | November 21, 2012 at 2:18 PM

    No matter how bad it turns out, at least it's not Countrywide

    – Former BAC Merchant Banking Analyst, Current BAC Teller

  22. Posted by Puck It | November 21, 2012 at 2:20 PM

    Y'know, if you're going to go all baseball and not mention Rollie Fingers…..tsk tsk

  23. Posted by Guest | November 21, 2012 at 2:24 PM


  24. Posted by jokekiller | November 21, 2012 at 2:30 PM

    he said as he stepped out of his Audi Quattro

  25. Posted by Einhorn | November 21, 2012 at 2:49 PM


  26. Posted by Grammar Police | November 21, 2012 at 3:25 PM

    Defense* – there, fixed it for you

  27. Posted by guest | November 21, 2012 at 3:37 PM

    I'd also note that the short time between signing and closing is irrelevant. Most of the diligence should be done before signing. If HP started digging into Autonomy's audits and financials after announcing an $11 billion public company deal, they have themselves to blame.

    (But good article anyway).

  28. Posted by guest | November 21, 2012 at 3:45 PM

    I will never, ever understand acquirors who blame sellside bankers for charging them too high a price. Seriously – grow up. An acquisition is worth what it's worth. Figure out what that is (here's a secret: it isn't that hard), factor in a little margin of error, and don't go over that price.

    Ok, maybe less relevant in cases of accounting fraud, but still, happens all the time.

  29. Posted by guest | November 21, 2012 at 3:57 PM

    public co + UK law…?

  30. Posted by Guest | November 21, 2012 at 4:15 PM

    um, maybe expand on that thought a bit.

  31. Posted by Guest | November 21, 2012 at 4:19 PM

    Except that you're not buying a balance sheet. The purchase price is usually based on multiples of EBITDA or on DCF (and usually from projections that you won't be able to verify before closing no matter how long between signing and closing), and purchase price adjustments are usually related to working capital and sometimes specific issues (such as taxes).

    Regarding the R/W and the indemnification rights, the former won't help you based on Matt's starting premise (that every deal closes no matter what is discovered between signing and closing), unless you add a mechanism (like Matt's suggestion) to adjust the purchase price based on a breach of the R/Ws. And the latter won't help you in a public acquisition, as generally the shareholders (who are largely hedge funds by the time of closing) just disappear.

    The only risk allocation and damage recovery mechanism generally available is that, no matter how bad the screw-up, public company shareholders generally are unable to throw the bums out.

  32. Posted by Guest | November 21, 2012 at 4:24 PM

    I'm not sure I follow any of that.

    – Folks who actually try to value things.

  33. Posted by Bejujular | November 21, 2012 at 4:28 PM

    British/Canadian/Australian spelling

  34. Posted by Guest | November 21, 2012 at 5:10 PM

    Why is Movember not a tag?

  35. Posted by guest | November 21, 2012 at 5:24 PM

    Standalone DCF + PV of synergies, the latter formulated and committed to by your management team. Everything else is noise/air cover.

    Deal dynamics, seller guidance, and everything else should determine how far under your maximum price you pay, not whether yo go over it.

  36. Posted by Guest | November 21, 2012 at 6:04 PM

    Since both of those methods are so robustly precise? DCFs are far too assumption based to extract a single "value" data point, and anything with the word "synergies" is basically hand-waving.

    I don't disagree that "it's worth what it's worth," but to suggest the valuation process is so cut and dry is either misinformed, astonishingly overconfident, or disingenuous.

    -Guy who is here way too late on Thanksgiving eve.

  37. Posted by The mo gives it away | November 21, 2012 at 8:09 PM

    No, no, no. It's Emil Muzz.

  38. Posted by LatamGuy | November 21, 2012 at 9:04 PM

    Audi Quattro? This guy probably can get a Hispano

  39. Posted by tgma | November 22, 2012 at 12:44 AM

    Heartily agree – you can tweak a DCF to get just about any number that you want. Part of the trick of being an analyst (market, not IB) is to lobby your bankers to allow realistic assumptions so that no one gets carried away with the price. Most bankers in my experience accept this, because they know that if they screw a buyer on the valuation once, no one will buy from them again. Although I can name one investment bank whose every IPO has fallen in value, except for one that they did in 1997 (which admittedly did very well). And at some point someone will do a fun piece of research which will compare promised synergies with actual synergies – this should be just about the easiest way to get yourself a career as a junior professor in finance.

  40. Posted by tgma | November 22, 2012 at 12:49 AM

    When someone comes to write the financial history of the last twenty years, one thing that will stand out is that corporate boards have been treated as jokes by management, board members, and most importantly shareholders. Directors' and Officers' insurance should NOT be paid for by the company (ie the shareholders) but by the individuals themselves. And it should probably be outlawed so that they are liable for the full damage caused by their incompetence.
    The days when the management of company A hired the management of company B to sit on their board and determine their compensation, in return for the management of company A sitting on the board of company B to determine the latter's compensation were meant to end with Enron. But the real question is, what are the shareholders – ie the pension funds and mutual funds doing in all this? There should be a shareholders' association that is as powerful as the NRA.

  41. Posted by tldr | November 22, 2012 at 7:12 AM

    In short, where are the shareholders' porn 'staches?

  42. Posted by grumpy | November 22, 2012 at 7:26 AM
  43. Posted by timbukthree | November 23, 2012 at 5:14 PM