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The Best and Worst Stocks of 1997

Winner -- Jackson Hewitt

(Nasdaq: JTAX) Price -- $67 1/4
Phone: (757)473-3300
Move: Up 1527.44% through December 15, 1997

The Company's Biz. Jackson Hewitt is the second-largest tax preparation service in the United States. You know, on that early April evening when you realize that filling out the 1040 tax form is way over your head, this is one of the two companies you go to for help. Jackson Hewitt does business in 41 states from stand-alone offices and from rented sections in discount and department stores like Wal-Mart and Montgomery Ward. The company franchises the majority of its units.

Jackson Hewitt's basic business is pretty simple to understand. Agents help individuals prepare tax forms and the company also offers refund anticipation "loans" on which it charges a pretty high rate of interest. Number two after H&R Block (NYSE: HRB), there is no other major competitor in the highly fragmented tax preparation industry. With the prospects for a flat tax still a dream and tax returns getting more complicated with recent capital gains reforms and other tax law revisions, it is no wonder that some view this as a great business.

The Story. Jackson Hewitt's story begins back in late 1995, when deteriorating financial results caused the company fell into default on short-term credit facilities. Although the lender waived the default, the company was forced to find new financing. Adding to questions about Jackson Hewitt's solvency was the early 1996 "flat tax" proposal that was pushed by some on Capitol Hill. Despite the fact that revenues climbed 37% in 1996 and the company closed the year with a $0.20 per share profit, the stock started the year abandoned and lonely at $4 and change.

From this nadir, the sucker started to move with a vengeance. Although revenue was flat in the first part of the fiscal year, the company's loss from operations narrowed under new, franchise-oriented management. Although the shares had tripled by June, rising to $12 1/4 mid-month, positive third-quarter results that showed revenues up 49.5% and the first-ever third quarter profit literally blew investors away. Results just kept getting better and better until HFS Corp. (NYSE: HFS) stepped in and asked Jackson Hewitt to be its merger bride.

How Could You Have Found This Winner. As the second-largest tax franchise in the country, once it became clear that Dick Armey's flat-tax would not see the light of day, a simple look at the numbers would have revealed a dramatically undervalued company. With new financing under its belt in early 1997, working capital turned deliciously positive by the end of the company's June fiscal year. An S-1 filed at the end of the month to issue 1.3 million new shares would end forever questions about the company's solvency.

At the end of a very solid fiscal 1997 (ended Apr. 30, 1997), Jackson Hewitt was valued at $11 per share, or $49.7 million. Over the past twelve months the company has earned $1.19 cents per share on a fully diluted basis before a one-time charge of $0.26 cents per share to retire a stock purchase warrant held by NationsBank in return for a prior credit agreement. The company's franchise sales were exploding and shares were valued at approximately 9 times earnings with all of the potential dilution from the warrants and the convertible notes gone. All of the major negatives were gone and the stock was at a rock bottom valuation.

After the road show for the secondary offering allowed management to get the story out, the stock exploded. The 1.3 million additional shares were sold at $21 1/4 per share, almost double the price the month before. Due to franchise sales, Jackson Hewitt began to book profits in its non-tax season quarters -- a first for the company. In what might have been another first, Business Week's Hot Stocks tipsheet actually made a good call when it profiled Roger Lipton of Lipton Financial Services and his bullish views on the stock. With earnings accelerating and franchise growth exploding to the point where by October the company had added 354 new franchises year-to-date compared to 85 in the prior year, it was clear that this would be a big year for Jackson Hewitt.

The Future. Franchise specialist HFS also noticed Jackson's good fortune and decided that the company would make a good asset to bundle with its pending merger with customer database king CUC International (NYSE: CU). The resulting Cedant Corp. would now be able to market Jackson Hewitt tax services to customers, giving Jackson a much needed leg up on its much larger competitor, H&R Block. Jackson Hewitt shareholders said yes to the $68 per share cash tender offer that paid 13.8 times sales for a company that started the year selling at meager 1.0 times sales. One of the keys to capturing a top performing stock is having the stamina to buy when the valuation is dirt-cheap.

[Fool Articles: Daily Double, 07/17/97: Jackson Hewitt (Nasdaq: JTAX)]

-Randy Befumo (TMF Templr)

Next Article: Winner -- MindSpring Enterprises


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