There are few things that are guaranteed, two of which are death and taxes. Although we all hate tax time, it's something we all must do. For companies that cater to this market, that means a high level of recurring revenues and cash flow. Investors looking to invest in this trend should focus on the purest play on the industry.
Billionaire Dan Loeb and his Third Point hedge fund is just the latest to realize this. Last quarter, Loeb's Third Point fund took a $105 million position in H&R Block (NYSE:HRB). He joins the likes of Ken Griffin's Citadel Advisors and Senator Investment Group as an owner of the tax-prep company.
Becoming more shareholder-friendly
H&R Block has sold its bank unit, which means it no longer has federal oversight. The company can now buy back shares without the Fed's approval. There's speculation that with the bank unit gone, it could be attractive for private equity buyers. Its free cash flow yield is close to 7%, which is something many private equity firms would likely be interested in. Without the bank unit, it's now a pure-play on tax filings.
A great market to be in
H&R Block also has little competition. TurboTax, owned by Intuit (NASDAQ:INTU), is its top rival, it focuses on online tax filers. H&R Block is the leader when it comes to in-person prep work. Thanks to its large presence in the brick-and-mortar market, H&R has a competitive advantage over companies that want to break into the in-person market. With its economies of scale, it can also offer tax prep cheaper than "mom and pop" shops. The other thing is that H&R Block has a presence in the do-it-yourself tax market. It owns just around 15% of that market.
The market shakedown
For Intuit, the big risk to its business model is the rise of free services. This includes the likes of TaxSlayer, which is offered via the IRS Free File program. There's also the rise of free e-filings for state returns via state websites. While you can still file free via TurboTax for a base-level return, state filings will still cost you.
Now, the biggest risk for H&R Block is the rise of digital tracking related to income and expenses. This includes Mint.com and other programs that integrate nicely into TurboTax. Now, tax filers can complete returns on their own much easier. The rise of mobile applications is making this even easier. However, even for customers who track their revenue/expenses, the tax filings are still a vastly complicated process for most. Being able to talk through the process in person still holds some value.
How shares stackup
H&R Block is near its 52-week high, but still only trades at a P/E ratio of 15 based on next year's earnings estimates. There's also the 2.5% dividend yield and potential increase in buybacks thanks to the fact that federal oversight is gone. H&R Block and Intuit have similar returns on investment, coming in at 21% Sorry about that, it should have been ROI not ROE. But yes on a TTM basis. But Intuit trades at a forward P/E of 20, and its dividend yield is also less than 1%.
The rising population and increasing complexity of the tax code is good news for H&R Block. It also has a strong recurring revenue base as customers keep coming back year after year to file their taxes. For investors looking for a solid play on a long-term trend, H&R Block is worth a closer look.
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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool recommends Intuit. The Motley Fool owns shares of Intuit. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.