Option Weighs Down H&R Block

The first quarter after tax season is supposed to be a quiet time for tax-preparation firms. Unfortunately for H&R Block (NYSE:HRB), recent market turmoil is making it hard to unwind its mortgage business. But once it does make the break from Option One Mortgage, do its other businesses have any appeal for contrarian-minded Fools?

It seems like eons ago, but H&R Block used to have a reputation for steady and profitable growth as it came to dominate the tax-preparation business. As of the most recent fiscal year, the company estimates that it held 16.1% of the market for individual tax returns, well ahead of Jackson Hewitt (NYSE:JTX), the second largest in the field and the holder of only about 4% market share. Intuit (NASDAQ:INTU) is the undisputed leader in online tax preparation, but most of the other competition is fragmented and consists of mom-and-pop shops.

To keep growth chugging along, H&R Block diversified into many other businesses, including other tax and business services as well as consumer financial services, such as H&R Block Bank. To date, most efforts have proved to be blockheaded, and a disastrous foray into subprime mortgages easily takes the cake as the worst move, since it placed the stock into the subprime penalty box along with Bear Stearns (NYSE:BSC), Countrywide Financial (NYSE:CFC), and just about every financial firm out there.

The mortgage business cost H&R Block close to a cool billion last year, and an agreement to sell the related business to private-equity shop Cerberus Capital Management is proving difficult, since current market conditions mean that "certain closing conditions of this agreement currently are not being met." It's hard to tell whether H&R Block will be able to sell the unit for as much as investors were expecting. If it can't, more losses could lie ahead.

Despite the mortgage woes, H&R Block said that sales from continuing operations grew 11% for the first quarter and its net loss fell from last year. The tax business is seasonal and usually results in losses until tax season hits, which is usually in the third and fourth quarters. But overall, until the company puts its mortgage woes behind it, there is probably little upside potential in the stock. After that, it will be up to management to prove it can return to its happier days of positive returns and capital generation for the benefit of shareholders.  

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Fool contributor Ryan Fuhrmann is longs shares of Jackson Hewitt but has no financial interest in any other company mentioned. Feel free to email him with feedback or to discuss any companies mentioned further. Jackson Hewitt is a Motley Fool Pay Dirt recommendation. The Fool has an ironclad disclosure policy.