Doing The Numbers On A Tax Preparer

That was just a ton of fun, wasn't it? Our spring income-tax ritual mixes dread, denial, despair, anger, and for most of us, resignation. Some 60% of individual tax returns are filed today by paid preparers, up from under 50% as recently as 1996. Now that's one nice growth trend.

The best way to invest in this hideous phenomenon has been familiar, old H&R Block (HRB ), whose prospects captured no less than Warren Buffett's Berkshire Hathaway (BRK ), which holds an 8.2% stake. Now investors are set to get a second way to exploit taxpayer confusion. Cendant, the giant franchiser of such travel and real estate brands as Days Inn Worldwide and Century 21 Real Estate, also owns Jackson Hewitt Tax Service. It's No. 2 behind Block in paid tax preparation. Having decided tax prep doesn't mix well with real estate and travel, Cendant (CD ) hopes by June to sell Jackson Hewitt in an initial public offering to be led by Goldman Sachs (GS ).

THE IPO PRICE IS YET TO BE estimated, and Jackson Hewitt's CEO, Block alumnus Michael Lister, isn't talking ahead of the deal. Fortunately, the company's securities filings offer plenty of details about its growth, some warnings about risks, and a few pointers to what Jackson Hewitt may be worth. This much you can't miss: At tax time, people sure are easy marks. In fiscal 2003, ended Apr. 30, Jackson Hewitt saw $172 million in revenue, a 9% jump. Most of that came from royalties and other fees from franchisees, who own 4,295 offices, or from preparing returns at its 642 company-owned offices. Yet Jackson Hewitt also took in $48 million selling such other services as an extended warranty on tax returns (in case its preparer errs), a debit card, and unsecured loans to those who need cash at the holidays. The most lucrative sideline: Jackson Hewitt's refund anticipation loan, or "RAL." Last year, 34% of its customers took out an RAL.

A looming problem, however, is what Jackson Hewitt calls "the perceived inequity of these types of loans." Regulators are focusing on RALs' fees and how they're sold. For example, New York City in February fined Jackson Hewitt $125,000 for "not clearly disclosing" its terms on these loans. At an extreme, closer regulation might make RALs uneconomic, Jackson Hewitt says. At at a minimum, it figures to pinch profits. Another risk: Jackson Hewitt has grown in part via kiosks in Wal-Mart Stores (WMT ), 1,100 at last count. Yet this deal is set to expire soon. Will it be renewed? And on equivalent terms? Both companies declined to say.

Despite these concerns, the business of helping taxpayers isn't going away. For investors, the question is price: What might Jackson Hewitt be worth? Cendant paid $476 million for Jackson Hewitt in 1998, when it was less than half its size today. While its revenue mix differs, Block offers another guide. The market values Block at $8.5 billion, or about 13 times this fiscal year's net, which is seen growing 19%.

Now assume a few things about Jackson Hewitt: that its growth rates through February -- 11% in the number of returns it prepared and 5% in revenue per client -- hold through fiscal 2004; that its net margin widens a bit, to 25%; and that it borrows $175 million, the sum it plans to pay Cendant in a farewell dividend. Given all that, I guesstimate Jackson Hewitt this year may see earnings grow by almost 22%, to $50 million. To be generous, grant Jackson Hewitt an earnings multiple of 22. Its value then comes to $1.1 billion. Subtract the debt, and the equity would be amply priced at $900 million or so. Smart investors will look to pay less.

By Robert Barker

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