H&R Block diversifies into troubled waters | VailDaily.com
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H&R Block diversifies into troubled waters

KANSAS CITY, Mo. – The $250 million lawsuit accusing H&R Block Inc. of fraudulent marketing of its retirement accounts shows the perils the company faces as it continues to remake itself into something besides just the place to go every winter with your W-2.The dustup provides yet another black eye for the tax preparation giant, which is in the midst of its busiest season as millions of Americans look for help in filing their income taxes but are increasingly looking to competitors or doing it themselves online or with store-bought software.The suit brought by New York Attorney General Eliot Spitzer also provides another example of how the company’s attempts to add value through diversification over the last few years – Block now offers investment advice, sells mortgages, takes over back-office accounting for small businesses and will even open its own bank next month – could be drawing its focus away from its bread-and-butter tax services.”It’s difficult to say to what extent some of these other actions have taken their toll on the tax business,” said Michael Millman, an analyst with Soleil Securities/Millman Research.Millman has soured on Block, giving it a “sell” rating, and saying some customers could be looking elsewhere to avoid the extensive cross-selling Block tax preparers now do, hawking investment accounts while searching for deductions.The company’s most recent figures show that Block has seen an overall decrease in the number of clients at its more than 12,000 retail offices through the first two months of the year, although higher fees have increased revenue by 2 percent.”A lot of things have occurred that have resulted in a decrease in retail (tax clients),” Millman said. “It would seem that that could be one of the factors that are generating a lot of interest in people doing their own taxes.”Spitzer charged Block last week with selling low- and moderate-income customers IRAs that charged more in fees than they generated in interest, saying thousands of customers ended up losing money.Block’s chief executive, Mark Ernst, has defended the accounts, calling Spitzer’s filing “an unfair attack” in a letter to The Wall Street Journal, and saying the prosecutor is ignoring other benefits customers saw from the accounts, including tax savings.He also noted that if Block is committing fraud, it’s not very good at it. The company has lost millions on the IRA program.Block added mortgage sales in the late 1990s and, combined with tax services, provided 82 percent of revenues last year and almost all of its earnings. Business services remain a small portion of the business, although the company became the fifth largest accounting firm last year when it acquired American Express Co.’s business services arm.Investment services, which includes the IRA business, lost $75 million last year. It’s unclear yet how much revenue will come from H&R Block Bank, which federal regulators approved last week.In conference calls with analysts, Ernst – who declined to be interviewed for this story – has portrayed the series of acquisitions in recent years as a way to use Block’s well-known and respected brand to raise revenue outside the tax season and insulate the balance sheet from the ebb-and-flow of the retail market.During a meeting in early January, Ernst stressed how the deep service portfolio helped Block “remain very flexible financially.””We think we can effectively both deliver results and at the same time strengthen the underlying position we have in our markets,” he said.That was before a series of setbacks that have kept Block in the headlines for the wrong reasons.Besides Spitzer, California Attorney General Bill Lockyer sued the company in February over its marketing of “refund anticipation loans,” upfront cash payments where the client pays high interest fees out of their tax refund.Also in February, the company reported disappointing third-quarter numbers, including an embarrassing restatement of earnings for the past two years because of mistakes Block made on its own taxes.Earlier, the company angered attorneys general in several states after disclosing that its marketing department had sent out tax preparation software to prospective customers with their Social Security numbers embedded in numbers on the mailing label.The news has rattled investors, who have pushed H&R Block’s stock down 13 percent from the first of the year, closing at $21.30 Monday.So far, analysts don’t think the run of bad news has had a big effect on tax clients and don’t think it yet points to problems in the Kansas City-based company’s headquarters.”That is surprising … anytime you have so many negative things happen in a short time,” said Kartik Mehta, an analyst with FTN Midwest Research. “Right now, it’s bad luck.”What I think H&R Block needs to do is execute on its core business and show the market that it can build on its market share,” he said.UBS analyst Kelly Flynn told investors not to worry in a recent research note, saying that even if H&R Block ended up having to pay fines on the Spitzer suit, its balance sheet could take the hit and that the company’s investment business was still a small portion of its overall portfolio.”If you separate the headline from the impact on the fundamentals, we conclude the market probably overreacted,” Flynn said, adding that she thinks the stock is undervalued. “I’ve been surprised by the flurry of bad headlines, but they haven’t touched on the fundamentals.”Vail, Colorado


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