H&R Block Gets Serious About Digital with Purchase of TaxACT

The past few years have seen the downfall of some once-dominant bricks-and-mortar retailers, in part due to less conventional and Internet-based competition. A prime example is Blockbuster Video, which recently filed for bankruptcy, finally succumbing to the onslaught of operators like Netflix (NFLX) and Coinstar's (CSTR) Redbox.

No doubt, investors are concerned about potential disruptions in other related businesses -- and they should be. Just look at H&R Block (HRB). The company has been a laggard in its online efforts while Intuit's (INTU) TurboTax continues to gain market share. So far this year, H&R Block's stock is down 44% and Intuit's shares are up 53%.

To start remedying the situation, H&R Block is making some bold moves. This week, the company agreed to pay $287.5 million for 2SS Holdings, which develops the desktop and online tax-prep software TaxACT.

A Look at TaxACT

Turns out, H&R Block's opportunity to make a move against Intuit can be traced back to moves made by Intuit earlier in its rise.

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One of the most important deals in Intuit's corporate history was its $225 million purchase of ChipSoft in 1993. At the time, ChipSoft's TurboTax had about 60% of the tax software market. A year later, Intuit bought Parsons Technology, which was the developer of the competing Personal Tax Edge product. But Intuit wanted the user base, not the software, so it put an end to Personal Tax Edge.

At that point, some of the developers of that software saw an opportunity to provide a new, low-cost tax prep program. The result was the creation of TaxAct in 1998.

It wasn't easy, their efforts took time to get traction, but that only spurred them to innovation. For example, TaxAct was the first to give away its federal tax program, which boosted their sales of add-on purchases such as state modules and premium packages.

TaxAct also developed an efficient online marketing platform. Then again, because of the low price points of its products, it had no choice. TaxAct only has 70 employees, yet it was able to generate $70 million in revenues in the past year.

The Impact

H&R Block can certainly benefit from the acquisition of a dynamic company like TaxAct to help it with online marketing and low-cost strategies. For example, TaxAct's EBITDA margin is a whopping 50%.

Even though the price tag for the purchase is far from cheap, the transaction is still expected to add $0.05 per share in earnings for fiscal year 2011. What's more, the deal will double the number of H&R Block's digital returns. Last season, about five million tax filers used TaxAct software.

Despite all this, the fact remains that H&R Block remains a predominantly a retail, bricks-and-mortar company. And unfortunately, the market is likely to remain stagnant. So while H&R Block is making the necessary moves to transition its business, its future is still uncertain. After all, even Blockbuster Video made several attempts to change its business model, and the outcome was still Chapter 11.