Warren Buffett first bought H&R Block (NYSE:HRB) stock in the fourth quarter of 2000. By the second quarter of 2007, Berkshire Hathaway (NYSE:BRK.A) exited its position entirely. The Oracle of Omaha's moved on since then, acquiring large positions in Walmart (NYSE:WMT) and ConocoPhillips (NYSE:COP). Buffett did well getting out when he did because its stock is still trading below where it was back in 2007. H&R Block's fiscal 2011 results came out June 23 and, while they weren't setting any records, they weren't awful. For the first time in a long while, it appears there's a glimmer of hope in Kansas City. Here are three reasons Buffett might reconsider owning the downtrodden tax preparer.
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New CEO
In late April, board member William Cobb became CEO of the company. Cobb, a director since August 2010, previously spent four years in charge of eBay's (Nasdaq:EBAY) Marketplace division. Understanding the company in his former role as director and his many years building consumer brands at Pepsico (NYSE:PEP) and Yum Brands (NYSE:YUM) allows him to hit the ground running. Although the Q4 results Cobb delivered after just six weeks in the job were mediocre, he enters the fray understanding what's necessary to move the company forward. In the fourth quarter conference call, Cobb made it clear that retail and digital tax services, H&R Block Bank and its international business are the four cornerstones of the new H&R Block. If this decision holds, it won't be very long before RSM McGladrey, its business services division, is up for sale. The two segments just don't mesh very well. It seems the company is going back to what brought it to the dance in the first place - tax returns.

Clients and Market Share
H&R Block became as big as it is by providing error-free returns to its customers year-in, year-out. It's amazing how many returns it still does manually despite the fact there are so many online tax preparation sites and software available. In fiscal 2011, it prepared 21.4 million tax returns in the U.S., 1.3 million more than in 2010 and 400,000 more than in 2009. According to IRS statistics, the company prepared 16.4% of all the tax returns filed in the U.S. in 2011. That's up 80 basis points from 2010. These are Buffett-like figures. However, if you're a glass half-full type of person as I am, you see greater opportunities ahead.

Americans filed slightly less than 131 million tax returns last year and H&R Block only got 16.4% of them. Its theoretical untapped market (I realize I'm reaching) is upwards of 100 million returns. That would do something to the stock price. Now add to the equation the international market where it prepared just 3.1 million returns in Canada and Australia last year out of my potential estimate of 24.2 million returns. That's a market share of 12.8%, even less than in the United States. It probably won't happen but not for a lack of trying.

Digital Growth
In terms of tax preparation, the big winner in 2011 was online, where 3.7 million returns were prepared compared to 2.9 million in 2010 (an increase of 28% year-over-year). Its total digital tax solutions, which includes software and the Free File Alliance now accounts for 31.2% of overall tax preparation compared to 29.3% in 2010. In October last year, it agreed to acquire TaxAct, a digital tax preparation solution, for $287.5 million. In May, the Department of Justice filed a civil antitrust lawsuit against H&R Block. Management believes that its acquisition brings competition to the digital marketplace, which is currently dominated by Intuit (Nasdaq:INTU). It has a preliminary injunction scheduled for September. Cobb's first order of business is to bring this acquisition home. Digital is the growth side of tax preparation and TaxAct will definitely help it compete with Turbo Tax.

The Bottom Line
If I read between the lines of the Q4 conference call transcript, I believe Bill Cobb is prepared to plant his flag with tax preparation. Further, while the company will certainly consider share repurchases in the future, I also believe he wants to use some of the cash previously used to reduce the share count for product development and acquisitions. At the end of the day, if H&R Block can continue to focus on its bread and butter. Warren Buffett would like what he finds more than four years later. (For additional reading, also see Warren Buffett: How He Does It.)

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Tickers in this Article: HRB, WMT, COP, EBAY, P EP, NYSE:BRK.A, YUM, INTU

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