The return of the taxmaster

VIRGINIA BEACH

When the share price of Jackson Hewitt Tax Service plunged more than 30 percent in one day last year, John Hewitt saw an opportunity.

He stepped up plans to make JTH Tax Inc., the parent of Liberty Tax Service, a much bigger player in the business of preparing tax returns. He talked with investment bankers about combining Liberty Tax with rival Jackson Hewitt.

"I've had this dream since I started in the tax business to be No. 1," said Hewitt, JTH Tax's founder and chief executive officer.

Last week, the company disclosed more about Hewitt's efforts to reach that goal. In a filing with the Securities and Exchange Commission, Virginia Beach-based JTH Tax said it accumulated a 9.3 percent stake in Jackson Hewitt during March and might increase its holdings.

The company paid $11 million for the shares and options it bought, Hewitt said.

Gaining control of Jackson Hewitt would be psychologically rewarding, Hewitt acknowledged, because he built the company from a tiny Portsmouth firm that he and a group of investors acquired in 1982. He expanded its geographic reach well beyond Hampton Roads before losing control of Jackson Hewitt in a dispute with shareholders in 1996.

The company was eventually sold to Cendant Corp., a company that specialized at franchising businesses. Cendant spun off Jackson Hewitt to shareholders through an initial public offering five years ago.

Pursuing Jackson Hewitt "is a little bit more interesting because my name is on the company, and I founded it and I know many of the franchise owners," Hewitt said.

However, he added, his pursuit of a combination is a calculated business decision.

Three years ago, he examined the prospects for a merger with H&R Block when Block's share price plunged. Some private-equity funds approached him about pursuing that company, Hewitt said, but nothing materialized.

Hewitt said he recently approached Jackson Hewitt about his interest in pursuing some type of combination. The company responded that it was willing to talk but wanted to wait until after the tax season was over, Hewitt said. He said he expects to talk with Jackson Hewitt's management in May.

Jackson Hewitt was aware of the filing by JTH Tax but had no comment, said spokesman Michael Freitag on Friday.

With about 4 percent of the market for tax-return preparation, Jackson Hewitt ranks second behind leader H&R Block, whose share is estimated to be 18 to 19 percent. Liberty, which ranks third, has a market share of almost 2 percent, Hewitt said.

All three rely on a combination of royalties and fees from their franchisees and sales of new franchises for their revenues. Under Hewitt's direction, Liberty has aggressively promoted the chain's services by unconventional means, including the use of women dressed as Lady Liberty and men dressed as Uncle Sam waving from busy street corners.

However, Jackson Hewitt is much larger than Liberty, with more than three times the revenue in its 2008 fiscal year and twice the number of tax-preparation stores this filing season.

Jackson Hewitt's revenues last year totaled $278.5 million, compared with $87.6 million for JTH Tax.

The difference in size doesn't daunt Hewitt, who insists that he could manage a combination of Jackson Hewitt and Liberty.

"I'm a compulsive competitor," he said.

Hewitt, 59, started in the business at age 20 by preparing returns at H&R Block while in college. Afterward, he worked full time for Block and became its regional manager responsible for eastern Pennsylvania, southern New Jersey and Wilmington, Del., at age 29. He left Block in 1981 to work with his father developing and selling software for tax-preparers.

No matter what emerges from his talks with Jackson Hewitt's management, Hewitt faces a handful of hurdles.

One is the deteriorating financial condition at Jackson Hewitt. Last month, the Parsippany, N.J.-based company called attention to its cash-flow problems by suspending its quarterly dividend. Discontinuing the dividend, it said, would save more than $20 million annually.

While reporting its financial results for the November-through-January quarter, Jackson Hewitt also warned in March of sharp declines in its revenues, earnings and volume of tax returns for the current tax-filing season. The number of returns probably will drop 12 to 13 percent from the year-earlier total, while revenues will fall 8 to 10 percent, Jackson Hewitt President and CEO Michael C. Yerington told securities analysts on March 4.

Hewitt figures Jackson Hewitt's problems can be resolved.

"What distinguishes a Wal-Mart from a Kmart? It comes down to the execution of many small things, including store placement and marketing," he said.

Another hurdle to a possible merger of Jackson Hewitt and JTH's Liberty Tax is the scarcity of funds to finance a deal. The crisis in world financial markets has made it much more difficult for companies, even those in excellent financial shape, to raise fresh equity and debt.

Jackson Hewitt's market capitalization, its share price times the number of shares outstanding, stands at $145.68 million. Its shares closed Friday at $5.06, up 56 cents for the week but down almost 68 percent for the year to date.

Jackson Hewitt also has a so-called poison pill, a device that would make its stock less attractive to a hostile buyer, Hewitt noted. However, Liberty and Jackson Hewitt could work out a joint venture or combine certain operations, such as software development and supply departments, to cut costs before pursuing a merger, Hewitt said.

"There are multiple scenarios for us to get this done, and many would not require significant capital," he said.

For guidance, JTH has hired investment bankers from UBS and Bank of America, Hewitt said. JTH, which has 500 shareholders, is a privately held company,

Another complication for a Liberty-Jackson Hewitt combination are the contracts that each company has with its franchise owners. To address the potential for conflicts, Liberty includes in its franchise agreements the right to buy back franchises, Hewitt said.

If a combination of Liberty and Jackson Hewitt materializes, the combined company might do business under different brands, he said.

If Jackson Hewitt agrees to a merger, joint venture or other combination, he would ask the company to poll its franchisees, Hewitt said. He won't follow through with a transaction, he said, unless a majority of franchisees at both companies endorse his plan. In conversations with the Jackson Hewitt franchisees he knows, the responses to his proposal have been mixed, Hewitt said.

"Some owners love me, and some hate me because I've been competing against them, but most of the responses have been positive," he said.

Tom Shean, (757) 446-2379, tom.shean@pilotonline.com