Jackson Hewitt's Q1 Results Misinterpreted by Nervous Investors

Includes: HRB, JHTXQ, SCSS
by: The Manual of Ideas

Jackson Hewitt (JTX) reported results for the first fiscal quarter ended July 31st today, coming in with a lower-than-expected loss in what is a seasonally weak quarter. Jackson Hewitt is the second-largest tax preparer in the U.S. after H&R Block (NYSE:HRB).

It is no secret that Jackson Hewitt is a "distressed equity," as the company's sub-$30 million market cap attests. Reflecting existing investor fears, Jackson Hewitt shares traded down 10% following the quarterly announcement.

While any investment in Jackson Hewitt stock continues to be a high-risk proposition, we believe the market misinterpreted the company's Q1 results, sending the shares lower when in fact management demonstrated good execution on its new strategic plan. The apparent reason for the selloff was the fact that Jackson Hewitt might be unable to submit a proposal for RAL funding to creditors and might seek an extension of the September 15th deadline. This is, objectively speaking, a minor issue that should not have significant consequences. However, when investors are already extremely nervous, even the slightest hiccup with regard to creditor deadlines is viewed as a major setback.

Instead of worrying about a RAL proposal deadline that should turn out to have been inconsequential, we are focused on what really matters in this situation: Does management still appear to be committed to defending shareholder value as best they can? And are they doing the right things to prepare for the next tax season? We believe the answer to both questions is yes. The company has reached a new business agreement with franchisees, and discussions are progressing with regard to lining up full RAL funding for the 2011 tax season. These are positive developments.

Ultimately, if management succeeds in executing on the 2011 tax season, investors paying less than $30 million for the equity of the entire company, stand to earn handsome returns. We do not believe creditors will force an outcome prior to the end of the tax season anyway, as it would seriously harm the value they would extract from Jackson Hewitt. Keep in mind that the company has little in the way of tangible assets, so both equity holders as well as creditors must look to the operating business to get their money back and earn a return on investment.

Few observers would dispute that for Jackson Hewitt the upcoming tax season will be decisive. With the tax season still some six months away, we believe no one can predict how things will turn out. This is the crux of the long thesis: Since no one can predict the outcome of the 2011 tax season, there is a real chance that Jackson Hewitt could do well, proving that the business is sustainable and worth more than the current depressed enterprise value. If this happens, the company should be in a position to refinance the debt on more favorable terms, opening the door to truly attractive shareholder returns. Keep in mind that this is a situation, in which investors have perhaps one unit of downside for ten or more units of upside.

Finally, we take this opportunity to commend Jackson Hewitt management on continuing to pursue a strategy that appears designed to maximize shareholder value. Much value has been compromised in the past couple of years, of course, but not all is lost, and management should not let the recent market action discourage it from its current path. Harry Buckley and company should draw inspiration from what another management team accomplished after Wall Street had already written them off -- we're talking of the team at Select Comfort (NASDAQ:SCSS). The latter avoided equity dilution when things looked bleakest, and management there has earned high accolades following the lows of early 2009.

Disclosure: Long JTX

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