In February 2016, Blucora (BCOR) plunged to a multi-year low in the single digits. Fourth quarter 2015 earnings disappointed. The acquisition of broker-dealer HD Vest, which had closed just weeks earlier, looked like a disaster amid a proposed “fiduciary standard” by the Department of Labor. As broad markets fell to a 19-month low, BCOR returned to a level not seen since the financial crisis.
The decline proved to be a buying opportunity. HD Vest straightened out. The DOL rule died in court. TaxAct, acquired in 2012, continued to grow. BCOR kept falling even as markets recovered, dipping below $5 in March. It would touch $40 in 2018.
For the first time in four years, BCOR has returned to the single digits. The story sounds awfully similar. Broad markets again are plunging. The acquisition of HK Financial Services, announced on Jan. 7, hasn’t closed yet and already looks like a misstep, at least in terms of timing. The Q4 2019 earnings release was better-received than the release four years prior, but it’s done nothing to stem declines in the stock. Blucora even picked up a new CEO on Jan. 30, as it would do a few weeks after bottoming out in February 2016.
I bought the dip four years ago. I bought this one too. But after taking a closer look, and with a 29% bounce last week, I don’t believe BCOR is the opportunity it was in 2016 — or the opportunity it might appear to be on the surface.
How Big Will The COVID-19 Impact Be?
As with so many bull cases at the moment, the argument for BCOR is that the recent sell-off has gone too far. Shares are down 56% year-to-date. They’ve been nearly halved since Feb. 19, the day the S&P 500 peaked and Blucora released fourth quarter earnings before the open. That report wasn’t spectacular, but it seemed good enough: BCOR gained 1.4% and another 1%+ the following session.
The COVID-19 pandemic and the ensuing response will have an impact on Blucora’s business. But that impact should be manageable. The company’s TaxAct business accounted for 58% of segment-level operating income in 2019. Its share of profit still sits above half pro forma for a full year of results from 1st Global (acquired in May) and the addition of HK Financial (whose acquisition was announced on Jan. 7).
That business doesn’t seem like it should take all that much of a hit. The Treasury is delaying tax payments by 90 days this year, which could spike operating expenses (including marketing) this year. But Blucora, by management’s own admission on the Q4 conference call, got off to a slow start with tax season.
That’s nothing new: Blucora historically has played catch-up, given its focus on paid users who often file closer to the April 15 deadline. It usually winds up performing well with that cohort: TaxAct’s revenue has grown for 22 consecutive years, and segment operating income has increased at a 14% CAGR over the past four years. And so it’s possible share gains in an extended tax season could offset a portion of what will be higher spend in areas like customer service and marketing.
On the Wealth Management side, the impact should be more pronounced. Just shy of half of 2019 revenue in the segment came from advisory fees, and the proportion likely moves above 50% on a pro forma basis. That revenue is going to come down simply from the shrinkage in the asset base driven by the equity market decline.
But the impact to the segment should be perhaps more moderate than an investor might believe. Advisory assets aren’t all equities; fixed-income portfolios likely have rallied over the past five weeks. Commission revenues (38% of the 2019 total) may rise; the 40%-plus share driven by variable annuities and insurance should at least hold up. The Fed funds rate will hit cash sweep revenue, but asset-based revenue (which includes margin revenue and other contributors as well) is less than 10% of the total.
Here, too, there’s a possible tailwind that can offset some of the pressure: a potential shift back to active managers from investors whose passive strategies worked well until recently.
The Case for BCOR Stock
And so, as with the market as a whole, there’s an argument that the sell-off has been an overreaction. But fundamentally, the argument looks stronger than that of other names. BCOR was hardly expensive even before selling off: at the Feb. 19 close, the stock traded for 10.5x 2019 adjusted earnings per share. It’s fallen further than the market since.
A ~3x pro forma net leverage ratio (based on 2019 figures) doesn’t necessarily explain that sharp level of underperformance. Decremental margins on lost revenue shouldn’t be that high. Blucora does have fixed costs, but for the Wealth Management business advisor commissions should come down along with revenue.
A back of the envelope model (and it’s hard to have faith in anything more specific at this point) might suggest EBITDA dropping ~10% on a 5% decline in the tax business, while Wealth Management sees something like a 20% reduction in profits as revenue falls ~10%. (We can get to that 10% with a 15% decline in advisory fees, 20% drop in asset-based revenue, and modest impacts elsewhere.)
Pro forma for a full year of 1st Global and assuming a 20% reduction in HK Financial Services profit (~$17 million including synergies), pro forma EBITDA drops to ~$130 million from 2019’s ~$160 million. Normalized free cash flow still nears $100 million ($22 million in interest after the HK deal, $5 million in cash taxes thanks to deferred tax assets, $10 million in capex gets to $93 million). Adjusted EPS still stays in the range of $1.50.
In this model, BCOR trades at 8x EBITDA, less than 8x EPS, and about 6x free cash flow. There are some concerns about stock-based compensation, which totaled $16.3 million in 2019 and probably is at least 10% of EBITDA in 2020. The EPS and free cash flow figures include an abnormally low tax rate, which should rise going forward. Blucora’s acquisition strategy has been driven by the vast amount of net operating loss carryforwards generated when it was known as dot-com bust Infospace. The majority of those carryforwards will expire between 2020 and 2024.
But even normalizing for taxes and share-based comp, BCOR trades at ~9x EBITDA, ~10x EPS, and ~8x free cash flow. Those seem like solid multiples given TaxAct’s long-term strength and defensive nature.
The Concerns on the Tax Side
That rough model is why I bought BCOR last week. The tax business looks defensive, the wealth management business won’t collapse, and valuation looks reasonable even assuming macro impacts.
But that buy also was a somewhat small position that was half trade and half “if I actually own this I’ll do my due diligence”. And looking closer, particularly with the stock up 34% from its lows, I worry that the simple case isn’t quite as attractive — and not as compelling in a market with no shortage of somewhat similar cases.
As far as the tax business goes, there are two issues. The first is that the business was showing some signs of stress even before this crisis. Blucora has struggled to attract free filers, which isn’t necessarily a huge near-term problem, but does limit the size of a user base which (hopefully) can be converted to paid filers down the line.
Indeed, guidance for 2020 given with the Q4 report was not strong. Blucora guided for first half revenue growth of 3-5% excluding the impact from SimpleTax (divested for just shy of $10 million) and segment margins of 56-57%.
Even at the high end, that guidance suggested ~flat year-over-year profit growth for the business, a notable deceleration. Should Blucora outperform that guidance, as has happened in the past, there’s still some deceleration from the double-digit rates that have predominated in recent years (including a 10.3% increase in 2019). There have been increasing signs in recent results that TaxAct is driving growth through price increases rather than user growth; meanwhile, the company is targeting a stable base of monetized users.
There’s also the worry that the crisis (and the 2020 election) may increase fears of a change in federal government policy. That’s already occurred to some extent. At the beginning of the year, the Internal Revenue Service changed its policies for the Free File Alliance, and eliminated its restriction against creating its own software. That seems a possible reaction to a ProPublica report in October detailing the 20-year fight by the tax preparation industry to prevent free filing.
Finally, if an investor is going to buy BCOR due to the defensiveness of the tax business, there are other options:
chart since 2/19/20
H&R Block (HRB) is cheaper on an earnings basis, with a smaller leverage ratio. I’m personally not quite sold on INTU, but it’s declined 25% since the market peaked on Feb. 19.
BCOR stock has fallen further than peers, and probably a little bit too far. But any case for Blucora stock that suggests big upside owing to the defensiveness of the TaxAct has to read across well to pure-play peers. An investor has to at least consider HRB and INTU as alternatives.
Wealth Management Concerns, Valuation, and the Case at the Bottom
On the Wealth Management side, there are some worries as well. For one, even with the market crash, Blucora has gone headlong into a business with significant secular pressures. (It’s worth noting in that context that new CEO Chris Walters was on Blucora’s board of directors for all three acquisitions.)
Per the 10-K, the average advisory fee rate in 2019 was 118 bps. That figure compressed 9 bps year-over-year due to 1st Global, but pricing pressure from both active rivals and passive alternatives likely will drive further compression. The move by Charles Schwab (SCHW) to zero commissions adds another source of competitive risk.
There were supposed to be revenue synergies between TaxAct and 1st Global/HD Vest (the combined company has been renamed Avantax Wealth Management). Avantax is a tax-focused firm; HK Financial focuses on CPAs as well. Those synergies don’t seem to have materialized to the hoped-for extent: professional revenue for TaxAct actually declined in 2019.
Taken as a whole, the argument for BCOR starts to weaken. The stock is cheap on an earnings basis even assuming a haircut to 2019 results — but there’s no shortage of ‘cheap’ stocks in this market, even after last week’s rally. There are alternatives on the tax side. Leverage is acceptable, but could be nearing 4x based on 2020 numbers. There were concerns before the crisis: BCOR traded above $40 (if briefly) in 2018 and at $22 coming out of February’s earnings report. Last week’s 29% bounce obviously changes the case as well.
In this market, most stocks have a reasonably solid bull case. BCOR is one of those stocks. But an investor (myself included) taking on the risk of timing the bottom and the need to ride out volatility probably should be looking for a case that truly stands out. I’m simply not sure Blucora stock meets that standard.
Disclosure: I am/we are long BCOR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I may sell my position this week, sell a covered call, or make no change to my ownership.
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