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Sep 10, 2005 4:48 pm

TALES OF THE TAPE: H&R Block Plan Includes Big-Firm Hires

By Greg Edwards

ST. LOUIS (Dow Jones)--As the giant brokerage firms focus on attracting wealthy individuals, H&R Block Inc. (HRB) smells opportunity among the less affluent.

The company, known for its no-frills tax services, has had poor results from its strategy of cross-selling financial advice to its tax clients. But these days, H&R Block says it is recruiting from the larger brokerages as it tries to make its investment services unit - a unit that has lost $438 million pretax in the last five year - profitable.

"There are some very good" brokers at firms such as Morgan Stanley and Merrill Lynch "who are not inclined to work exclusively with the very, very wealthy," said Mark Ernst, chairman and chief executive of H&R Block.

Part of the company's plan is to recruit brokers who are being pressured or forced out at the big firms. It also seeks to improve productivity among its brokers, while paying them less than the big firms, thereby keeping expenses low. That means, unlike larger firms, no fancy offices or other extravagances.

As of July 31, the number of advisors stood at 985, compared with 1,010 three-months earlier. Ernst attributed the decline to "stringent productivity levels," which forced out some brokers, despite "very good recruiting success."

But in the long run, he said, the number of clients "that we would like to serve is substantially larger than our ability to serve it with a thousand financial advisors."

H&R Block did not disclose specific numbers of brokers hired from big firms, but it said, "Many of our new recruits across the country have come from large firms, including Morgan Stanley, UBS Paine Webber, Wachovia Securities (and) Smith Barney."

The company also said its recruiting is "on plan" and in August, for example, resulted in the hiring of "nearly 50 advisors."


Skeptics abound about whether the company can turn around its brokerage unit. Some question the company's strategy of hiring brokers who weren't prolific producers at other firms. Brad Hintz, at Bernstein & Co., said bluntly: "I'm not certain that hiring somebody's low-producing brokers is a good strategy."

But Carlton Hall, a broker who was forced out at Morgan Stanley, said the strategy "could work," especially if H&R Block's tax preparers are "educated" to identify potential investment clients. He suspects "rookie" brokers might be more interested than veterans.

H&R Block's Ernst says a big firm's underperformer may do well at his company, with its less affluent clientele. Volume is the key, he said, and H&R Block's millions of tax clients offer not only volume but also "a distinct cost-of acquisition advantage. That is a savings that goes right to the bottom line."

"We have an expectation of making substantially less per client than what some of the larger firms would expect," Ernst said. As of July 31, H&R Block's average assets per traditional brokerage account was $69,000.

H&R Block has been in the investment services business since 1999, when it acquired Olde Financial Corp., a discount broker, for $850 million. Those were heady days; the Nasdaq was nearing its peak, and brokers were in high demand.

"It was a classic top-of-the-market acquisition," said Wistar Holt of Holt & Shapard Capital Management.

In fiscal 2001, H&R Block's first full year of ownership, the pretax loss in the division - renamed H&R Block Financial Advisors Inc. - was $5 million. And the pretax losses have continued: $63 million in 2002, $219 million in 2003, $76 million in 2004, and $75 million in 2005.

Something More 'White Shoe'

In the latest first quarter, the investment services unit had a loss of $7.6 million on revenue of $68 million, compared with a year-ago loss of $20.3 million, on revenue of $53.6 million. Overall, H&R Block had a first quarter net loss of $28.3 million.

The investment services unit is relatively small compared with the company's large tax and mortgages divisions. In fiscal 2005, revenue for investment services was 5.4% of overall revenue.

Ernst said the company hopes to narrow the investment services losses by $25 million to $35 million for the full fiscal year.

Alexander Paris Jr. of Barrington Research believes the company's reputation as a no-frills tax adviser may be an impediment in the financial advisory arena.

"H&R Block is a great brand for low-end tax services," he said. But "it doesn't play so well in the world of stock brokerage."

"A great first step might be to change the name from H&R Block Financial Advisors to something a little more 'white shoe,'" Paris said.

Ernst said he has ruled out an acquisition to bolster the investment services business. But H&R Block has applied for a bank charter and he said that may play into the company's strategy for Financial Advisors.

A bank charter could "enhance the profitability of the client relationships we have," Ernst said.

But Holt is pessimistic about H&R Block's strategy for the advisory business. "I don't see that as a cure-all to turning around the losses they've faced the last several years," including "pretty good years for the market in '03 and '04," he said.

Ernst, however, sees the investment market shifting, to H&R Block's advantage.

"Increasingly, the larger firms out there are concentrating their efforts to get a much wealthier client base," he said, and that will create "a very big opening in the middle market."

H&R Block was trading recently at $24.88, down 12 cents.

-By Greg Edwards, Dow Jones Newswires; 314-588-8443; [email protected]