Intuit reported third-quarter earnings in line with our top line estimates and coming in slightly above our EPS expectations. The quarter was marked by unsurprising seasonal weakness from delays in Intuit’s tax revenue offset by robust QuickBooks online growth, despite its quarter’s end deceleration. While Intuit did not disclose an outlook for the upcoming fourth quarter, we reaffirm our expectations for fiscal 2020, which consist of healthy annual consumer growth, despite the tax deadline shift, but significant deceleration in Intuit’s small business group. As a result, we are maintaining Intuit’s fair value estimate of $277 for this wide-moat company. This leaves the stock fairly valued in after hours, with shares trading near $289 per share.
In the third quarter, Intuit reported revenue of $3 billion, a year-over-year decrease of 8%. The seasonal weakness on the top line was a result of the IRS' extension of the federal tax deadline to July. The consumer group, which houses the TurboTax solution, recorded a year-over-year revenue decrease of 15%, as the company detailed that its customers with the most complex taxes appear to be postponing their tax filings till closer to the July deadline. Similarly, Intuit’s strategic partner group’s revenue, based on professional tax services, declined by 18% year over year due to the shift in seasonality. Intuit’s small business and self-employed group, which houses its QuickBooks products, increased its revenue by 11% year over year, despite the challenges small businesses are facing amid the COVID-19 pandemic. Intuit’s QuickBooks online offering had strong growth of 36% year over year. However, toward the end of the quarter, Intuit noted that new customer acquisition decelerated by roughly 15% when compared with the start of the quarter and retention decreased by 2 points year over year, largely coming off its lower account value customers.
Business Strategy and Outlook
Intuit is the giant behind U.S. small-business accounting software QuickBooks and do-it-yourself U.S. tax software TurboTax. With TurboTax online sales having eclipsed its desktop sales and our estimate that the same will happen for QuickBooks in fiscal 2020, Intuit has now transitioned into a cloud-first company. Consequently, this has enabled Intuit to leverage customer data to streamline the user experience across disparate products and to natively market its offerings, in turn supporting switching costs and a network effect, which we consider to already be the backbones of Intuit’s wide moat.
Over the past several years, Intuit has continued to innovate, in our view. It has realized the insecurity customers have in accomplishing the consequential tasks of tax filing or business accounting on software alone. In turn, for both its small-business and consumer customers, Intuit has launched matchmaking systems. In accounting, that means matching small businesses with accountants, and in tax, that means adding a human review to the filing process. We think both matchmaking mechanisms pose meaningful opportunity ahead, in the form of increased customer retention on both sides and getting exposure to the assisted tax market. Now that Intuit is starting to reap the benefits of playing matchmaker, next up is to take big bets on QuickBooks complements, such as creating an omnichannel sales platform for small businesses. While these buildouts will take time, we think such direction is a good one to keep propelling the QuickBooks network effect as customers continue to demand all-in-one software to run their businesses.
Intuit’s business is not immune to risk, which we think lies particularly in IRS tax-filing regulation as well as the risk of new entrants in the small-business accounting space. Still, such risks, in our view, would only gradually chip away at Intuit’s accounting and tax dominance, given the force of its network effect and its financial health equipping Intuit with the ability to turn the tides.
We assign Intuit a wide moat rating derived from the significant switching costs and network effects in both its small business and self-employed segment and consumer segment.
Intuit derives just over half of its revenue from its small business and self-employed segment, which offers QuickBooks bookkeeping software for small-business and self-employed customers, as well as their accountants. QuickBooks online has 4.5 million users, and, according to several sources, is estimated to have approximately 80% of the U.S. market share for small businesses using financial software. We think that QuickBooks exhibits high switching costs given the regularity in bookkeeping and the pain of transferring a business’ accounting record as well as learning a new software to record entries. Switching bookkeeping software would also require relinking new bookkeeping software with various third-party apps--such as those for connecting point-of-sale software with bookkeeping software, or those that integrate payroll data. QuickBooks has noted that its software links to up to 700 applications. We think QuickBooks’ retention rate of 79% is indicative of the hassle QuickBooks clients deem will ensue if they switched. While retention is low compared with enterprise software solutions as a whole, we think its retention is healthy for QuickBooks’ small-business customer base, which has significant churn simply due to lack of small-business survivorship. In other words, QuickBooks’ customers don’t typically switch to an alternative software vendor, but instead shut down their businesses altogether. QuickBooks’ retention isn’t unusual compared with other small-business software providers’ metrics, like Shopify’s estimated retention of 75% or Xero’s retention rate of over 80%.
We think that QuickBooks merits a network effect because despite using an accounting software, many small businesses opt to hire an accountant to go over their books that they track through software like QuickBooks. Since QuickBooks has the majority of the U.S. market for small-business accounting software, we think accountants have very little incentive to buy accounting software compatible with the minority of U.S. small businesses, which we believe makes small-business accountants more likely to opt for QuickBooks. QuickBooks also has partnerships with U.S. universities in which about 50,000 students receive the software for free each year--perpetuating, in our view, a cycle in which QuickBooks is the most well-known small-business accounting software, giving users more benefits from using the software as QuickBooks’ user base increases. These benefits are derived for both the accountant and the small-business owner. For example, accountants will have a higher probability that their clients use the same software they do. By both having the same software, the accountant can see the client’s books live rather than manually importing customer data into his or her software. We think these synergies are what lead Intuit partners, like PricewaterhouseCoopers, to do bulk QuickBooks orders in the thousands of units in order to sell the software to their small-business customers. Another reason users might hesitate to switch from QuickBooks is the need to retrain on other platforms for services already offered on QuickBooks, such as invoicing, payroll, assisted tax services, procurement services, and capital. We think that these options strengthen switching costs.
Accounting for roughly 41% of revenue is Intuit’s consumer offerings, including TurboTax software for DIY tax filing and Mint, a free platform in which consumers can connect their checking, savings, and mortgage accounts to get a holistic view of their financial health. We think that TurboTax exhibits high switching costs due to the stress of learning a new tax filing interface during an often short amount of time for many tax filers. According to the IRS, 20%-25% of Americans put off filing their taxes until the last two weeks before April 15. Apart from tax-season stress, TurboTax Online users can access former tax returns, which will autofill current tax forms with basic information from the previous year, which we think supports high switching costs and which we believe is reflected in the software’s 79% retention rate. Competitors like H&R Block, on the other hand, have retention rates near 73%.
We think that Mint has lower switching costs than TurboTax, given that it pertains to something less imperative than taxes, which is checking up on one’s financial health. Mint is offered for free, as Intuit makes money by allowing users to share data with lenders, which gives them access to possibly lower interest rates. This extra benefit to Mint users is discrete, in our opinion--meaning a user would not lose a loan after it is secured merely because of leaving Mint. While Mint, in our view, doesn’t have strong switching costs, we think that it directly contributes to upholding TurboTax’s switching costs. Tax documents from financial institutions customers have linked their Mint accounts to will automatically feed into TurboTax if cleared by the customer, making TurboTax renewals more likely, in our view.
Fair Value and Profit Drivers
Our fair value estimate for Intuit is $277 per share, implying a fiscal 2020 enterprise value/EBITDA of 35. We forecast Intuit’s five-year projected compound annual growth rate of 11% to be a function of entering new markets and increasing its retention in its traditional markets and inorganic growth from acquiring Credit Karma. To detail, we think Intuit will gradually increase market share of assisted tax-filing services, having entered the market in 2017 with TurboTax Live. As for retention, we think this will increase among surviving businesses as a result of a greater portion of QuickBase customers being connected with accountants via QuickBooks, which Intuit has said raises retention by 10 percentage points.
We expect Intuit’s revenue growth to outpace its growth in sales and marketing expense in the years ahead, leading to operating leverage and rising operating margins. We think that sales and marketing expenses will be able to come down to 34% of revenue by fiscal 2024 from 37% of revenue in fiscal 2019. Meanwhile, we think continued scale will help drive research and development costs down from 18% in fiscal 2019 to nearly 16% in fiscal 2024, as synergies are yielded between Credit Karma and Mint. In turn, we forecast Intuit’s operating margins rising from 27% in fiscal 2019 to 36% in fiscal 2024.
Risk and Uncertainty
We think Intuit’s business operates under high uncertainty, given the risk of intensified regulation on online tax-filing software. Many developed countries have systems in which taxes are automatically filed for citizens, which are then reviewed by the citizens themselves, and the IRS could develop its own e-filing software. However, this was close to being restricted in April 2019 with the proposal of the Taxpayer First Act. If passed, the IRS would be barred from ever producing free tax-filing software--a feature of many developed countries.
Intuit is also under threat of the IRS requiring more tax-filing features to be included in its free filing offerings. Both Intuit and H&R Block are required under Free File, a 2002 agreement with the IRS, to provide basic filing software for free to those with annual income of $66,000 or less--which is approximately 70% of the U.S. taxpaying population. Despite the free filing option, only about 3% of taxpayers use Intuit’s or H&R Block’s free filing options--signaling that there’s room to grow with pressure to add on features to the free filing offerings.
We think Intuit’s greatest risk associated with QuickBooks is the possibility of a current small-business software provider like Stripe or Shopify entering the accounting space, which could create compelling reasons to switch from QuickBooks.
We consider Intuit’s stewardship rating to be Standard. In January 2019, Sasan Goodarzi took the helm as CEO, adding to his 14-year tenure at Intuit, which included former leadership within the small-business and self-employed group. We think Goodarzi has advocated for stewardship of capital that has been consistent with the company’s record. In our view, this entails continuing to innovate to defend its moat, closing on value-creative acquisitions when fit, and increasing shareholder returns via continuation of the company’s dividend and repurchase policy.
Over the past four years, Intuit has delivered roughly $5.5 billion to shareholders via share repurchases and dividends. Over fiscal 2016 to 2019, the company’s payout ratio has fluctuated from 31% to 36%. With Goodarzi’s leadership, we think the company will be able to maintain a payout ratio in the low to high 30s and return nearly $2.4 billion in share repurchases over the next five years.
Intuit is a provider of small-business accounting software (QuickBooks), personal tax solutions (TurboTax), and professional tax offerings (Lacerte). Founded in the mid-1980s, Intuit controls the majority of U.S. market share for small-business accounting and DIY tax-filing software.