Spruce Point Management issued a negative report on Intuit (INTU) on September 20, 2024, which was covered widely by the financial media. Along with publishing the report, Spruce Point also took a short position in INTU. Among the things covered in the report were:

• Opacity in reporting in INTU’s Small Business & Self-Employed segment. INTU used to break out its reporting segments, especially Mailchimp’s. Now, they have consolidated all of it under the said segment.

• A questionable valuation was supposedly paid for acquiring Mailchimp and Credit Karma.

• The Turbotax business is threatened by anti-consumer behavior, questionable disclosures, unsettling trends, and growing existential risk. As we shall see, if this were to be true, it could certainly be an existential threat to INTU and its shareholders.

• Intuit’s AI efforts are just a branding exercise, leading to no material benefits.

• Overvaluation concerns.

Like any negative report where the publisher has taken a short position simultaneously, one needs to evaluate the merits of the report and the intent behind it.

Financial Statements Analysis

Let’s look at the highlights of the yearly income statement numbers for INTU and see if there is any slowdown or issues.

While revenue is growing Year-over-Year (YoY), the growth rate has slowed materially. INTU has been able to manage its costs well. While there is a slight deterioration in Gross Margin and Operating margin, costs such as SG&A and R&D have been under control. INTU has benefited from tax benefits which has helped show a better Net Income in the last two Financial Years. However, things get interesting when one looks at the quarterly numbers.

The first thing that stands out is the seasonality. INTU’s revenue starts picking up in the January quarter and it makes most of its revenues and Net Income in the April quarter. This aligns with tax reporting season. After all, INTU’s cash cow in TurboTax and other tax-related offerings for small and medium businesses. However, this raises concerns about the rest of the business units. Also, other than the April quarter INTU does benefit inordinately from tax benefits. Hence, Spruce Point may be correct about raising concerns about INTU’s acquisitions.

The seasonality also shows up in the Cash Flow Statement and it is glaringly clear.

Hence, if Spruce Point is correct about the issues with INTU’s tax business, their call about valuations and trouble for INTU could have huge implications. Are there any issues lingering for INTU?

Legal Proceedings

Beginning in May 2019, various legal proceedings were filed and certain regulatory inquiries were commenced in connection with our provision and marketing of free online tax preparation programs…..

The financial implications of this matter are unknown, however, the reputational damage could be immense. It goes back to the concerns raised by Spruce Management about the TurboTax business. As most of INTU’s revenues and free cash flow come from the tax business, any adverse ruling could be material.

Mailchimp Acquisition

Mailchimp Acquisition

On November 1, 2021, we acquired all of the outstanding equity of Mailchimp, a global customer engagement and marketing platform for growing small and mid-market businesses. We acquired Mailchimp to help deliver on the vision of an innovative, end-to-end customer growth platform for small and mid-market businesses….

So, INTU paid 11.8 times the Price-to-Sales for Mailchimp. As the $762 million accounted for nine months, I adjusted it for twelve months.

Again Spruce Point seems to be right about INTU overpaying for Mailchimp. There is another issue related to Mailchimp.

Revenue Reporting Changes

While the management of INTU may have good reasons to make this reporting change, it does raise questions about the openness of reporting. Again, Spruce Point may be right about the opacity of reporting. As investors will not have a view of Mailchimp’s performance, it would be hard to judge how well the acquisition is doing. Also, it becomes harder to do a like-for-like comparison. It is not that companies have not done something like this previously, it sure does raise eyebrows.

Auditor’s Note

Ernest & Young LLP, INTU’s auditor from 1990, communicated a critical audit matter to the Board of Directors. While E&Y resolved the critical audit matter, it does raise questions about the sanctity of financial reporting by INTU. It is a serious matter when an auditor raises critical audit matters even though it was ultimately resolved. E&Y raised concerns about the revenue recognition policies.

Again, Spruce Point may have a point about the opacity of the financial reporting by INTU. It seems to be a valid concern given that E&Y raised an issue about the revenue recognition policies..

Conclusion

It must be said that INTU’s balance sheet looks fine. Its current assets are greater than its current liabilities, hence, it has the assets to cover its current obligations. Also, yearly, INTU’s Cash from Operations is greater than its Net Income, thereby its operations are fine even though it is subject to seasonality as highlighted above.

While INTU’s Gross Margins and Operating Margins are fine, its seasonality and inability to consistently generate Cash from Operations remain a concern. Let’s look at some Financial Health and Valuation ratios.

INTU’s returns and solvency ratios are fine. The issue is with INTU’s valuation ratios. A high P/E in and of itself is not bad, however, a PEG higher than 2.0 raises concerns as growth is slowing down. Also, the EBIT/EV is less than the 10-year yield, hence, it is certainly not in the value zone and the P/B pops out in the table above.

Given these facts and the risks highlighted, I would take a neutral stance on INTU with a negative bias. INTU’s best quarters are coming and it would be best to reevaluate after the tax season. Any investor looking to open a new position in INTU would be better served to avoid the stock and wait and watch for now.

Disclosures: Here are our internal governance rules to ensure no conflict of interest. For companies we write about:

1. No existing position.

2. If we have an existing position, we exit and wait seven days before publishing.

3. Wait seven days after publishing before initiating any new position.