On Rex Stores, Real Estate, and Ethanol
In my post “On Posco, Berkshire, and Buffett“, I mentioned that I had published a quarterly newsletter when I began this blog, but discontinued it during the second half of 2006, when I found bargains had become too scarce to reliably provide enough material to fill a newsletter each quarter.
In the first issue of the newsletter, back in April of 2006, I wrote about a company called Rex Stores (RSC). Theoretically, Rex Stores is a chain of electronics retail stores. In reality, a considerable amount of the corporate assets an investor acquires an interest in when he buys the company’s common stock has little or nothing to do with selling electronics.
Some of you may remember how Bill Rempel answered the last of his twenty questions on January 24th, 2006:
20. What’s the most interesting company we haven’t heard of?
Rex Stores (RSC). I looked at them in mid-2005 as a possible value play. This little electronics store in the heartland, sitting on a bunch of real estate, with an extremely low effective income tax rate. Huh? Turns out the company had a big hand in these synthetic fuel plants that were getting oodles of tax credits, and the IRS was investigating several of these things because they were throwing off tax credits but the fuel they were producing synthetically was costing more than normal fuel, something along those lines. I can’t remember if the synfuel plant they owned a part of was in the investigation or not, but I decided I didn’t like the notion of buying a small cap retailer that was into quite that diverse an investment. It pays to read the fine print.
Bill’s intriguing description of Rex Stores is essentially correct (note: the IRS audit was concluded favorably). This is how the company is described in its most recent 10-Q:
We are a specialty retailer in the consumer electronics/appliance industry. As of October 31, 2006 we operated 207 stores in 36 states, predominantly in small to medium-sized markets under the trade name “REX”. Over the past eight years, we have also been active in several synthetic fuel investments and as of October 31, 2006, we had funded two ethanol producing entities and had contingent agreements to fund three additional ethanol producing entities.
The synthetic fuel partnerships are separate from (and older than) the recent funding of ethanol producing entities. The production of synfuel generates tax credits; synfuel production is only economical because of these tax credits. The credits are phased out once the price of oil exceeds a certain level.
As you can imagine, the historically high oil prices of the recent past threatened to impair the value of Rex’s synfuel investments, because such high prices would effectively cause synfuel production to cease.
On October 31st, 2006 Rex made the following announcement:
… Read moreREX recently received confirmation that all synthetic fuel plants for which it receives income are in operation. As such, the Company expects to record higher