Value Investing

Senvest Capital 2Q16 Letter To Investors

Senvest Capital letter to investors for the second quarter ended June 30, 2016.

Also see Q3 hedge fund letters

Senvest Bets On Wilbur Ross With Bank of Cyprus

After 80% Return In 2013, Senvest Starts 2014 With Gains

Senvest Capital – Overall Performance

The second quarter began positively with the markets up for the months of April and May. The release of Federal Reserve Bank minutes in the middle of May indicated a hawkish stance and had signaled a potential rate increase in June or July. Markets seemed to digest the possibility of a rate increase as acceptable. A late May speech by Fed Chair Yellen stated that the Fed would raise rates “gradually and cautiously”. This may have bolstered confidence with the additional observation from Ms Yellen that “the economy is continuing to improve…growth looks to be picking up”. This calm was then shattered. Equity markets roiled in June in response to the UK referendum vote on EU membership and the unexpected outcome of “Brexit.” European equity markets in particular suffered some of their worst two day performances (in USD terms) in the last 30 years (Bespoke Investment Group). Despite the uncertainty created by Brexit, US equity markets managed to bounce back toward the end of the month and earn back some of their losses.

Senvest Capital

Pundits and the media have been wringing their hands in the face of Brexit. We don’t dispute the notion that the near term economic outlook for the UK will be under pressure given the uncertainty of the rules of engagement that will likely pause investment spending. However, we think that further out in time, the economic impact on the UK and the broader global economy doesn’t have to be gloomy. Since the UK operates with its own currency, the exchange rate mechanism enables trade flexibility. Moreover, it remains to be seen if Brexit actually occurs and if it does take place, what will it look like? It is in the economic interests of both Europe and the UK to minimize disruption. The Brexit vote has to deal more with politics than anything as the UK and Europe posture and position to negotiate what they each need. In the end, the likely outcome may be something that allows each side to declare victory with minimal economic pain. In any case, Brexit hasn’t influenced our investment outlook or positioning.

As previously reported Senvest Capital Inc. (“Senvest” or the “Company”) had a difficult year in 2015. These difficulties persisted into 2016. Most of the major benchmarks have been relatively flat for the year to June 30. We experienced losses in the first quarter of 2016 which were mostly unrealized, mark-to-market losses. We made back some of these losses in the second quarter but were still down for the year.

Some of our largest holdings as at June 30, 2016 were, Deckers Outdoor, Tower Semiconductors, Depomed, NorthStar Realty Finance, and Radware. Of these, Depomed and Tower Semiconductors increased in price in the quarter while Deckers, NorthStar Realty and Radware fell. Specialty pharmaceutical company Depomed was our largest gainer for the second quarter increasing by over 40% and making back the loss it incurred in the first quarter. Activist investor Starboard Value LP (“Starboard”) filed a 13D which indicated it owned a 9.8% stake in DEPO. Starboard presented its view that management and the board were entrenching themselves at the expense of shareholders, particularly in the way in which DEPO handled the hostile bid from Horizon Pharmaceuticals (“HZNP”). Starboard further indicated its intention to call a special meeting and nominate its own slate of directors in order to replace the entire DEPO board.

NorthStar Realty Finance (NRF) is affiliated with asset manager NorthStar Asset Management (“NSAM”) and both are significant holdings of the Company. At the beginning of June, NSAM announced the results of its review of strategic alternatives with the three-way stock merger of NSAM, NRF and another diversified equity, mortgage and institutional asset management REIT Colony Capital (“CLNY”). The market seems to have been underwhelmed with this proposed transaction. The deal does provide a number of benefits including substantial cost savings (north of $80mm in annual cash costs according to the company); the recombination of NRF with NSAM which would alleviate investor concerns about external management of NRF; and the addition of an institutional asset management platform from CLNY, which will round out NSAM’s retail non-traded REIT asset management business. NSAM expects the deal to close in January 2017. Moreover, it appears that the new company will operate with relatively less leverage than NRF’s current level (which would be designed to appeal to potential investors who previously took issue with NRF’s leverage ratio). We also note that real estate equity related stocks, such as NRF and NSAM, will likely benefit from the imminent creation of a new real estate industry classification. Presently, under the Global Industry Classification Standard (GICS) developed by Standard and Poor’s and MSCI, real estate equity related stocks are classified as financials. On September 1, 2016, these companies will be reclassified under their own real estate sector which should create more awareness of the group. JP Morgan research stated that active equity managers have been underweight real estate equities for “years” and estimates that “…it would take $125-$150 billion of buying to move to a benchmark weight.”

Senvest recorded a net income attributable to the owners of the parent of $14.7 million or $5.22 per diluted common share for the quarterly period ended June 30, 2016. This compares to net loss attributable to owners of the parent of ($29.8) million or ($10.87) per diluted common share for the second quarter of 2015 year. After a 2015 year where there was significant appreciation in the US dollar versus the Canadian dollar, the first half of 2016 resulted in a reversal of some of that appreciation. For the first two quarters of 2016 the result has been a currency translation loss of about $50 million. This amount is not reported in the Company’s income statement rather it is reflected in the Comprehensive income. The Company remains committed to being profitable over the long-term. However the volatility and choppiness of the markets will result in wide profit swings from year to year and from quarter to quarter.

The Company’s income from equity investments in the second quarter of 2016 was the biggest contributor to the net income recorded and partially offset the loss on equity investments incurred in the first quarter. The net gain on equity investments and other holdings totalled $67.5 million in the current quarter versus a loss of ($53.4) million the second quarter of 2015. Due to the continued depreciation of the US dollar versus other major currencies, our foreign exchange loss for the quarter was approximately $1.6 million.

The Senvest Partners fund is focused primarily on small and mid-cap companies. The fund recorded a loss of 5% net of fees for the first six months of 2016, however it was up more than 4% in the second quarter. Since inception in 1997 the fund is up over 2000%. With most of the long portfolio invested in small and mid-cap stocks, the fund outperformed its most relevant benchmark the Russell