Senvest Capital Q3 Letter To InvestorsVW Staff
Senvest Capital condensed interim consolidated financial statements for the month ended September 30, 2015.
Senvest Capital – Overall Performance
In the third quarter the major US stock indices suffered one of their worst quarters in many years, with most of the losses occurring in the month of September. Senvest Capital Inc. (“Senvest” or the “Company”) had the same experience reporting its worst quarter since the financial crisis. It was a quarter filled with turmoil from many parts of the world economy.
US equity indices started the quarter with a mixed July as market turmoil bounced from Europe to China. On the positive side, fears of a “Grexit” abated after Greece secured a third bailout from Europe while capitulating to more austerity and demands for asset sales and market reforms. On the negative side, China’s equity market continued to plunge but stabilized somewhat after the government intervened by halting trading in many securities and providing support through a coordinated stock buying effort that Goldman Sachs estimated at about $144 billion. Concerns of a slowing Chinese economy were probably connected to the ongoing decline in commodity and oil prices. In contrast, on the US domestic economic front, the Fed said in its July meeting that the “…labor market continued to improve, with solid job gains and declining unemployment.”
In August, China devalued its currency and reported weak macroeconomic growth data which probably perpetuated large declines in the Chinese stock market. Commodity prices continued to swoon with the Commodity Research Bureau’s spot market price index hitting new five year lows. These data points likely undermined global growth expectations and when mixed in with the prospect of a potential Fed rate hike, equity markets were primed for a sell off. After more than four years without a drop of more than 10%, known as a “correction”, US equity markets tumbled. This correction though was unusually rapid in its descent and occurred over a four day period, including Monday August 24th when the S&P 500 fell 4%. Much of the selling appeared to be forced, with selling begetting more selling. On the worst day of declines (August 24th) we observed ridiculous prices. For example, Ford and JP Morgan at one point fell about 20%. Some exchange traded funds (“ETFs”) traded at large discounts to the underlying value of their shares and many were halted for trading (80% of the roughly 1,300 securities halted that day, according to an analysis by the Wall Street Journal). Some had attributed the violent sell off to systematic selling from “risk parity” and “volatility targeting” strategies (for example, prominent investor Lee Cooperman in a letter to investors, as reported by CNBC). JP Morgan Research (“JPM”) estimated that volatility strategies quickly rebalanced to the tune of $50-75bb in one to five days and that risk parity strategies could represent $50-100bb. JPM further noted that August mutual fund outflows estimated at $40bb fell in the top five highest outflow months since 2007. No matter which strategy was to blame, the rush to the exit appeared to have come mostly from relatively newly developed, passive/systematic financial products and strategies, and less so from fundamental investment strategies.
Equity markets initially started the month of September with a bounce off the August lows of the year while investors awaited Fed chair Janet Yellen’s mid-month decision on the “lift-off” of the fed funds rate. Yellen held off raising rates and cited increased global risks and their potential impact on the U.S. economy in explaining the Fed’s decision. Equity markets didn’t take kindly to the message, even after Yellen attempted to clarify her remarks along with other Fed board members who indicated a likely “lift-off” later in the year. Moreover, the Fed unwittingly revealed a bit of a pickle it has created for itself. On the one hand, Fed members have reiterated the intention to raise rates at some point this year. On the other hand, raising rates may potentially exacerbate the newly cited global risk concerns. Higher rates have in the past led to a stronger U.S. dollar, weaker emerging market currencies and a reversal of capital flows away from emerging markets, straining their economies. (Witness the steep slide in the Brazilian real, at one point down almost one third this year. Chinese foreign reserves have plunged almost $500 billion from their peak last year, including a record outflow of $190 billion in the three months ended September 30, 2015.) Not to mention, a single tweet from Democratic Presidential candidate Hillary Clinton calling for regulation of pharmaceutical prices likely set off the firestorm of selling of drug company stocks, especially those focused on high-cost medicines (biotech) and growth-by-acquisition strategies (specialty pharma), which often include post-acquisition drug price increases. This likely impacted many long-short equity funds with outsized pharma exposure, including our portfolio due to one of our larger long positions in specialty pharma company Depomed (“DEPO”). Some of our largest holdings as at September 30 2015 were, Tower Semiconductors, NorthStar Realty Finance, Ceva, Mellanox Technologies, Radware, Depomed and NorthStar Asset Management.
DEPO plunged 30% in September and 12% in the third quarter. As we have discussed in our prior letter, the company rejected a hostile takeover bid from competitor Horizon Pharma (“HZNP”), which has subsequently countered with a proxy fight to replace the current board members of DEPO. Because HZNP’s offer consists entirely of stock, DEPO has been trading at the hip with HZNP, which also slumped 30% in September. Whether DEPO would have suffered a loss in lock-step with HZNP in the absence of the takeover bid remains unknown, although it surely would not have remained unscathed given the hit the specialty pharma sector has taken.
DEPO stock traded as low as $15/share in September, or roughly 15x its analyst estimated run rate for Q4 earnings, far too cheap (we believe) considering that its proven management team has only just started the “re-launch” of Nucynta (acquired from Johnson & Johnson in 2015). Moreover, weekly prescription numbers provided by the company for its other core product, show strong growth and so far have proven management’s ability to execute on its acquisition growth strategy.
Flavor technology company Senomyx (“SNMX”) fell more than 30% during September, and perhaps slumped in sympathy with bio-pharma companies due to its biotech like business model. SNMX, of course, has nothing to do with drug prices. At the end of August, the company announced the commercialization of Sweetmyx with Pepsi, which has launched a roll out of reformulated Manzanita Sol in the U.S. and the launch of two test markets for reformulated Mug root beer. This is a major milestone for SNMX and we believe that if consumers accept the reformulations of these two sodas, Pepsi will incorporate SNMX further into its artificially flavored beverage portfolio.
Real estate asset manager NorthStar Asset Management (“NSAM”) and its associated REIT NorthStar Realty Finance (“NRF”) lost 14.5% and 12.1% in September, respectively. We can’t point to any specific news to cause the decline in these investments but we suspect that the stocks suffered from a selling-begat-selling condition that can plague companies with high hedge fund ownership. This is speculation on our part. A review of fund holdings on Bloomberg shows that some funds that have a high ownership in both stocks have seen other of their positions decline significantly as well. In any event, NSAM closed out the month at $14.36/share or about 15x analyst estimated Q3 run rate cash flow/share, which, in our opinion, is cheap for a growing asset manager earning fees from permanent capital vehicles. NRF traded down to about $12/share, and with a sustainable dividend of $1.60/share the stock offers an attractive yield of more than 13%. Moreover, NRF announced a spin off its European assets into a new REIT (“NRE”) in October.
Other losses in the quarter came from bunker fuel supplier Aegean Marine Petroleum Network (“ANW”), which had a stock price decline of 40%. ANW reported disappointing earnings in August but reported positive news in September with the renewal of its $1 billion credit facility at improved terms for the company. Given that ANW’s revenues are tied to the economically sensitive shipping industry, it is possible its shares have been affected by the increasing concerns over global economic growth. We believe that ANW shares are undervalued as the stock’s price trades at about $8/share or roughly 8x our estimate of Q3 run rate earnings and at 60% of book value.
In light of the continuing market turmoil from August into September, we made a conscious effort to focus on those investments that we felt offered the strongest bounce-back and risk-reward opportunity. As a result, we sold down some holdings, eliminated some remaining stub positions, trimmed certain core investments that hadn’t suffered from declining prices and added selectively to certain core positions. We also partly covered certain short positions as their stock prices traded lower and we added new short positions, principally in the pharmaceutical sector.
September, true to its historical record, has proven once again to be the cruelest month, with many of our core holdings trading close to our downside case scenarios, representing what we consider to be attractive risk / reward in the portfolio. However, we remain confident that our portfolio has not suffered a permanent loss of capital. We believe that time is ultimately on our side and that the upside potential of our investments should yield significant results in the future.
Senvest Capital Inc. (“Senvest” or the “Company”) recorded a net loss attributable to the common shareholders of ($143.4) million or ($50.72) per diluted common share for the quarter ended September 30, 2015. This compares to a net loss attributable to common shareholders of ($25.5) million or ($9.11) per diluted common share for the 2014 period. The appreciation in the US dollar versus the Canadian dollar in the quarter resulted in a currency translation income of about $48 million to the income attributable to common shareholders. 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 loss from equity investments in 2015 was the biggest contributor to the net loss recorded. The net loss on equity investments and other holdings totalled ($293.1) million in the current quarter versus a loss amount of ($74.6) million the prior year quarter. Certain individual stocks were highlighted above. As we have said before we began the 2014 year with a much higher net long bias than we ended the year with. This continued into 2015. We continued putting on short positions and found more short opportunities. We have also said that we short stocks opportunistically rather than being forced to find shorts in order to achieve a targeted net long exposure. The Company continued its use of currencies in 2015 to both protect and enhance the portfolio’s returns. Due to the continued appreciation of the US dollar over other major currencies, our foreign exchange gain for first nine months was approximately $23.4 million.
The Senvest Partners fund is focused primarily on small and mid-cap companies. The fund recorded a loss 15.6% net of fees for the nine months of 2015 and it had a loss of over 18% for the third quarter. It is up over 2200% since inception in 1997. With most of the long portfolio invested in small and mid- cap stocks, the fund underperformed its most relevant benchmark the Russell 2000, which was down 12% for the quarter. The fund also underperformed the S&P 500 index for the quarter although it does not consider that index as a benchmark. The Senvest Israel Partners fund was initiated in 2003 to focus on investing in Israel related companies. This fund recorded a loss of about 15% in the third quarter and is down 1.1% for the year. The two funds had a total of about $980 million of net assets under management at September 30, 2015. Both of these funds are consolidated into the accounts of the Company.
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