Thursday, February 26, 2015

Why I Bought Senvest Capital

I've had trouble finding good values in the Canadian currency portion of my portfolio. In it I owned Andrew Peller (TSX:ADW.A) a Canadian wine producer for the last 1½ years. In that time the stock has returned 15%. However, that is still an overall loss in my "base" currency which is USD. The Canadian dollar depreciated by about 20% in the same period versus the USD.

Wine makers are in a very competitive capital intensive business anyway. I doubt ADW can have outstanding gains in the coming years. Don't get me wrong, it is a decent investment, but nowadays when I make an investment I expect to beat the market.

For this reason, I traded in my ADW for Senvest Capital (TSX:SEC). Senvest Capital is a Canadian investment firm, it owns several subsidiaries. The biggest two are basically hedge funds. One is Senvest Master Fund LP which operates out of New York, and Senvest Israel Partners which invests in Israel. Senvest is a well-known secret in the financial blogsphere. There are numerous writeups about it; I list them below. This article will mostly just summarize what has been written.

Senvest got attention several years ago when it was having very good results and growing equity nicely. I first read the glowing reviews about it 1½ years ago. Since then the the company results have exceeded the most optimistic expectations. The company grew equity from CDN$ 358M in 2012 to CDN$ 630M in 2013. After the first 9 months of 2014 equity grew to CDN$ 684M. The company's 2014 year end results are not out yet, but the fund's results are out. The Master Fund grew by 79% and 22% in 2013 and 2014 respectively. And the Israel Fund grew by 43% and 1%. This hints that the parent company's 2014 results are at least satisfactory. Since inception more than 10 years ago both funds returned more than 20% net of fees!

The parent company Senvest Capital owns 43% of the Master Fund and 48% of the Israel fund. The Master fund is a long/short fund, with about USD$1.4B in over 100 holdings. The fund holdings are known because as a US based company it is required to report its holdings. They are an eclectic bunch of companies with a lot of exposure to tech and pharma/biotech.  SEC does not require funds to reveal short positions but it is around $300M. Whatever the fund is doing is original and excellent. And it is even better that I don't understand it, because if I did I could buy those holdings myself without a middleman.

The Senvest Israel Fund is also attractive investment to me because Israel is an growing and stable emerging market. I have looked into some Israeli companies. But nothing really attractive stood out. And even if I found something, investing in Israel is not easy. The one brokerage that I can use to invest there charges about USD$130 per transaction plus the currency exchange and spread. So, something like the Israel fund is my best way to ride with Israel at a reasonable cost.

The two funds however are still hedge funds, and as all hedge funds, they are expensive. The fee is 1.5% expenses plus 20% of gains as performance incentive fee. I don't think hedge funds in general are a good proposition for that reason. But admittedly, even with that, the Senvest funds have merit.

But there is even more reason that Senvest is a great investment. At the current price of CDN$163, it is selling for 2/3 book! Since I heard about the company, I estimate book value increased by 60% and the share price increased by the same. So in that time the company is equally mispriced. It does appear odd that such a mispricing exists. But I don't fret as to why. As a value investor my job is simply to profit off mispricing.

Seeing as Senvest is a business that makes money from capital gains and dividend income, I found it instructive to see how much of the gains flows back to the Senvest Capital shareholders. The Senvest Capital parent company owns RIMA Senvest Management which manages the investments of the hedge funds and gets the fund's 1.5% and 20% fees. However it keeps only 60% of the fees, the remaining 40% goes to Richard Mashaal whose family owns half of Senvest. So 20%*40%=8% of the investment gains goes to Richard Mashaal as a performance incentive and shareholders can claim the remaining 92% of the gains — for simplicity I ignore salaries and incentives for the other members of the management team. The previous several years report shows that the company's gains are taxed at about 10% rate. This means the shareholder keeps about 82% of the investment gains. And because the stock price is 2/3 of book value, the shareholder gets actually gets 82% ÷ ⅔ = 123% of the investment gains. The following tables compares Senvest Capital stock versus investing directly in the Senvest holdings versus someone who is able to invest in a hypothetical mutual fund that does the exact same thing as the funds and therefore gets the same performance before fees.

Investment in Funds Senvest Capital Mutual Fund
Equity 100% (neglecting expenses)150%100%
Gains 80%123% 100%

Admittedly there is a lot of hand-waving approximations in these calculations. But it shows that the Senvest Capital stock is so cheap that it outweighs the tax penalties of investing through a corporation and the high hedge fund fees.

The biggest risk in this investment, in my opinion, is the performance of the funds. While in theory hedge funds are suppose to hedge the upside and downside, Senvest's funds do the opposite. They are more volatile than the market; the performance will exceed the market during up years and be much worse during down years. That has served the company well in the last two decades, but I fear the funds may suffer some awful permanent loss of capital in a future downturn. But of course the company does have the margin of safety. As well, the company has other investments outside of the hedge funds. For example, it owns unlisted companies as well as REITs. These hopefully will have some uncorrelated risks to the hedge funds. In addition, the rest of my portfolio should have uncorrelated risks from Senvest. I run a relatively concentrated portfolio with about 20 main holdings. And as such I consider risk management paramount.

Below are some useful articles on Senvest.

A recent Barron's article. An earlier Barron's article.
A dated article by oddballstocks
Value Investors Club 2014 article.
Barel Karsan 2015 article.

Tuesday, February 10, 2015

Recent Portfolio News

IEHC recently reported Q3 2015 results. Q3 revenue was $4.73 M versus $3.66 M the same period a year ago. Income was $0.59 M versus $0.19 M the same period a year ago. EPS was $0.26 versus $0.08 the same period a year ago. EPS for the first 9 months was $0.65 versus $0.51 a year ago. So the company is on track for another record year!

The gains came from increased revenue and improved margins. Gross margin was a eye-whopping 39.8% in Q3 versus 31.2% a year ago. It was 35.9% for the last fiscal year, which was a record year. If the company can maintain a close to 2% margin improvement in the current year that would mean a more than 20% income improvement even if the revenue is flat.

The company credits the commercial space for the great quarter. While the military business is a more traditional customer for IEHC, I feel it has plateaued. Instead, I feel the growth will come from the commercial space, in particular the medical and transportation areas.

I feel IEHC is a $8 stock.

Tachibana Eletech just reported earnings that show it is also having a record year. The company earned ¥ 203 for the first 9 months versus ¥ 133 for the same period a year ago. Tachibana is a distributor of factory automation and electronics equipment made by Mitsubishi Electrics. Tachibana serves the Asia region and China is a lucrative market as it modernizes. Exports to China is made even easier because the Chinese Yuan is virtually pegged to the US dollar as it appreciates against the Yen.

Tachibana stock has doubled in local currency in the two years that I've owned it. And to get a better sense of why, I compiled the following data on both companies. The chart shows Tachibana's revenues and that of Mitsubishi Electric. It also shows the revenue of the Mitsubishi Factory Automation (FA) group and the Electronics group. But if we focus on the red and purple bars which are the Tachibana revenues and the Mitsubishi FA revenues, we see they move in tandem. That is very reasonable as FA accounts for almost 50% of Tachibana's revenue. Mitsubishi's stock (TSE:6503) has also doubled in local currency in the last two years. So, Tachibana's success has really been the result of Mitsubishi's success.

Putprop announced it will do a R100M (US$9M) capital raise to buy more properties and diversify away from Larimar, the bus operator that is responsible for 80% of the company's revenue This is a rights subscription to buy shares at R6.30 whereas the stock is at R7.00. So, I feel it is in the shareholder's interest to participate, or sell the stock before the deadline. This capital raise should increase the company market cap from US$20M to US$30M. I haven't decided on my choice because earlier this month the company announced that Larimar was late with the rent. Larimar seems to have some financial troubles and needs a few months to be current with the rent payments. Maybe this is nothing but it caused the stock to drop 10%, and it is factoring into my decision for the rights description right now.