Author: Eric Uhlfelder

19 January 2010, Barron’s

This fund isn’t for the feint of heart. But for investors who can handle the turbulence, it’s well worth the ride.

Richard Mashaal never tries to make money the easy way. His curious, entrepreneurial spirit, rooted in his heritage from Baghdad’s Diaspora, leads him to seek out value where few would bother to look.

This was never more evident than in 2003. In the midst of recession, the collapse of TMT shares, and the US preparing to invade Iraq, Mashaal thought it was a good time to ratchet up exposure to Israel and to start up an Israeli-focused hedge fund.

Most market observers thought he was nuts. No other country was more exposed to the current traumas than Israel. Its market was heavily focused on technology, and its infrastructure was just a short SCUD ride away from Iraq.

Yet, over the nearly seven years since it started, the Senvest Israeli Partners Fund is up an annualized rate of 23.4%, nearly tripling the Nasdaq returns of 8.9 percent.

Mashaal’s $200 million long-short Senvest Partners fund–half of whose assets are owned by his family–has directly benefited from its Mideast venture. With 10% of the fund’s assets in Israel, it is this kind of far from the crowd thinking that has helped Senvest achieve remarkable, albeit volatile, results.

Last year, the fund more than tripled in value. More impressive is his fund’s annualized returns since inception in April 1997 of more than 20%.

But it hasn’t been all smooth sailing. Senvest has experienced significant losses at market inflection points. But its contrarian responses have set the stage for huge gains. “Establishing positions a bit too soon doesn’t bother us,” says Mashaal, “because the strength of our convictions and a medium-term investment horizon have helped us generate substantial returns.”

A tech-oriented shop when it began, Senvest got slammed in 2000 when the Nasdaq collapsed. When realizing the sell-off was more than a correction, Mashaal started selling short, focusing especially on small caps. As the market continued to slide in 2001, Senvest was up nearly 20%.

By 2002, feeling that the market was bottoming, Mashaal reversed course and started buying tech again. He was early, and his fund declined 37%. But when the market did rally in 2003, his fund soared 169%.

The fund tacked on another 91 percent over the next five years as it diversified beyond tech with positions spread across financials, real estate, health care and energy.

But Mashaal got hit again in late 2008 by tacking too early against the bear market, leading to a whopping loss of 54% for the year. Mashaal thought the market was bottoming in October, as he saw the government deciding it couldn’t permit another Lehman-like failure. However, backstopping AIG didn’t assuage the market, and stocks started their final decent into the first quarter of 2009.

But he stuck with his 100% net long position, replacing cheap stocks with even deeper value plays, figuring the market was vastly oversold. The result: Senvest roared back 229% in 2009.

This kind of rollercoaster-like performance produces nerve-rattling volatility. According to hedge fund data tracker BarclayHedge, Senvest’s volatility is 2.5 times the broad market. But its long-term gains are 5 times the market.

Senvest’s New York-based seven-person team works closely together to find growing small- and mid-cap companies that are undervalued, underfollowed, or misunderstood. They speak with industry consultants, concentrate on price-to-sales and book valuations, sustainable free-cash flow, viable balance sheets, growth catalysts, and meet with management, customers, and competitors. In the end, Mashaal has the final say on all trades.

Though this discretionary process looks for positive stories, the fund will not hesitate to short when it uncovers vulnerability.

This happened when looking at Wall Street darling Vistaprint [VPRT]. “We saw a chink in this fast-growing on-line printing company,” says Brian Gonick, Senvest’s principal and director. “When finishing their order, customers often unwittingly signed up for a membership discount club and ended up getting hit with recurring monthly fees.” Senvest estimated these fees were providing a majority of the company’s free cash flow. Without them, the firm thinks Vistaprint was trading at 50 times trailing free cash flow. The fund also thinks the company is understating maintenance capex.

So it started shorting the stock in October 2007 when it was trading around $40. Senvest took a profit when the entire market sank in 2008 and the stock fell into the teens. However, Vistaprint continued to surprise on the upside, sending its shares straight up to the $50s. By the end of 2009, the fund’s investment was down 16%, which it has since mostly sold.

The problem: Vistaprint recently decided to exit the membership club referral business. But core growth appears to be sustaining the company’s guidance, and the stock has held up.

When Senvest started buying shares in Genworth Financial [GNW] in November 2008, there were few greater contrarian plays than a company offering mortgage insurance. Since it peaked above $36 in April 2007, Genworth shares collapsed to $1.45 in November 2008. That’s when Senvest started buying.

Mashaal saw an excessively beaten down stock based on the value of its core businesses and misperceived risks. “Three-quarters of Genworth’s sales actually come from life, retirement, and long-term care insurance premiums as well as wealth management,” observes Mashaal, “with the company enjoying leading mortgage insurance positions in Canada and Australia, whose housing markets and economies have fared much better than ours.”

Genworth clearly struggled on certain fronts. But Senvest thinks a significant portion of unsettled mortgage claims in the US will not be paid because of fraudulent documentation. With the housing market bottoming, mortgage insurers are benefiting from rising premiums and falling risks. Investors now seems to concur with Senvest that the worst is over for this specialty insurer as underwriting conditions continue to improve across its various markets. On January 15, the stock closed at $13.39.

Israeli internet traffic management and security product maker, Radware [RDWR] was left for dead at the end of 2008 when it was trading at 0.1 times sales and below cash on hand. Senvest has been in the stock since the tech bubble burst in 2002 when shares were trading in the upper teens. But two years ago they collapsed below that level as the company suffered from weak sales growth and rising product development costs that produced several years of operating losses.

Despite clear problems, Senvest saw several positives: solid IP and R&D pipeline and a strong balance sheet with more than $7 per share in cash. With a key acquisition from Nortel, improved control of operating expenses, the company having likely turned profitable in 2009 [Bloomberg projects EPS of $0.25], growing demand for improved internet delivery and security, and Gartner Group projecting IT spending in Radware’s markets likely rising 15% annually over the next five years, Senvest sees Radware earning $1.00 a share in 2010. [Bloomberg’s estimate is $0.57.]

Mashaal kept adding to his position as the ADR broke below $6 at the end of 2008 and continued buying as it rallied past $11. He now owns 9.4% of the company. The stock closed on January 15 at $16.06.

Perhaps no holding is more contrarian than Mashaal’s 6% stake in the Royal Bank of Scotland–the sickest of the world’s global banks. “Too big to fail was an opportunity for us,” exhorts Mashaal.

Senvest started buying stakes in a series of $25 par preferred shares back in January 2009 at $5 when the world expected the bank to be entirely nationalized and such shares wiped out. But Mashaal and company thought otherwise.

“The government limited its ownership stake at 85%, it doesn’t want to see the bank fail, and the prevailing sentiment is that the bank has continued to pay its preferred dividends because to do otherwise would be a confidence killer,” says Brian Gonick. Accordingly, Senvest kept adding to its position throughout 2009 at prices ranging between $3 and $10.

When the European Commission recently announced that after the 4Q09 payments, the bank has to suspend dividends for two years on a series of these preferred shares, Senvest divested about one-third of its position. But it started buying back some of these shares that dropped to around $8, believing they were of extraordinary value.

Assuming the bank gets itself healthier, it will want to reinstate its preferred dividends by early 2012. At that point, presuming a 9% yield would suggest average forward prices of the preferreds ranging between $17 and $20 [due to various coupons]. Or if the bank wants investors to convert these shares into common stock [which may be the reason the EC has delayed suspension of dividends until April 2010], then RBS would be offering a significant premium to abet their exchange. Since the dividend extension was announced, effected preferred shares have jumped between 30% and 50%.

Mashaal is optimistic about 2010. “The recovery play will continue through the year, which should provide us with a number of solid opportunities,” he says. But he expects things to get increasingly more opaque by the following year. But even if the fund starts to stumble, given its track record, investors who hold may be well rewarded.

Company Ticker Industry Total Gross Portfolio Dollar Position

Genworth Financial GNW Specialty Insurance 11% $36M
Radian Group RDN Mortgage Insurance 7% $24M
Royal Bank of Scotland RBS Preferred Series: M, N, R, S, T, Q Banking 7% $22M
Sandisk SNDR Flash Memory 4% $13M
Radware RDWR Network Equipment 3% $12M
Source: Senvest Parners, 31 December 2009

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