Value range – as the money pours in, can Israel takes its high-growth stars global?
08 April 2016 09:00
by Chris Crowe
Investment is pouring into Israel's technology sector. Can increased capital take Tel Aviv's high-growth stars global?
Israel's regional tensions contrast with optimistic hopes for foreign investment and a burgeoning economy. While war still rages over the border in nearby Syria, Israel's start-up and hi-tech sector is flourishing. In addition, its nascent natural gas industry finally looks primed for substantial development.
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Life is good in Israel's commercial capital Tel Aviv, says Barry Levenfeld, a partner at Yigal Arnon & Co: 'Economically and politically, Israel remains stable, while our neighbours are more dangerous by the minute. Sitting here on the 47th floor in Tel Aviv, looking across the Mediterranean and with all the restaurants and coffee houses below, you just wouldn't know that any of this was going on.'
Israeli start-up companies raised a record $4.43bn in 2015, according to Israel Venture Capital (IVC) Research Center, the figure contrasting with a slowdown in venture funding in the US and other start-up hotspots. IVC says hi-tech exits increased by 16% in 2015 to $9.02bn.
Israel continues to ride high in the investment stakes thanks to its dynamic start-up community, but also because Israeli growth stars are often seen as better value to many international investors tired of over-sold tech firms.
Simon Jaffa, a founding partner at Barnea & Co, has just returned from an extended visit to the west coast of the US, where he argues he saw an unprecedented eagerness for the Israel growth story. Jaffa says that the large number of prominent Israelis that have entered Silicon Valley and other growth company centres in recent years are helping to fuel this enthusiasm for Tel Aviv as a global tech hub. 'There is a dynamic flow of information and transactions between the US and Israel, and this is significant because many perceive a slowdown in the US market,' he remarks. Jaffa maintains that valuations remain relatively subdued because foreigners are naturally wary of the geopolitical situation and feel that prices should be lower on account of regional volatility.
That said, any residual concerns have hardly dampened investment flow, not least because Asian investors are following suit.
It means the Israeli legal community has become alive to the Start-up Nation moniker and is now taking a lead from Silicon Valley.
Jaffa says his firm looks to west-coast legal icons such as Cooley, Fenwick & West, Gunderson Dettmer and Wilson Sonsini Goodrich & Rosati for inspiration, particularly in their willingness to take risks in offering discounted or free legal advice for companies they see as prospects to be the next big thing. Jaffa says that start-ups tend to stick with their traditional legal counsel throughout their lifecycle and sees potential parallels for Israel's legal community. '[US law firms] are waiting for the next Steve Jobs or Mark Zuckerberg to come through the door. We need to make that assessment of the start-up and there is a degree of risk in that. If you want to be working in the technology sector, you have to be prepared to take that risk.'
A willingness to 'invest' in your growth clients doesn't always come easy to legal professionals, but it is a strategy that is becoming increasingly dominant in the entrepreneurial Tel Aviv market. So much of the domestic economy and cross-border investment is driven by hi-tech and start-ups. Amazon.com launched a research and development (R&D) centre in Israel last year, following the example of other tech leaders, such as Cisco, Apple, Google and Facebook. Cisco has spent more than $1.5bn in acquiring ten Israeli start-ups, according to the Israeli newspaper Haaretz, and has invested in around 25 others.
Nitzan Hirsch-Falk, a partner at Israeli law firm H-F & Co, says that US tech companies often struggle to find the right legal talent to develop an R&D centre, and can take advantage of a globally-cheap and highly-educated workforce in Israel.
Israel's start-up community is constantly expanding. MassChallenge, the Boston-based start-up accelerator, launched a Jerusalem branch in January this year. Doron Stern, a founding partner of Tulchinsky Stern Marciano Cohen Levitski & Co, says that MassChallenge accelerator is a venture intended to transform the lives of lower-income orthodox Jews and Arabs that populate the vicinity.
Consolidating market share
A desire for expansion has created a frenetic legal market, with a series of mergers and headline team moves in recent months. The volatile nature of the market also provided a major casualty in February when the well-regarded Zellermayer, Pelossof, Rosovsky, Tsafrir & Co shut its doors. Seasoned dealmaker Michael Zellermayer joined FBC&Co, after leading litigator and fellow name partner Eyal Rosovsky and his team moved to Meitar Liquornik Geva Leshem Tal Law Offices in January. Earlier, high-profile M&A partner Doni Toledano had switched to Erdinast Ben Nathan & Co. The demise of the firm sent a jolt through the local profession but is symptomatic of the unpredictable character of the market.
In recent years, a spate of mergers created relative legal giants Goldfarb Seligman & Co, Herzog Fox & Neeman and Meitar Liquornik, all with in excess of 250 fee-earners. Anxieties over losing national and international status due to lack of size have become increasingly apparent. One partner in a leading smaller firm admits to worrying about the largest firms ‘pulling away’ and his practice ‘being left behind’.
In 2015, the merger trend continued with the union of Tadmor & Co and Yuval Levy & Co, creating 85-lawyer practice Tadmor & Co Yuval Levy & Co.
Opher Levy, co-chairman and co-managing partner of the new firm, says the merger created a larger firm that could offer a much broader suite of services and this was crucial to its ongoing credibility: ‘Foreign clients expect the law firms that they work with locally to have a one-stop shop and offer various practice areas that operate at the highest level.’
Until recently, the vast majority of the start-up community has existed in Tel Aviv and the surrounding region. But growth is pushing the industry into other areas, such as Jerusalem and Beersheba in southern Israel, the latter being a flourishing sector for cyber security firms. Many of the nation's military and former military personnel, having been intensively trained in cyber defence, are now part of the growing tech scene in Beersheba.
Ram Toren, a partner at Gideon Fisher & Co, says that Tel Aviv has become too expensive for some businesses that are now seeking cheaper real estate and labour costs. 'There is a big shift towards the south. The mayor of Beersheba is helping to build it into a hi-tech area and there are government incentives for people to move there.'
A more dispersed economy may represent additional challenges to the legal sector, but Levenfeld is comfortable with it, saying that Jerusalem is only a 40-minute drive from Tel Aviv without traffic, similar to travelling from Palo Alto to San Francisco on the west coast of the US.
'I never thought there would be a hi-tech future for Jerusalem, but now I am a believer,' he says. 'There seems to be a buzz that wasn't there before.'
Israel's buzzing economy continues to capture attention across the world, including China and the far East, in hi-tech industries and beyond. Last year, China's Bright Food acquired a 77% stake in Tnuva, the largest food manufacturer and distributor in Israel, from Apax Partners for $1.07bn. Herzog Fox & Neeman advised Apax with FBC&Co representing Bright Food.
'Israel is not somewhere that you can ignore and the valuations are more sensible than in other jurisdictions.'
Jonathan Morris, Berwin Leighton Paisner
Jonathan Morris, head of corporate at Berwin Leighton Paisner, says that the Chinese and other Asian jurisdictions are also enthused by Israel's dynamic business culture, but also the ability to find relative bargains in acquisitions: 'Investments are both direct and indirect. We see companies coming in and acquiring entire companies, taking a majority stake or even establishing an incubator. Israel is developing cutting-edge technology, whether it is cyber, fintech or medtech. Israel is not somewhere that you can ignore and the valuations are more sensible than in other jurisdictions.'
Morris is seeing a growing interest from other Asian jurisdictions such as Singapore, Japan and Korea. Elie Sprung, a partner at Tadmor & Co Yuval Levy & Co, believes that Asian investment so far is only the 'tip of the iceberg'.
Israel is in investment mode itself. Last year, Teva Pharmaceutical Industries, the world's largest generic drug maker, launched an audacious $40.5bn bid for Ireland-based Allergan. Tulchinsky and Sullivan & Cromwell advised Teva, with Latham & Watkins representing Allergan.
Despite the cooling of the capital markets in 2015, international investors still have an appetite for Israeli companies. In March, ZAG-S&W, a joint venture between Zysman, Aharoni, Gayer & Co and US-based law firm Sullivan & Worcester, advised two Israeli-based companies, Nano Dimension and LabStyle Innovations Corp, on their Nasdaq listings.
The regularity and size of cross-border deals is forcing Israel's legal community to 'learn new perspectives' says Tulchinsky's Doron Stern: 'We are learning how to cope with the different expectations of China, South Korea and other jurisdictions.'
For a few shekels less – flexi-lawyering hits Israel
Israeli lawyers are not shy of highlighting the quality of professional expertise that exists within the nation. It is common to hear claims that Israel’s legal elite is on a par with the best that London and New York has to offer.
And just as sophisticated alternative service models are springing up in the UK, Israel’s own LawFlex launched last year. Its pool of freelance lawyers is hired out to plug gaps at firms operating above capacity or where specific expertise is required.
While the same sort of model is well established in other jurisdictions and many international firms are attempting to formalise their use of alumni networks for similar resourcing, LawFlex’s co-founder Jackie Donner Stocki says that the business has sated a latent demand. LawFlex has already grown to over 70 lawyers and Donner Stocki says it gives Israeli firms another option rather than joining the popular merger-and-rapid-growth trend.
The former London associate at Freshfields Bruckhaus Deringer began working in Israel at Epstein Rosenblum Maoz before leaving to become a freelance lawyer after having three children. Having launched LawFlex with Zohar Fisher, the head of Robus – Legal Marketing and Consulting Services, Donner Stocki says that the business is already working with 20 mid-sized firms and is now targeting the larger practices.
So far the business is more oriented towards the complex and higher-value work with the average LawFlex lawyer being seven-years qualified. Lower-value volume work is not the priority. LawFlex usually takes between 10% and 15% of the lawyer’s hourly rate.
Donner Stocki argues that LawFlex can further eat into foreign markets, as its lawyers are largely internationally-trained and would charge ‘a quarter of the price that they would be paid in England’. She adds: ‘We have seven years-plus-qualified lawyers with impressive CVs that are charging 300 sheckels ($77) per hour.’
Internationalisation has also intensified the emphasis on English language skills. Even the smallest Israeli start-ups have their corporate documents drafted in English to make them more attractive targets. Guy Ne'eman at Ne'eman, Keynan & Co says that he 'hardly engages in Hebrew anymore' as clients want 'everything set up in English to welcome foreign investors'.
Clifford Davis, a partner at S Horowitz & Co and a former London associate at Jones Day, has worked on a series of recent export credit financings, including Bank Hapoalim's $200m financing to the Ethiopian Sugar Corporation for a large-scale sugar-cane irrigation project to be developed by Netafim, the Israeli drip and micro-irrigation leader. Davis says that the firm needs to recruit more international lawyers to enable it to work on the growing number of cross-border transactions involving Israeli investors, acquirers and lenders. 'These loan documents are not subject to Israeli law. They are subject to English law,' he remarks, indicating that there is a growing demand for people that can 'write perfect English' particularly for 'off-piste drafting'. He believes that Israeli clients still prefer to work with a local adviser, even on English and US law transactions, because charge out rates are less than a third of equivalent lawyers in New York and London. Gil White, a partner at Herzog Fox & Neeman, agrees: 'The Israeli market is cosmopolitan by its very essence. The majority of transactions have an international element. This makes lawyers with international experience and training a valuable commodity.'
Open for business
Further cross-border activity is poised to develop with greater regulatory clarity. The development of Israel's nascent natural gas industry had slowed with uncertainty over the regulatory framework for market access. This had followed antitrust concerns about the dominance of Noble Energy and the Delek Group, and their control of all the gas reservoirs off Israel's coast. Uncertainty stalling investment of offshore exploration and the commercialisation of the major Tamar, Leviathan, Karish and Tanin fields.
The new framework will help ensure that the recent gas discoveries will be developed, but will require significant divestitures by the incumbent owners and see new players coming into the market.
Under a new regulatory framework that is still subject to court approval, Noble and Delek are expected to sell their stakes in Karish and Tanin, with the buyer of these assets expected to develop them for the Israeli domestic market. In addition, Delek is required to sell all of its interest in Tamar within six years and Noble is to reduce its stake in the field from 36% to 25%. This is intended to further incentivise the development of the Leviathan gas field.
Dan Hacohen, a partner at Agmon & Co Rosenberg Hacohen & Co, represents both Tamar and Leviathan consortiums, and expects a fervent movement in the gas sector, including further exploration, once the new framework is approved. 'There has been little new exploration activity recently. It has all been frozen until the regulatory environment is cleared up,' he says.
If further foreign investment in the energy sector is expected, the same is true for the wider economy. The long-debated anti-concentration law, that seeks to increase competition in Israel, is beginning to bite. Under the law, Israeli owners of financial sector businesses are restricted from holding industrial businesses. It is an attempt to dismantle the dominance of Israel's conglomerates.
According to Adir Waldman, Freshfields Bruckhaus Deringer's representative in Tel Aviv, this is encouraging Israeli businesses to expand overseas in place of domestic exposure. Major asset sales are also attracting foreign investors. 'Sentiment has changed and people have started to address the anti-concentration law, conform to it and bring it into their thinking. More Israeli business people are looking to invest abroad as they are conscious of not holding assets across sectors,' Waldman comments. 'If a business in the non-financial sector goes on sale today, you are likely to have fewer local bidders than you would have before the law. If you are in the FIG [Financial Institutions Groups] sector, you will be thinking about not buying a business today that you will not be able to hold in three years.'
Though businesses affected by toughened competition laws have until the end of 2019 to comply with the new regulations, there is already movement in the market with the major conglomerates hoping to avoid a last-minute fire sale. Even so, recent transactions that have been linked to the new law have not all gone to plan. China's Fosun International abandoned its $462m acquisition of a controlling stake in Phoenix Group Holdings from Delek Group in February, blaming market turmoil. Fosun's chair Guo Guangchang was recently detained in connection with a corruption investigation and many in Israel are suggesting that the deal was blocked by Israeli regulators.
'I hardly engage in Hebrew anymore. Clients want everything in English to welcome foreign investors.'
Guy Ne’eman, Ne’eman, Keynan & Co
In January, Chinese investment house Macrolink Group also backed out of a deal to buy a controlling interest in Israel's Clal Insurance Enterprise, citing regulatory obstacles. IDB Group, the financially distressed Israeli conglomerate, had agreed a deal with the Finance Ministry to sell its 55% stake in Clal Insurance over a three-and-a-half-year period.
The deals are not thought to have damaged Israel's strengthening relations with China. 'I don't see this denting the enthusiasm for China-Israeli collaboration,' Morris argues.
Enthusiasm for Israel continues to outweigh its small population and economy, and largely withstood widely-broadcasted geopolitical tensions. 'Relative prosperity is around, but a lot of it comes from the way that business has matured,' Stern concludes. 'People tend to forget that this was a huge refugee camp only 30 or 40 years ago, and now it has transformed into a healthy and vibrant business arena.' LB