Israeli Investment

The landmark privatization at the end of 1998 of Israel's largest financial institution, Bank Hapoalim, was the largest single capital infusion into the Israeli economy to date. A consortium led by Israeli-American entrepreneur Ted Arison bought control of Hapoalim; at about the same time, Claridge Israel, owned by Charles Bronfman of Canada and Canadian-Israeli Jonathan Kolber, bought a controlling stake in Koor Industries, the telecom, chemical, and construction company which comprises 7% of Israel's economy. Until just a few years ago, Koor was controlled by the Histadrut, Israel's largest labor organization.

International investment bankers were particularly impressed by these developments because they are emblematic of Israel's emergence from a socialist, union-controlled economy into a thriving free enterprise system with the confidence of the international investment community. This confidence level is a result of Israel's impressive development as a center of technological innovation and its maturing into a full-fledged player in the global capital markets.

From the late 1950s to the early 1970s, Israel experienced strong economic growth with demand consistently outstripping production capacity. The result was overemployment and little regard for either efficiency or profitability. Indeed, the very concept of a profit motive had negative moral overtones for Israel's socialist founding fathers. Furthermore, over half of Israel's industry was owned by either the government or the Histadrut, and much of the rest of the economy was indirectly controlled by the government through the large banks.

All of this, accompanied by the general political uncertainty of the period, restricted foreign investment.

From 1973 to 1984, Israel was a maturing state, experiencing reasonably predictable growing pains: slow growth, runaway inflation, excessive currency volatility, and acute instability in the nascent Tel-Aviv Stock Exchange. 1983 brought with it a major stock market crash, wiping out an enormous volume of savings, and leading to the nationalization of the country's four major banks. Foreign investment, not particularly robust to start with, declined to a trickle.

In 1985, the government launched a rigorous economic reform program which included, among other things, courageous fiscal and monetary policies that produced tighter credit, higher interest rates and the reduction of inflation to low double-digit figures. The TASE slowly regained credibility. The price of these austerity measures was higher unemployment and the failure of weak businesses. Still, the plan was ultimately successful, leading to a restructuring of labor-owned industry and the international recognition of Israel's leading private companies in the global capital markets.

Today, led by a vigorous private sector and encouraged by government policy, Israel has evolved into a capitalistic economy, dominated by free-market forces, deregulation and competition. With a $17,000 per-capita domestic product, a 2.5% annual population growth rate, and a 6% average real GDP growth rate over the last seven years, Israel has the positive characteristics of an emerging economy. At the same time, with its highly industrialized economy and advanced technological infrastructure, Israel has the stability associated with developed economies.

The tangible result of all this is an economy valued by equity markets for its growth potential and by debt markets for its maturity and stability. A wave of public stock offerings this decade in various global capital markets has brought approximately 100 Israeli companies to the NYSE, NASDAQ and AMEX equity markets. No other foreign country, apart from Canada, is so heavily represented on Wall Street. Most of these stocks are of high-tech companies traded on NASDAQ, and over a dozen of them now have market capitalizations of over $500 million. These include a number of well-known world leaders in their fields, such as ECI Telecom, Comverse Technology and NICE Systems (telecom equipment), Orbotech (optical inspection), Scitex and Indigo ( digital imaging), and pharmaceutical giant Teva.

In 1996 alone, Israeli companies raised almost $1 billion in the United States equity markets, and a large number of these offerings have been highly successful "blow-out" deals with strong institutional investor interest, in line with the general IPO boom. It was not, of course, always

Israel has evolved into a capitalistic economy, dominated by free-market forces, deregulation and competition

thus. Virtually all the stock offered in 1961 by Bank Leumi (and underwritten by a predecessor of Lehman Brothers ) in the first introduction of Israeli securities to the US markets ultimately "flowed back" to Israeli investors. The 1987 offering by Lehman Brothers of $30 million of Teva stock, one of the earliest transactions in the "modern era" of Israeli finance, was notable for being the first Israeli issue which attracted institutional investors. However, only one-third of the issue was sold to institutions (after much effort by the underwriters) in contrast to the 75% institutional investment that is normal for a successful offering (recorded in subsequent Teva offerings). Teva now boasts a number of prominent and well-known global institutions in its investor base, and in 1996 completed the acquisition of US drug company Biocraft for almost $300 million. Tellingly, the 1987 prospectus for Teva included a four page section entitled "Conditions in Israel," which began with the words "Israel has suffered from rapid inflation since 1973." The comparable section of a recent Lehman Brothers prospectus for the Israeli satellite company Gilat, raising $75 million, was only two pages long and began with the phrase "In 1996, for the seventh consecutive year, the economy of Israel continued to expand." And the "Israel discount" of 10-15 percent of a company's public valuation has long since disappeared.

The success of these offerings generated unprecedented interest on the part of the global investment banking community in Israel. In 1994, Lehman Brothers, which has historically been the most active investment bank in Israel and has been responsible for most of the Israeli offerings on Wall Street, became the first major investment bank to open a permanent office in Israel.

Foreign investment in Israeli technology is likely to continue. Over 1,500 Israeli start-up companies have been established in recent years, most of them high-tech oriented. In 1996 alone, over $400 million of venture capital was raised for investment in Israeli start-ups. Israeli investment in R&D, as a percentage of overall GDP, is higher than that of either the United States or Japan.

Part of the reason for this massive concentration of technological innovation is governmental: Israel fueled its high-tech boom in its infancy, when capital was hard to come by, by providing a unique assortment of state-funded R&D grants and investment benefits. Most of these programs are still in place.

However, the most important reason for Israel's development as a technology center is not related to the government but to the country's people. Israel's population is the most highly educated in the world, with 135 engineers for every 10,000 people in the work force. In comparison, the U.S., which ranks second in this regard, has a mere 70. (We won't go into why engineers per capita, rather than, say, investment bankers per capita, is the accepted standard.) In addition, the 700,000 new immigrants who arrived in Israel this decade from the former Soviet Union have contributed an enormously talented pool to the local work force.

All of this has led to a dramatic surge in foreign investment, even outside the public stock markets. In the last few years, such major multinational companies as Intel, Applied Materials, Siemens, Johnson & Johnson and Deutsche Telekom have made significant investments in Israel, by the acquisition of Israeli companies or through the placement of R&D operations in Israel. The most recent of these was the acquisition by AOL of Internet company Mirabilis for $300 million in June 1998.

In addition to Israel's emergence as a "silicon wadi," the country has become a notable regular borrower on the global capital debt markets, which are several orders of magnitude larger than the equity markets. Historically, Israel's access to the large pool of debt capital available worldwide has been limited to borrowings guaranteed by the U.S. Government, or by quasi-governmental agencies such as the Export-Import Bank. At the end of 1995, based on Israel's prospects for economic development and growth prospects, as well as on positive developments in its relationship with its neighbors, the Standard & Poors and Moody's credit rating agencies gave Israel an A-/A-3 investment grade credit rating, and the government of Israel issued $250 million of Yankee bonds. The government followed this up with offerings in the Euro and Samurai markets.

More significantly for Israel's economy, from a long range point of view, in 1996 the Israel Electric Corporation, Israel's largest company, which had for the most part relied on the Israeli government for its funding, raised $600 million in an issue of Yankee bonds through Lehman Brothers. Part of that $600 million debt issue was in the form of a century bond - notes that will not mature until the year 2096. Thus, investors were willing to stake over $100 million on the economic progress of fifty year old Israel for the next hundred years. Israel Electric followed up on the success of this offering by setting up a $1 billion global shelf.

The Israel Electric offering opened up the largest pool of capital in the world to Israel's corporate sector, and, from an investment banker's perspective, in a sense marked a coming-of-age of Israel's economy. The year 1997 saw continued progress in Israel's transition from its socialist beginning, including deregulation of the Bezeq telecommunications monopoly, with the introduction of two new, and successful, long-distance carriers, as well as the raising of over $2 billion by the government through the long-awaited sale of state-owned companies, including Bank Hapoalim. The government has also taken dramatic steps toward currency liberalization, aiming for full convertibility of the shekel by next year. Thus, from a banker's perspective, Israel's emergence from socialism has made possible its economic fruition in its first half century and seems set to do so well into its next.