Despite political and diplomatic uncertainties and a volatile economy Israel appears to be selling its investment story to international capital markets. “There is a lot more banking activity in all directions,” says Ron Lubash, Lehman Brothers managing director for Israel. “The country has opened up. You see a whole slew of new companies and new issuers.” Lehman predicts at least six new debt issues in the coming year. “There is a general acceptance of Israel shifting to the debt market,” says Lubash. “Now the door is open. Israel has more exciting growth prospects than some other as, and a pretty good debt-repayment track record. Both country and companies have little default history.”
Israel may be a tempting market for the banks, many of which have stayed out because of the threat of an Arab boycott, but some of the story has to be taken on trust. Economists point to near double-digit inflation, comparatively slow growth at 3.5%, and a budget deficit of 3.7%. One economist admits: “Israel is a tough sell at the moment.”
For the moment, though, banks are talking up Israel, especially the opportunities surfacing in the equity and debt markets. Many have set up representative offices in the main commercial centre, Tel Aviv. Barely a month passes without a new entrant to the local market hanging out his shingle, in the hope that a high-tech entrepreneur or company official will drop in with a listing proposal. Citibank, Salomon Brothers and Lehman, among others, have all set up offices in the last 30 months: BNP and UBS plan to do so.
There are three prizes for the winners of the headlong rush to Tel Aviv: a place in the government’s affections as it goes to the international capital markets with regular yankee, Eurobond and samurai issues; lead positions in syndicated loans for big Israeli corporates; and underwritings for the IPOs of small, high-technology start-ups on Nasdaq.
Citibank opened a representative office in February 1996. Ronny Strauss, the bank’s Israel director, gives three key reasons for the move: Israel’s new stability in the wake of the Middle East peace process; the strong economy; and Israel’s key role in Citibank’s strategy for emerging markets. “We cannot develop a regional presence without a presence in Israel,” Strauss notes on the last point.
Citibank, Strauss says, is “assessing the market” for products such as its treasury management system, trade finance, and investment management. If the findings prove positive, Citibank will upgrade its representative office to branch status and then go “head-to-head with local banks in fund-raising and trade finance”. Says Strauss: “I don’t believe that the local banks have the capacity to underwrite syndicated loans or bonds, and fund-raising is Israel’s fastest-growing area.”
Another old Israel hand to open a Tel Aviv office is Salomon Brothers. It was co-lead with Lehman in Israel Electric’s $600 million offering last year and has participated from New York or London in many offerings by Israeli state and quasi-state entities. But Salomon is now approaching a new customer in Israel and needs to get on the spot. “It is more difficult to deal with private companies out of New York,” says the head of its representative office, Itay Makov. “[Setting up locally] shows our commitment to the government of Israel.”
The bank promises to bring international standards to what Makov sees as the sometimes poorly serviced Israeli high-technology sector. “We treat the Israeli companies in the same way as we treat us companies,” he says. “When Israelis say ‘your competitors are willing to take us public a year earlier, your competitors are more flexible in their standards’ we insist that we stand on quality. We look at the market as a global market.”
Most to lose
The bank with most to lose because of competition from new entrants to the market is Lehman Brothers, which has had a close relationship with the Israeli government for 36 years through its New York-based director, Harvey Krueger. Lehman, which claims to have had 75% of the debt-issuance market and 50% of new equity-raising in 1996, was also the first foreign bank to open a local representative office, 30 months ago.
Lubash says Lehman is ready to see off the newcomers. “We intend to be the dominant leader. Others are muscling in. That just means the battle is stiffer, but in most cases that doesn’t change the outcome. All of the credible parties are playing ball in this market. Not all of them will be there for the long term, but right now all are.”
The competition for Israeli business has been clear when the government has invited proposals for mandates to run its medium-term note programme. On one occasion, 30 banks lined up with proposals and the government achieved wafer-thin pricing, says Citibank’s Strauss. “Israel was seen as no different from any other respectable OECD issuer,” he says. “What happened was typical for deals undertaken by a developed institution or country.” Salomon won the bookrunner position for the Israel government bonds in December 1995 (for $250 million), and Salomon won the position in December 1996 (for $200 million). Both tranches had coupons of 6.375%.
An Israel Electric offering for $600 million launched last year had coupons ranging from 79bp above treasuries on the first $350 million over 10 years to 129bp over treasuries on $125 million over 100 years. Issues of this type are set to be a fixture over the next few years, says Lubash, as the larger privatized and quasi-state companies exhaust their permitted domestic borrowing levels and have to go to the international capital markets.
Prices are equally tight in the underwriting of Nasdaq-listed high-technology companies, says Lehman’s London-based executive, Amir Chen. The prize here is a stake in the fast-growing sector of the Israeli economy. Hundreds, perhaps thousands, of small companies are queuing up to join the 80-strong Israeli sector on Nasdaq. “It has been an amazing development,” says Alan Adler, a director at Evergreen, a high-technology venture capital company linked to Robertson Stephens. Israel venture capital funds have 250 portfolio companies at different stages of development. Many have been operating for three to four years and are beginning to prepare for IPOs. A further 800 or 1,000 smaller companies are in the sector, but earlier in their development.
Aggressive competition
Underwriting fees are falling fast, says Chen, from 7% of the issue amount five years ago to between 5.75% and 6% now. Lehman’s Lubash says: “There is aggressive competition between rivals over the last two years in the heat of the booming high-technology market. Every new bank setting up in Israel does their first one or two deals with slightly more aggression, and they have a more lax attitude towards the maturity of the company with slightly lower fees.”
The rush for business has led to some controversial decisions over the pricing and timing of IPOs. This has led to several flops which observers fear might result in growing disillusionment with the sector. “Many companies are going to Nasdaq too early,” says a manager of a prominent bank in Israel. Valuations have reached extraordinary levels, says Lehman’s Chen: “We have found that companies with no revenues have been offered to the public on a $400 million valuation. People are overvaluing high-tech start-ups.”
One recent problem case was the launch of educational software house Logal Educational Systems and Software, whose two issues, valued together at $15.2 million, were underwritten by Lehman. The company failed to perform up to expectations in the subsequent months and the shares were punished, falling from $10 to $5. According to Lehman’s Lubash: “If the offering has not done justice to the company, which is the way we look at Logal, we stick by it, cover, support and finance the company.” Ed Mlavsky, the chairman of Logal’s board and head of venture capital company Gemini Capital Fund, concedes the company may have been listed too early but says Logal is now back on track.
Hope also prevailed over experience at the time of the roadshow of orthodontic company Perio Products in January. The issue had to be pulled when investors gave it the cold shoulder. According to one local broker, the IPO failed to attract investors because of excessive valuation by underwriters Smith Barney. Other firms had valued Perio at no more than half the final valuation, says the broker.
“A lot of Israeli companies have not succeeded on Nasdaq,” says a local bank official, “and that has hurt the reputation of other companies.” Mlavsky says the overheating of the Israeli high-technology industry is not exceptional but mirrors the experience of emerging sectors in the US and elsewhere. “A market with so many new entrants does have extra heat attached to it. But is it hotter here than in Silicon Valley, or Route 82 in Boston or Ireland? Probably not by much at all.”
Pushy entrepreneurs also have unrealistic expectations, says Mlavsky. “When an Israeli company sees someone up the road getting an offer, they want the same offer plus, whatever the real merit of the company. It is a slippery slope which banks must watch.” But banks that seek to restrain the determination of the high-technology entrepreneur to prepare for market are likely to lose their business for ever. “If you advise a high-tech start-up to delay its IPO because you believe it is premature,” says a banker, “it is very likely the company will go to one of the non-blue chip firms out here that is prepared to cut fees and boost valuations to win a foothold.”
The growth of the Israeli high-technology sector on Nasdaq has prompted the Tel Aviv stock exchange to try to bring back home some of Israel’s best and biggest companies. Chairman of the exchange, Yair Orgler, has instituted measures to encourage dual listing. “We know why the companies go to Nasdaq, it is to get the best possible price, but we argue that the advantages of a listing in Israel are not properly understood.” Orgler points out that a listing widens the investor base to include Israelis. It also puts the shares within reach of provident and mutual funds which have a tight limit on overseas investments.
But the Tel Aviv exchange also claims there is a tax benefit for founders and employees who acquire shares at the issue price. Israeli tax law imposes a tax on shares based on the difference between the issue price and the price at which they are allocated to the investor, whereas US tax authorities tax the difference between the listing price and the final sale price. For the company whose shares rise sharply and quickly after listing – which is not unusual in the high-technology sector – great benefits are available to Israeli entrepreneurs holding locally quoted shares.
Yet high-flying entrepreneurs continue to shun Tel Aviv, believing US funds are far from exhausted and that the Israeli exchange’s disclosure requirements are excessive. Orgler says the exchange has sought to eradicate unnecessary bureaucracy, and it is planning to exempt companies already listed on Nasdaq from making additional disclosures to the Tel Aviv exchange. “We would like to have a dual listing for the 50 biggest [Israeli] companies currently only listed on Nasdaq,” says Orgler. “The companies don’t need to raise money, just list. We accept that their IPO will continue to be on Nasdaq, and the valuations will be set by US investors.” The Tel Aviv exchange is also proposing to remove some disclosure requirements, to encourage high-technology funds to list on the local exchange.
The ease with which Nasdaq has accepted the Israeli arrivals suggests there is little likelihood they will choose Israel for a listing.
Foreign seats
Local brokers are also sceptical about the Tel Aviv exchange’s efforts. “The companies right now do not need the Tel Aviv exchange, the exchange needs them, they are doing fine on Nasdaq,” says Ezer Soref, vice-president for banking at brokers Giza. “However, it is good for a company to be traded on more than one exchange.”
Israelis will certainly benefit if more start-ups choose Tel Aviv. The exchange has low transaction costs compared with those on Nasdaq. Tel Aviv transaction costs range between 0.3% and 0.5% while on Nasdaq an investor can pay between 1.5% and 2%.
The quest to have the Tel Aviv exchange accepted as a base for high-technology companies will be helped by foreign banks’ interest in positions on Israel’s capital markets. UBS, for example, is reported to be taking advantage of rule changes and applying for a seat on the Tel Aviv exchange – the first foreigner to do so.
This nation of entrepreneurs and technologists will give the banks a good run for their money. The only caveat is that the politicians and generals stay out of the picture.
