Spreading its wings

Israel's private equity sector has really only taken off in the last five years and it is increasingly ambitious internationally. Financed both by domestic sources and foreign investment, the capital exists to make a significant mark on the international financial scene. Hillel Schuster explains.

Israel has a dynamic, technologically advanced market economy, with a GDP of approximately US$200 billion¹. Over the past five years, GDP has grown by an average of five percent annually, while inflation has been near zero and the Israeli Shekel has remained stable versus the US Dollar². The Bank of Israel's interest rate is at a record low, at 0.5 percent, and is among the lowest in the world³. Raw materials (excluding diamonds and fuels), constitute 40 percent of total imports, while manufacturing (low-to-high technology products and services), constitutes 87 percent of total exports⁴. In addition, there are more Israeli-domiciled companies traded on NASDAQ (currently 63) than in any country outside the US⁵.

The country's entrepreneurial and competitive environment is underpinned by a number of cultural and social factors. Education is one of the key drivers with high numbers of science and engineering students graduating each year - Israel boasts a ratio of 135 scientists per 100,000 workers, the highest in the world6. Immigration is another contributing factor to Israel's growing entrepreneurial environment. After the collapse of the Soviet Union in the early 1990s, approximately one million Russian nationals emigrated from the former USSR and settled in Israel; having settled and integrated, they are contributing energy and innovation to many aspects of the economy.

In the 1990s, following the successful establishment of Yozma, one of Israel's first venture capital (VC) programs, nearly 100 VC firms have been established, using foreign and local investment capital, to help catapult the creation and expansion of a large number of high technology companies. Approximately US$9.4 billion of capital was invested from these sources between 1993 and 2000⁷, however it then began to decline by approximately 22 percent annually. In 2003 there were virtually no investments due to the collapse of high-tech stock markets world-wide and heightening tensions in the region.

In 2004, in place of the VC world, Israel's traditional private equity market was born, with the establishment of Markstone Capital, now Israel's largest private equity fund⁸. Much of the capital for such funds was raised internationally. However, investment activity in this sector took off after 2005, receiving in excess of US$2 billion, and has continued to remain stable through the end of 2008⁹. Until then, Israeli insurance companies and banks could only invest in domestic government bonds. When this restriction was removed, high levels of domestic capital began to flow into private equity as well, stimulated by investors' search for alternative asset classes and higher-yield opportunities.

In all, approximately US$4.2 billion of capital has been invested in Israeli private equity firms¹⁰. Markstone Capital, with nearly US$800 million of assets under management, is supported among others by the New York State retirement fund. Tene Capital was established to invest into Israel's kibbutzim (community cooperatives) and is supported by local financial institutions.

Typically, these Israeli private equity funds and others invest in 'old economy' assets such as mid-tech manufacturing companies, healthcare and service industries. Most investments in the last few years have been into Israeli family/kibbutz-run businesses. However, the continuing flow of capital into these funds together with a stable, even strengthening Shekel, is increasingly turning their attention outside the domestic market, and larger numbers of Israeli-led transactions in foreign markets are beginning to emerge. Between 2005 and 2009 Israeli corporate investment internationally was approximately US$39 billion; representing a 189 percent increase over the equivalent value for the period 2000-2004.

Israeli funds have made a number of significant investments in India, in sectors as diverse as real estate, telecoms, engineering and software. Two or three of the larger Israeli funds are said to be looking to invest in the US and Germany. While asset prices remain depressed, Israeli capital is increasingly looking to pick up stakes in sound, strong-yielding companies in stable markets.

Clearly, Israeli funds have the talent and experience to find promising targets and manage the resulting transactions. Where they perhaps need to gain more experience is in developing funding partnerships with local sources of finance and in forming investment partnerships. Once this begins to happen, Israeli private equity is likely to emerge as a significant player in the mid-market¹¹ international deals space.

Article author

Hillel Schuster
Principal, Corporate Finance
KPMG in Israel +972 3 684 8000 Hillel Schuster View all articles by this author

1. GDP per capita of US$27,350. Central Bureau of Statistics Israel, 2008.
2. 'Israel at 60: A statistical glimpse', Israel Ministry of Foreign Affairs, April 15, 2008.
3. 'The Bank of Israel reduces the interest rate for April 2009 by 25 basis points to 0.5 percent', Bank of Israel, March 23, 2009.
4. 'Israel's Balance of Manufacturing Exports and Imports, by Technological Intensity 2008', Central Bureau of Statistics Israel, July 22, 2009.
5. 'NASDAQ International Companies', http://www.nasdaq.com/, August 18, 2009.
6. 'Israel's Exceptional Workforce', Exceptional Workforce 2008, Invest in Israel, August 4, 2009.
7. 'Note on Private Equity in Israel', Tuck School of Business at Dartmouth, August 2, 2005.
8. Although it must be said that FIMI had existed previously.
9. 'PWC Private Equity Report', IVC-online, April 27, 2009.
10. Capital IQ, IVC-online.
11. Up to US$200 million.