Private equity takes its place in Israel

Ira Moskowitz presents an overview of Israel’s private equity industry along with the viewpoints of leading private equity fund managers on how the industry is developing.

Private equity is a broad term used to describe a range of investment models. In general, private equity funds focus on investment in mature companies with a history of sales and earnings. As one fund manager succinctly explains, “Venture capital funds invest in ideas and try to nurture them into real companies. Private equity funds buy real companies.” Private equity investments offer lower potential returns than venture capital investments, but also entail lower risk for its largely institutional investors.

Partly because of the higher risks often associated with technology companies, private equity investments tend to focus on traditional industries rather than on new economy enterprises. Private equity funds also generally seek either control or extremely substantial holdings in companies, while venture capital funds inject smaller amounts of money and are usually not interested in acquiring actual control over a company. Latecomer to Israel

“Private equity is just in its infancy in Israel,” declares one local expert, and partly attributes this to the fact that Israel’s public market is relatively hyperactive. That is, Israeli enterprises are quicker to opt for public offerings in situations that would be considered more appropriate for private equity in other markets. Israeli high-tech enterprises have often gone public by the time they have reached the level of maturity typical of private equity investment.

Yadin Kaufmann, a co-founder of Veritas Venture Partners, suggests that one of the reasons private equity funds were slow to develop in Israel is that “these funds tend to target traditional industries, while most of the more interesting investment activity in Israel – and virtually all the attention of foreign money – was focused on the high-tech sector.”

On the other hand, the development of the private equity market in Israel may have received a boost from the high-tech slump of 2000-2001.

“People started looking at other ways to put money to work here,” adds Kaufmann. “Private equity deals have actually been around for a long time in Israel, but were previously conducted through Israel’s major holding companies rather than via dedicated funds,” explains Roy Machnes, the managing partner of Israeli fund FITE (First Israel Turnaround Enterprise). “The Koors, Clals and IDBs of the world invested equity in other companies and really operated as private equity resources,” maintains Machnes.

But Machnes also notes how private equity funds are substantially different than holding companies: “Holding companies take a different view of the world. Private equity has an expiration date, while holding companies do not. Private equity comes into these companies with the goal of bettering the asset and turning it over. Holding companies have various options – they can hold it forever, merge it with other assets, and so on.”

Another fund manager attributes the development of the Israeli private equity market to the fact that Israeli holding companies and other sources of local financing (that is, the government and major banks) receded in the early 2000s as a result of the global economic slump and regional political developments. “When the world went south,” he explains, “government turned to privatize aggressively and families either crumbled or went overseas, while banks were forced by regulators to get out of real investments.” The result, Machnes says, was a more balanced Israeli economy: “All of a sudden you had room for a fourth leg, an institutional leg, which is commonplace in every developed economy.”

FIMI

Ishay Davidi founded the first private equity fund in Israel, FIMI (First Israel Mezzanine Investors), nearly ten years ago. He has no ready explanation why such funds did not develop earlier. “We assessed that there was an interesting and important market for investing in non-VC, mid-sized and larger companies, where no one was – so we entered it,” he explains. FIMI, which specializes in buyouts and mezzanine financing, has so far invested $650 million in a diversified portfolio of 37 plastics, defense, communications, software, and food companies, and has made 16 exits. Davidi cites the following investment criteria for FIMI: “Sales of over $50 million, a stable balance sheet, strong management, a horizon for foreign markets, and growth potential.” At the end of 2005, FIMI closed on its latest fund, the $350 million FIMI Opportunities II. This leveraged fund will invest about $700 million over the next three to four years, according to Davidi, and has recently made its initial investment.

FITE

Davidi is also one of the three partners of FITE (First Israeli Turnaround Investors), a turnaround investment fund that began operating in 2004. It was created as a separate entity from FIMI because it entails “a different type of thinking,” Davidi explains. FITE has raised $130 million from institutional investors – about 55 percent from Israel and 45 percent from the United States. The fund has invested so far in four old economy companies, including those manufacturing copper wire and plastics, with the goal of achieving exits within three to four years.

FITE’s Machnes, explains the fund’s strategy: “We seek investments in companies that are in distressed situations, which means a weak balance sheet, cash flow issues, and so on. We look at companies that have revenues of at least $20 million, so that there is actually a business and a model that has been established. We’ll come in and buy control or close to control. We’ll institute a turnaround plan, stay very close to it, implement it and then seek to sell at a profit.”

Maches distinguishes this niche of the private equity market from the sector that does leveraged buyouts, management buyouts and mezzanine investments, “which usually requires real and often strong balance sheets and healthy cash flow to service the debt associated with these transactions.” He also notes that turnaround investments entail a higher risk than other private equity investments, but have generated better returns in recent years in world markets, particularly in the United States.

Markstone

Markstone Capital, which began operating about three years ago, is the largest Israeli private equity fund. It raised $800 million and committed about 40 percent to major investments including the Netafim drip irrigation company and the Steimatzky bookstore and publishing company. Markstone is a buyout fund that acts as a bridge between institutional sources in United States and the Israeli old economy. Investors include the employee pension funds of the states of New York and California. The fund’s buyout model of active investment ranges from 100 percent ownership to a protective minority and participation in a company’s control group. Markstone plans a 10-12 year turnover cycle for its fund.

Apax

Apax Partners is one of the world’s leading private equity investment groups, with about $20 billion under management. The Israeli branch of Apax was inaugurated in 1994 and has invested about $450 million in 40 companies. Most of this investment has been directed to venture capital, with the prominent exception of Apax’s acquisition of Bezeq. Apax has decided to shift the focus of its operations in Israel from start-ups to large and established enterprises, thus aligning it with the group’s core business abroad. Apax Israel also has a new CEO, Dr. Zehavit Joseph-Cohen, former CFO and executive vice president at IDB Holding Corporation.

Rothschild

Edmond de Rothschild Venture Capital Management (RVCM), established in 1999, is responsible for the private equity activities of the LCF Rothschild Group in Israel. The LCF Rothschild Group, with headquarters in France and Switzerland, is one of Europe’s leading private investment houses. It has some €80 billion under management.

To date, RVCM has pursued a dual focus, operating both a seed venture capital fund for early stage technology companies and a late stage private equity fund for more mature, mid-sized enterprises. Each of these funds has approximately $40 million under management.

RVCM’s president and chief executive, Joel Warschawski, says the company is strongly increasing its focus on the private equity side and, accordingly, is planning to change its name to Edmond de Rothschild Private Equity Management. “Private equity – that’s where our new funds are going to be developed,” he explains. “That’s the direction the market should go and will go, though I don’t think it is doing that yet.” Warschawski notes that until recent years, there were very few large Israeli companies. “But this has changed, and Israel has been able to develop billion dollar companies. There are a lot of $20 million to $50 million businesses that need to go to the next step; and if we can move them from $30 million to $60-$100 million by financing a strong growth plan oriented towards increasing international activities, then they become very attractive for acquisition by large companies, holding companies and especially buyout funds,” he says.

“There are a lot of large buyout funds in Europe looking for good opportunities, and with our strong European orientation, we hope to be one of the sources of deal flow for them.”

Private equity investment in Israel is gaining more attention, Warschawski adds, “because the world market is now looking at Israel as an economy, and not only as a reservoir of ideas.”

This article appeared in the Israel Venture Capital & Private Equity Journal (IVCJ). IVC Research Center publishes the Israel Venture Capital & Private Equity Journal, a quarterly review of trends and developments in the Israeli-related venture capital industry. IVCJ, distributed worldwide, is dedicated to provide wide-range coverage of Israel's venture capital industry. For more information please visit www.ivc-online.com