updated on 25 July 2017
QuestionHow are innovation and technological advancements making Israel such an attractive environment for M&A?
Dubbed the "startup nation," Israel is an epicenter of innovation. It boasts more venture capital firms and startups on a per capita basis than any other country in the world. In tech terms, it is second only to Silicon Valley.
Much of this is borne of necessity, with a large portion of government R&D spending dedicated to technology relating to defense and national security. But many of these technologies have been adapted for the commercial sector, opening the door for ample M&A opportunities.
Yet many Israeli startups struggle to gain scale. Few unicorns (private companies with $1 billion-plus valuations) originate from Israel, and only one of the 500 largest global companies, Teva Pharmaceutical, is Israeli. Will this continue to be the case? And does M&A offer a way for Israeli innovators to achieve greater scale?
To get a clearer sense of the forces shaping M&A in Israel, White & Case worked with Mergermarket to survey 66 senior-level executives at Israeli companies and PE firms. That provided a qualitative and quantitative basis for assessing dealmaker sentiment, which we analyzed along with data on current M&A activity. This article offers a perspective on Israel M&A, including views on which sectors are likely to be in demand, how deal activity may evolve and where investment opportunities may emerge in the future.
Key takeaways include:
While Israel's technological prowess has attracted inbound interest for years, domestic limitations are now prompting some Israeli firms to search for scale abroad.
Israel's rich entrepreneurial ecosystem makes it a prime target for M&A. In 2016, there were 99 M&A deals with an Israeli target, worth a total of $20 billion, a record in value terms and a joint-record by volume, tying with 2015. Indeed, total annual inbound deal values in 2016 were more than double those of any previous year going back to 2007.
This momentum continued into 2017, with 19 deals worth a total of $15.3 billion in Q1. Most of this value can be attributed to the largest deal of the period: Intel's $14.7 billion acquisition of Mobileye, a developer of advanced driver assistance systems and autonomous driving. This means that, in one quarter, the market already reached the second-highest annual value on record (following 2016), with three quarters left to run.
The Mobileye deal, which falls under the industrials and chemicals category of deal activity, pushed that sector to the top of the value charts, with 25 deals worth $21.9 billion through 2016 and the first quarter of 2017. But in terms of volume, TMT was the clear winner: the sector notched 45 deals worth $7 billion during that same period.
It's worth noting that the Mobileye deal could quite easily have qualified for the TMT category, as emerging technologies and the solutions they provide are adopted by adjacent industries.
This trend toward convergence is particularly evident in the automotive sector served by Mobileye, where manufacturers rely heavily on technology to enable autonomous vehicles, connectivity, advanced safety systems and high efficiency. We expect to see more cross-sector deals underpinned by technology in Israel in the future.
As the head of business development at one company says, while fintech, foodtech and automotive are attracting the most attention at the moment, "automotive is the most appealing because the industry is in transition worldwide. Manufacturers are looking to add technological innovation to their vehicles, with many companies in Israel pursuing this strategy aggressively."
On the inbound side, the top bidder through 2016 and the first quarter of 2017 was the United States, with 37 deals worth $17.1 billion. In second place was China, with 10 deals worth $10.9 billion.
The United States and Israel, in particular, have strong ties, with the former showing robust diplomatic and economic support for the latter, but savvy Chinese and US investors know that, in terms of technology, Israel remains one of the best markets in the world for innovative thinking.
Israel may boast more startups per capita than any other nation, but with a population of only 8.4 million, about the same as New York City, the scope for domestic growth, through M&A or otherwise, is relatively narrow. Outbound acquisitions offer inroads to foreign markets and opportunities for scalability.
In 2016, there were 25 outbound M&A deals with an Israeli bidder, worth a total of $2.2 billion, down from 42 deals worth $47.8 billion in 2015. However, 2015 was an outlier, with values inflated by Teva Pharmaceutical Industries' $39.6 billion acquisition of the US generics business of Allergan.
The eight-year mean average of outbound M&A by Israeli firms between 2009 and 2016 (excluding Teva-Allergan) was 27 deals worth $3.8 billion. This suggests that 2016 volume was average, although value was low. Global markets were highly volatile at the beginning of 2016, which is likely to have hampered activity.
Through 2016 and into the first quarter of 2017, the top outbound market was the United States, with 17 deals worth $2.1 billion, followed by the United Kingdom, with five deals worth $1.1 billion. The latter claimed the largest deal of the period—the $1.1 billion purchase of Ithaca Energy by Delek Group in February 2017, which saw the firm secure a foothold in the North Sea.
In terms of industry, the majority of the largest 10 deals were accounted for by the software sector, including the second-largest deal of the 15-month period, the $940 million acquisition of US-based on-demand contact-handling application services firm InContact by NICE.
Activity has also been strong in the lower end of the market, as Israeli companies pursue scale through acquisitions. In a bid to expand its product offerings, for example, CyberArk purchased US-based Conjur for $42 million in May 2017. Flavour and fragrance company Frutarom has been highly acquisitive over the past five years, with multiple small and mid-market outbound deals each year, purchasing French flavour producer René Laurent and South Africa based Unique Flavors in Q1 2017 alone.
Despite a relatively subdued year in 2016, the outlook for outbound deals in 2017 holds promise. In Q1 2017, there were 15 outbound transactions worth $1.9 billion, closing in on the previous year's stats with nine months still to go.
Israel's deep talent pool in data science enables it to excel in a range of rapidly growing fields. Demand for tech assets are driving Israel's M&A market, with cybersecurity firms gathering pace.
According to Israel's National Cyber Bureau, the country accounted for approximately 20% of the world's new investment in cybersecurity in 2015, making it second only to the United States. Israel owes most of its cybersecurity expertise to its advanced military: its computing division, Unit 8200, releases thousands of veterans equipped with world-class hacking skills every year, many of whom launch startup ventures or join existing companies.
"Cybersecurity has become a major concern, and many new companies are coming to market to address it. The pace at which these companies are developing shows a lot of promise for growth," says the chief corporate strategy and development officer of a media company.
This mirrors respondent views: While 69% cite tech and media as the most appealing sector for acquirers of Israeli companies, cybersecurity is rated as the hottest tech sub-sector, with 67% ranking it in their top three.
Israel's deep talent pool in data science enables it to excel in a range of rapidly growing fields—including fintech, a sub-sector that was ranked as the most attractive in tech by 46% of respondents.
According to The Floor, a startup hub in Tel Aviv, at least 430 Israeli fintech companies are developing products for needs ranging from digital banking to fundraising. This includes cross-border payments company Payoneer, which completed a $180 million equity financing round in October 2016; online crowd-investing platform OurCrowd; and Lemonade, an online mobile platform that uses machine learning to deliver homeowners' and renters' insurance to New Yorkers, and which raised $34 million in December 2016.
“Israeli technology companies are known to have superior innovation capabilities due to the significant intelligence they possess in this field. There are significant opportunities to invest in startups, while established players are looking to expand and diversify their product and service offerings," says the CEO of an industrial company.
Companies in Israel are enthusiastic about the future of deal-making in the country, supported by government initiatives and strong interest from global investors.
The outlook for the Israeli M&A market remains resolutely positive. Over the next 12 months, more than a third of respondents expect to be involved in more M&A deals than they have been in the previous 12 months. Half of respondents expect activity to remain constant.
More than half (53% ) of respondents expect to see an increase in competition for Israeli assets over the next year, and only 6% anticipate a decrease, with activity fueled by demand for tech and tech-related targets. This reflects wider trends: computer and software stocks have increased to more than one-fifth of the S&P 500 index's value, with half of the top 10 highest valued companies today being tech stocks.
The government is doing its part to encourage and support this activity. For example, the Israel Innovation Authority launched an Innovation Visa program at the end of 2016. This will allow entrepreneurs to reside in Israel for 24 months while receiving help from the Authority's Tnufa program, which supports entrepreneurs at the pre-seed stage. The initiative is a strong signal that Israel is open for business.
"Companies are demanding Israeli assets like never before, with the government making the region stable and companies growing at a fast pace," says the partner of a private equity firm.
China has taken a particular interest in Israel. Examples of significant deals include the acquisition of Israeli games company Playtika by a Chinese consortium for $4.5 billion, announced in July 2016; ChemChina's $1.4 billion takeover of Adama, a manufacturer of crop protection products, announced in the same month; and the purchase of Israel's largest dairy, Tnuva, by China's Bright Food for $2.1 billion, announced in July 2015.
Chinese buyers are often interested in accelerating promising technology that is developed by Israeli firms, who benefit from gaining access to China's vast market. The Tnuva deal is a prime example of this dynamic. China's Bright Foods gains access to foodtech that significantly increases the volume of milk produced per cow, and Tnuva gains access to the rapidly growing consumer milk market in China. Eighty-one percent of respondents say they expect an increase in the number of Chinese entities bidding on Israeli companies in the future; just 8% expect a decrease.
"In their bid to acquire new technologies and business opportunities, Chinese companies will continue expanding into the Israeli market," says one corporate director of mergers and acquisitions.
Israel may be a hive of M&A opportunity, but investors recognise that the country still presents challenges for dealmakers. The country's regulatory landscape is complex and can be a hindrance to foreign buyers unfamiliar with the terrain. But within that complexity lies the potential for growth.
Government measures are expected to add to deal flow in Israel, despite the fact that 47% of respondents believe the regulatory environment in Israel is more difficult to navigate than in other developed economies; only 13% believe it is easier to navigate.
In the late 2000s, about 20 major business groups controlled approximately half of the market capitalisation traded on the Tel Aviv Stock Exchange. These businesses tended to be family-controlled and highly diversified.
Observers began to worry that the high levels of concentration in the Israeli market presented potential system risk for the country. Concern erupted into protests in 2011, prompting the government to analyse concentration levels, which resulted in the Law for the Promotion of Competition and Reduction of Concentration being passed in 2013.
The implementation of the "Concentration Law" will turn many Israeli holding companies into sellers. It will restrict the use of multi-tiered corporate holdings structures—so-called "pyramids", where a control group owns multiple layers of publicly traded companies.
Existing structures will have four years to divest to three levels of public companies and six years to divest to two levels. These anticipated divestitures could be a golden opportunity for private equity buyers.
In addition, the Competition Law will prevent joint ownership of financial and non-financial businesses. Current joint owners will be given six years to divert one type of asset.
In early 2017, the Israeli parliament passed the "Strum Law", requiring Israel's two largest banks, Bank Leumi and Bank Hapoalim, to divest their credit card businesses, Leumi Card and Isracard, respectively. Under the law, other Israeli financial institutions will be prevented from acquiring them. This will leave the field open for other buyers.
But challenges still remain: The Israel Antitrust Authority has been imposing increasingly larger fines on companies that do not comply with its rulings. In at least one case, the Authority ordered a custodial sentence for officers that violated its rulings.
"Legal problems are growing," says a partner at a PE firm. "The government has changed a few regulations that have made the market stricter. Antitrust enforcement activities have also increased and a few regulations have restricted the growth of companies to avoid market monopolies. Securing finance will also be problematic and this will have an impact on growth."
Global economic volatility is seen as the biggest challenge to deal-making over the next 12 months, with 76% of respondents citing it as one of their top-three challenges. The CEO of one company notes that it is not just economic turbulence, but policy trends in the two biggest inbound acquirers, the United States and China, which may dampen deal-making.
Other major challenges that rank highly include agreeing on valuations and regional instability. As a partner at one PE firm points out: "Regional instability has deterred investors in the past. If this persists or escalates, companies will not invest in the market. Reaching agreements and carrying them out can be difficult. Due diligence processes have suffered in the past and this has affected deal-making activity."
Israel's innovative drive will continue to create ample M&A opportunities for investors looking for growth opportunities within the country. To profit from these opportunities, investors must learn to navigate challenges within the country's complex regulatory environment.
Based on our survey, we have identified three trends that are set to influence M&A activity over the next 12 months:
David Becker and Colin Diamond are partners at White & Case. David Becker is based at the firm’s London office and Colin Becker is based at the firm’s office in New York.