Unrest in Israel’s High-Tech Industry
Last year, the red-hot high-tech sector handed Israel its most prosperous year in recent memory and helped turn it into one of the great economic success stories of the decade.
What a difference a year makes. Israel’s high-tech leaders are girding for leaner times, citing a free fall in technology-heavy Nasdaq stocks, uncertainty over the recent election of hawkish Likud Party leader Ariel Sharon as prime minister and, worst of all, violence in the Palestinian territories.
For months, executives of high-tech companies have insisted that their businesses were more affected by Nasdaq than by Nablus, a reference to a militant Palestinian town in the West Bank. Now they are slowly acknowledging that the 5-month-old intifada, or uprising, is beginning to take some toll on the economic climate inside Israel.
The inflow of foreign venture capital is slowing. Dun & Bradstreet, which sells financial data on millions of businesses worldwide, recently downgraded Israel’s impressive credit rating a notch, citing the heightened political unrest.
And only this week, the Finance Ministry said the escalating violence in the Palestinian territories--along with the U.S. economic slowdown--was responsible for its slashing 2001 growth estimates from nearly 6% to between 2% to 3%.
Many international investors, who during the 1990s flocked to Israel to grab a piece of its Internet-driven economy, are staying away because of a U.S. State Department advisory warning travelers to avoid the strife-torn nation. An Israeli venture capital firm promoting high-tech businesses recently hosted a conference in Amsterdam because clients were reluctant to visit Israel.
Increasingly, international customers are worried that the unrest could affect their ability to get Israeli goods.
“People are asking: What will happen to our businesses if you can’t make or deliver your product because of all the trouble that is going on?” said Chemi Peres, managing director of Polaris Venture Capital, Israel’s most successful venture fund. “They are seeing us through a CNN window, when many of us know that’s not the reality.”
Peres was referring to international media coverage of the intifada, which so far has claimed the lives of about 400 people, most of them Palestinians.
Some high-tech executives worry that their lot could worsen if Sharon, a retired army general who is reviled in the Arab world, appears inflexible in dealing with the Palestinians.
“Israel faces critical times,” said Augusto Lopez-Claros, a senior economist with Lehman Bros. in London who tracks the Israeli economy. “Clearly the main risks in 2001 are political.”
Mindful of the stakes, high-tech industry leaders are trying to exert some influence on the political situation. Some recently paid for a newspaper ad calling on Sharon and his rivals in the center-left Labor Party to put aside differences and form a coalition government--a move that Labor agreed to this week.
Top executives of high-tech companies also joined other industrialists who held a series of meetings with the prime minister-elect, lecturing him about the need for national and regional stability.
Sharon, who is more familiar with tanks than tech, is paying heed--for now. Since defeating Prime Minister Ehud Barak in the Feb. 6 election, he has been taking private lessons in economics from former Bank of Israel Gov. Yaacov Frenkel.
Stopping a Tech Brain Drain
Like any good student, he told the top-selling Yediot Aharonot newspaper that he’s filled his notebook. “There are many things in economics which I still don’t know,” he said.
But one of his first tasks as prime minister, Sharon promised, would be to “implement tax laws that stop high-tech companies and brains from leaving the country.”
High-technology executives have long complained that the country’s antiquated tax laws were causing the majority of Israeli start-ups to incorporate in Delaware and other tax-friendly havens. If Israel’s capital gains taxes were reformed, they say, many of those companies would stay at home.
Raanan Gissin, Sharon’s spokesman, said the prime minister-elect believes that a unity government is the first step toward projecting stability, luring back investors and maintaining a high credit rating.
“Mr. Sharon is making all the right noises,” said Yossi Vardi, a venture capitalist who invests mainly in high-tech companies.
But “the big question is what kind of approach Sharon will take to the Israeli-Palestinian problem,” said Peres of Polaris, which manages a $500-million portfolio.
“We only hope the peace process will continue,” said Peres, the son of former Prime Minister Shimon Peres. The elder Peres is expected to serve as foreign affairs minister in Sharon’s government.
Though some business leaders worry that Sharon’s reputation as a coldhearted warrior could hurt him, others are betting that Sharon will soften his hard-line policies toward the Palestinians.
“The peace process is irreversible,” said Yaacov Sheinin, head of Economic Models, a business consulting firm in Tel Aviv. “Sharon is not an idiot. That’s why he wants to make Peres the foreign minister--to bridge the gap with the Palestinians.”
Others say they have merely lowered their expectations.
“Sharon will not bring us war, just like Barak did not bring us peace,” said Ami Erel, head of the Israel Assn. of Electronics & Information Industries, a trade group representing top high-tech companies.
Analysts say the peace process has been as important as venture capital to the high-tech economy. About $7 billion in foreign capital poured into the country after Israeli and Palestinian leaders signed the Oslo peace accords in 1993, which laid out a timetable for the peace process.
The new money turned Israel into the third-largest incubator of start-ups in the world, with local inventors churning out some of the top software programs.
Three of the programs pioneered by Vardi, for example, are among the five most-used products on the Internet. Vardi became a symbol of Israel’s high-tech success in 1998 when America Online paid $407 million for his company, Mirabilis Ltd., the marketer of ICQ, an instant-messaging technology.
Last year, the high-tech sector propelled the Israeli economy into its best year in recent memory. Software, electronics and other high-tech goods accounted for half of all industrial exports, totaling $9.2 billion--a 58% increase compared with 1999.
Gross domestic product doubled from 1999 to a growth rate of 6%, the Israeli shekel was stable, and inflation was held to zero during some periods of the year.
But not all was rosy.
The eruption in late September of the second Palestinian intifada came as high-tech businesses were absorbing other body blows from the Nasdaq market. Many Israeli companies saw their market valuations decline by tens of millions of dollars.
One measure, the Goldman Sachs Israel Technology Index, which comprises the stocks of 34 local high-tech companies, plunged to a 52-week low of 147.47 on Jan. 8 from its high of 407.65 on March 10. The index closed Thursday at 148.76, down 13.8% year to date.
Government officials estimate that the economy has lost a little more than $1 billion--about 1% of the gross domestic product--as a result of the intifada. A large chunk of those losses was recorded in the tourism industry, which virtually collapsed as tourists deserted hotels and historic sites. The once-robust construction industry also crumbled as the army’s blockade of Palestinian towns and villages prevented construction workers from getting to work.
To Some, Unrest Is Business as Usual
Analysts are not optimistic that the high-tech sector, which accounts for 10% of the Israeli economy, will compensate for the losses in tourism and construction. Investment in high-tech companies is expected to decline by about 20% this year. Like their cousins in Silicon Valley, some of the smaller high-tech firms are starting to disappear, a trend that is expected to continue.
Itamar Rabinovich, president of Tel Aviv University and a former ambassador to the United States, said the high-tech industry could face more challenges under Sharon.
“Consumers and businesses needing our high-tech goods will continue to buy them, but whether [new] business will come and other [investment] money will come is another question,” he said.
To be sure, some investors are still sending their money to Israel even though they’re avoiding trips to check out their investments.
David Helfrich, a partner at Comventures in Palo Alto, which maintains several Israeli companies in its portfolio, said he will continue to invest in Israel because it still boasts “some of the greatest entrepreneurial and technical minds.”
“The travel advisory and turmoil in the country are an obstacle,” he said, “but there are things that can be done as the conflict flares up to mitigate some of the risks, such as holding board meetings in North America and Europe.”
Erel, the trade group leader, said investors who know Israel realize that political unrest here is a way of life.
“In terms of stability, we’ve never been Switzerland,” he said.
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Israeli Slowdown
Israel’s technology-driven economy, coming off its best year in recent memory, is slowing abruptly as new Middle East violence and the global tech downturn depress the country’s prospects. Recent and projected growth in gross domestic product:
2001 estimate: 2.5%
Researched by NONA YATES / Los Angeles Times
Source: Bank of Israel
