Big Business Swarms for Israeli Start-ups, but Has the Interest Peaked?

As technology moves from application to content, the weakness of Israeli entrepreneurs is that they don't get the American consumer, warns an expert.

Wanova, an Israeli company that develops desktop computer virtualization technology, was sold this month for roughly $100 million. The buyer, the multinational company VMware, is a subsidiary of American storage giant EMC. That in turn recently acquired Israel's XtremIO, a maker of flash-based organizational systems, for about $45 million.

That same week, Black & Decker spent $240 million to purchase AeroScout, another Israeli company that develops WiFi ID tags for monitoring people and equipment over the Internet.

In Israel, where forming a start-up has become a national aspiration, the string of recent acquisitions is nothing exceptional. After a dry spell of a few years, Israel is again a hub for international investor interest.

According to the IVC Research Center, no fewer than 85 Israeli high-tech companies were acquired in 2011 alone, for a combined $5.2 billion. In 2010 only 67 companies were sold for a total of $2 billion.

Also, the biggest five acquisitions in 2011 each topped $300 million. One deal – the acquisition of the online advertising company MediaMind – hit the $500-million mark.

The total value of these transactions is the highest since 2006, which was considered the best year for Israeli high-tech in the last decade, with transactions amounting to roughly $10 billion.

"There was a big wave of sales in 2006-2007, but with the 2008 crisis came uncertainty, which paralyzed buyers and sellers. The market only started recovering in 2010, and that's a trend that continued into 2011 and 2012," says Moti Weiss, an associate and founder of Plenus, a Viola Group venture lending fund. Viola has invested in 23 Israeli start-ups in the last decade.

Madly morphing technologies

But there are few similarities with the boom of technology exits (selling the company) during the bubble era at the start of the millennium. Some say that the exit trend of 2012 marks a whole new development in the local start-up industry.

Koby Simana, CEO of IVC, feels the surge of transactions in 2011 was a no-brainer. The tech scene ground to a halt with the advent of the global crisis that started in late 2008 and as uncertainties waned (albeit not for long…) there was a surge. "The big technology companies have tons of money and nothing to do with it except buy new technologies," Simana says.

He believes that every company has its own glass ceiling of expansion, and for many, the best and most profitable option is to be sold. "In Israel there are lots of good, mature companies," he says. "Not every company can afford to be a gorilla. Some need to be sold, and that's the most common thing today."

In today's cut-throat, fast-moving world, behemoths like Broadcom, Google and Microsoft have to be nimble; they have to buy technologies to stay ahead of the game. Also, technologies morph overnight.

"That's why exits have to be quick. Since development takes ages, it's easiest to look around and purchase new companies and technologies [rather than develop them]. When you think about it that way, Israel is the world's second Silicon Valley. The number of companies and technologies developed in Israel is higher than in European countries, if not in all of Europe combined."

"A new species of entrepreneurs"

The most obvious spike in investments is in Internet companies, yes, the very sector responsible for the great bubble.

In 2011, Internet companies got 23 percent of total start-up investment. Contrast that with 15 percent in 2007 and 4 percent in 2002.

In short, last year Internet companies got more than telecommunications (20 percent), software (19 percent), natural sciences (18 percent) and semiconductors (7 percent).

Kissin' cousins

Ever since that fateful day when the Internet invaded our private cellphones and turned us all into potential investors, attention and resources have been diverted towards improving the user experiences. "New media" is the flavor of the day.

Content and commerce are close cousins, and their tight relationship started to really matter after the smartphone swept into our lives. While academia has yet to sink its teeth into this phenomenon, technology is miles ahead.

"In the world of New Media, entrance barriers are constantly coming down. Today you could run a start-up with one person in Israel, one in India, and one in America," says Oren Raviv, a senior analyst at IDC, a consultancy and technological research group. "You can hire freelancers. You don't need a lot of time or money just to see if something works. There are tools and professionals that can provide immediate feedback at very low costs."

How big is New Media? Look at it this way. There are currently 6 billion cellphones in use around the world today.

To understand that number, consider that only 5 billion people have access to running water and electricity.

Here's another kicky stat: Smartphone users have 650,000 apps at their fingertips.

"The cellular world is full of opportunities, and dozens of entrepreneurs come to see us every week," says Rona Ben-David, CEO at OnTheMob, which creates strategies for large cellphone brands. OnTheMob also offers investment and guidance to entrepreneurs seeking profit from Internet products.

"Once, to open a company, you needed tens of millions of dollars just for the first phase and five times more than that for the second phase," she says. "Now the technological threshold is very low, and only takes a few dollars to make an app. Some apps cost a few thousand dollars and others can be created for less than $100. This brings all sorts of new people to the market. There are folks from the diamond industry or from real estate. They put money down for some kid to develop their ideas, and usually they're not really involved. This is a new sort of entrepreneur."

While development is easier, marketing has become a huge headache, says Ben-David. "Venture capitalists can take advantage of this situation to maximize potential and minimize risk. They send fledgling entrepreneurs to angel investors [who typically invest in very early stages of a concept] and only come in when a significant number of users has been achieved. What's important isn't the idea, but how you make money off the product. It's very important to be focused. The one who gets the users is then positioned to get the big names to buy him out. In this field, the question is always 'who can buy me out?'"

One upshot is that exits today typically take longer, says Zohar Levkovitz, founder of Amobee. "It used to take four years. Now it takes seven. And we're not just talking about Israel – this is happening in California, too."

Apple has more money than the State of Israel

Levkovitz knows whereof he speaks. Last year, Amobee was purchased by Singapore Telecom (SingTel) for $340 million. So why are we seeing a tidal wave of Israeli exits?

"Because multinationals have accumulated a ton of money," Levkovitz explains. "Apple has more money in the vault than the entire state of Israel. Microsoft has $50 billion, and even RIM, the producer of Blackberry, has $20 billion."

According to Levkovitz, the recent series of exits are just an adjustment after a 3-year hiatus. "The fact that the big companies didn't buy out start-ups in middle phases for $100 million allowed bigger companies to develop. So by nature the scale of the transactions becomes bigger," he says.

Meanwhile, the nature of the beast is changing. "Interest in innovative technology is waning. People are going to the content world, where consumption is constantly rising. It actually scares me because Israelis were always very strong in terms of technology, and now technology is less relevant. Marketing is king."

The Israeli weakness, Levkovitz says, is that they don't understand the American consumer.

"I've seen more than a few Israeli companies that developed solid apps but failed in comparison with American companies that invested their first million in marketing, getting to the right exhibitions and the App Store. That's why lots of Israeli start-up guys rent an apartment in San Francisco even before they raise a single dollar."

Israel, where it's okay to fail

Broadcom, which manufactures networking and communications ICs for data, voice and video applications, has become one of the leading purchasers of Israeli start-ups. Today, 10 of its 50 subsidiaries are Israeli. It bought nine of them in the last decade alone, five in the last year and a half.

"It's not that we suddenly decided to buy a company in Israel. Broadcom has to constantly be at the cutting edge of technology, and so we so look ahead and find the places where there are the best teams and best technology," says Shlomo Markel, Broadcom VP. "The attitude [in Israel] is that if you try and didn't succeed – it's okay, try again. In places like Japan for example, it's shameful to fail or to make mistakes."

The Israeli high-tech industry now revolves around a second generation of entrepreneurs, who have by and large shed, at least in part, the arrogance and hastiness of its pre-bubble days. The first generation, now in the role of investors and mentors, offers guidance and advice.

"We used to just spend money like it was water," says Ofer Shoshan, serial entrepreneur and CEO of the translation service OneHourTranslation. "We'd hire expensive engineers, sit in fancy offices with fridges stocked with goodies and company cars to drive us around. In some companies that is still the case, but mostly we're more humble now. Businesses run like they should."