An Exit Drought, or Has Israeli High-tech Matured?

Exits are just part of the picture, and their shrinking number could derive from an uptick in other criteria that reflect growth and maturity in the high-tech industry.

The Israeli flag hangs outside the New York Stock Exchange on Wall Street in New York December 1, 2014.
Reuters

The just-published 2016 PwC Israel High-Tech Exit Report (first in a series of summaries due out in the coming days) shows that exits have declined by nearly half compared to the previous year. This figure may sound alarming – but does it signify a crisis?

Before jumping to conclusions, it’s worth examining just what the exit milestone means to a company, and to the Israeli high-tech industry as a whole. It’s also important to look at how an exit is counted in such a report. Exits are just part of the picture, and their shrinking number could derive from an uptick in other indicators that reflect growth and maturity in the high-tech industry. Still, for the long-term, this trend needs to change.

Here are a few points worth keeping in mind when analyzing the data in the exits report:

1. A drought year for exits: In 2016, there was a decline in the number and size of exits, and no iconic deals that will go down in the Israeli high-tech history books (like the billion-dollar sale of Waze to Google in 2013). The biggest deal this year was the acquisition of Ravello Systems, founded by Benny Schneider and Rami Tamir, by Oracle. The average value of the 10 biggest deals of 2016 was $275 million.

2. What counts as an exit?: The deals listed in the survey, including two of the 10 largest, include some that do not meet the standard definition of the term “exit.” In popular jargon, the term generally refers to the first liquidity event in which stockholders in the company – including the founders, employees and venture capital investors – can realize their holdings. This can occur when the company is acquired by another company, or by an initial public offering (IPO) on the stock exchange.

But among the biggest deals listed of 2016 was Jerusalem company SintecMedia changing hands from private equity firm Riverwood Capital to private equity firm Francisco Partners. This deal created financial value for the investment fund, but was probably of no importance to the Israeli economy.

Another deal initially listed in the report was the acquisition of RR Media – which already had a first exit with its IPO (an exit that was counted at the time in the exit reports). After inquiries from journalists, this deal was removed from the report. In other words, the report includes all sales deals involving an Israeli company, even if this isn’t the first time the company is being sold or having an IPO, and even if there is no significant impact for Israelis.

3. It’s the same background noise every year: This same problem frequently recurs in exit surveys, as was the case in the last few years, with the questionable inclusion of some major deals in reports of this kind. One recent example was the $800 million merger of two public companies, Ezchip and Mellanox, which was included in the 2015 report. These deals tend to be large ones, and could significantly impact the annual exit figures.

4. In the broader picture – the industry is growing: This may be the most important and interesting point, and should be looked at over time. In the coming weeks, a variety of end-of-year reports will be coming out, looking at the industry’s situation in terms of exits, investments in startups, venture capital fund fundraising rounds, and workers’ compensation. Each one illuminates another aspect of the high-tech industry, and as a whole can give a broader picture of where the industry stands.

It can already be said that while there has been a decrease in exit activity, capital fundraising for high-tech companies is increasing. According to IVC, in the first three quarters of 2016, Israeli startups raised nearly $4 billion (up from $3.1 billion in the same period the year before, and $2.2 billion in 2014). The greatest growth was in rounds exceeding $20 million.

This means that a growing layer of companies are fueling their engines and readying for more growth. Many are companies that already have hundreds of millions of dollars in annual sales, employ more than 100 people (and often use the new rounds of capital to increase their number of employees) and generally make a wide contribution to the economy – often more than an exit deal in which an Israeli company changes hands without creating value for Israelis. Assuming there is no major shift in the fourth quarter of this year, there is no cause for worry about the industry’s growth.

5. Unicorn-hunting season is in full force: What we’re witnessing in Israeli high-tech mirrors the situation in American high-tech. The big companies that have flourished in the last few years have remained private – companies like Uber, Airbnb and WeWork – and achieved estimated valuations of many billions (even if yet to be included in any exit reports).

In Israel there are a handful of companies that could be termed “unicorns” – i.e., startups valued in excess of $1 billion, but at the same time Israel has an unprecedentedly large number of (relatively) mature tech companies that in the coming few years will likely be sold for major figures or go public.

6. The exits will come, eventually: Despite the optimism, if the trend in exit activity that we saw over the past year continues, it could create a problem for investors in the long-term. They will eventually need to realize their holdings and create dividends. Without the sales or IPOs of companies, the model won’t work.

Exit activity could be boosted in several ways. One is by opening a window of IPOs in the world, for example by creating a success story with the Snap (Snapchat) IPO. Anticipated changes in the U.S. tax laws once Donald Trump is in office could also affect decision-making in U.S. corporations, which make up a large proportion of buyers of Israeli startups.

Bear in mind that the generation of companies now reaching an exit came into being, more or less, during the time of the 2008 crisis. This connection with the crisis generation could also be influencing the current exit situation, eight years later.

7. Israeli companies have forgotten about Wall Street: In 2016, there wasn’t a single major IPO of an Israeli tech company (There were two relatively small IPOs, in Tel Aviv and London). Although there have been a number of Israeli success stories on the New York Stock Exchange in the last few years, including the IPOs of Mobileye and Cyberark, current market conditions are not attracting Israeli companies to there. The expanding number of growing Israeli companies that aren’t yet ready for a Wall Street IPO could present an interesting opportunity for the Israeli stock exchange, which currently is not part of the map of opportunities that Israeli tech companies look to. This situation is also not unique to Israeli tech companies. A similar trend can be seen among American tech companies, where the rate of IPOs has also declined.

8. Bottom line: The decline in the number and size of exits could attest to a maturing of the industry and growth of more firmly established companies – which in the future we will see reach IPOs or be sold for significant sums. The decline in exit activity and growth of independent companies are part of a worldwide trend in the growth of private companies that attain major valuations outside of the public market. An exit needn’t be an end unto itself, certainly not on the economy-wide level. A better goal is building sustainable business activity, creating jobs and contributing to exports.