Merged Israeli Investment Houses Vow New Investment Style

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On a winter evening in 2011, Zvi and Avner Stepak were sitting in the lobby of Washington's Westin Hotel. The father and son, who were in the United States to celebrate a birth in the family, were discussing the future of the investment house they control.

Meitav was one of the bigger and most influential players in the capital market after a series of mergers and acquisitions that had increased its assets under management dramatically. Still, the Stepaks analyzed the situation and concluded that to stay alive the firm had to grow even more – all at once.

They agreed they could no longer grow via small acquisitions; they needed to merge with a mid-sized investment house. They mapped out the Israeli financial services industry and after returning to Israel, Avner Stepak put in a call to Eli Barkat, controlling shareholder of DS Apex. He set up a first meeting to discuss a prospective tie-up.

For Barkat, the time was also ripe for merger talks. "The fact that we needed to grow in a nonorganic fashion was clear to us when we first entered the capital markets three years ago," he said in a joint interview with his son following the merger that resulted last week from that first phone call.

"Joining up with Meitav seemed to me a good choice, and when I met with Zvi – a man with a lot more experience than me in investing and a doer – it was clear to me that this partnership had to happen."

After sealing a few initial understandings, the two controlling shareholders quietly brought their CEOs – Ido Neuberger from DS Apex and Ilan Raviv from Meitav – into the talks. "In the first stage, Ido told me it wasn't a good deal," recalls Barkat. "But after investigating the matter over three days he changed his mind."

Last week, after a year facing bureaucratic and regulatory obstacles, the merger was completed as a share swap between Stepak and Barkat. Each was left with a 28.6% stake. To make that possible, Stepak bought out shares controlled by Gaon Investment House and Shlomo Simanovsky at a cost of NIS 150 million. For that, Stepak took bank loans totaling NIS 105 million.

Neuberger and his partner in managing DS Apex, Victor Shimrich, who were also shareholders, received NIS 100 million in the merger, on top of compensation in the tens of millions they had received in the past. They weren't alone. Was Barkat happy to pay out that kind of compensation?

"I inherited contracts and honored them," says Barkat. "But one of these contracts will be renewed. The new executives that came into the business, for instance Gabi Ravid and Yadin Antebi [who have since left], received fair salaries, and when I had a chance to coordinate matters, I took it."

In addition, says Barkat, "a large part of the compensation executives received was in the form of options on which they made nothing. I come from this world but I think we need to operate differently. When I opened talks to buy DS I told Ido that if I take control, I won’t renew his contract under the same terms. 'If that bothers you, tell me now,' I said."

The matter of senior executive salaries was a discussion topic for Stepak and Barkat as they tried to establish a joint vision for the merged business. But it wasn't just an issue for the two shareholders; at a certain stage, senior executives gathered at a retreat in the Galilee to participate in the discussion.

"It's the key to a successful merger. I have a lot of experience with this because I always had partners," says Barkat. "Some of those partnerships didn't succeed, but when there is a common goal, the chances of succeeding are better. Together with Zvi, Ilan Raviv and Avner, we saw an opportunity to do things differently. Management compensation is a critical matter for us and we needed to take a new approach."

According to Barkat, "In every country, this industry is structured incorrectly, but we needed to deal with the problem first at home. We cut back on senior management, including directors who are shareholders. We reduced the wage gaps inside the business and increased salaries to lower-level staff. We had a compensation committee long before the regulators demanded it."

Adds Stepak: "A merger of two businesses inevitably brings with it a lot of self-criticism. Ilan's and my salaries are no more than nine times the average in the company."

And how many times is that compared to the lowest salary? "We committed to it being no more than 40 times," says Stepak.

And is 40 times a reasonable ratio? "That includes bonuses. The real cost is how much I get every month. With bonuses we set parameters for ourselves based on profitability….We voluntarily reduced it after it had already been approved by the board," he says.

The document that lays out the merged business' vision is called "The New Financial Code." It was written with an eye to the new era of social justice and the criticism of the financial services world after the 2008. Managers were accused of enriching themselves at the expense of their clients.

In addition, the vision calls for simpler and easier-to-understand products, greater transparency in investment policies and pricing, a reduction of potential conflicts of interest, and shareholder activism among institutional investors. In this context, Meitav reduced its holding in its underwriting business to less than 20% and has taken the lead in fighting companies that don't meet their debt-repayment obligations to the public.

Stepak and Barkat contend that a bigger investment house, like the one they have now created, is in a better position to lead change in the capital market's behavior.

"We were the first and only to commit to not raising management fees on mutual funds and to not change our investment policies," Stepak says. "We promised to release details a month before we reweighed our assets. That kind of transparency is difficult and it cost us."

Will you do the same as Psagot and prepare a blacklist of businesspeople to whom you won’t give money?

"I don’t advocate boycotts. But we do have a track record. Already a year and a half ago we didn't hesitate to say that the management style of IDB disturbed us, so we have no IDB Holdings bonds," Stepak says.

"With Plaza Centers, which is controlled by Motti Zisser, we prevented an increase in the dividend it was going to pay to Elbit Imaging. With BGI Investments we stood up and prevented a deal with Manofim, otherwise the bonds we held would have fallen to a value of zero. In the case of Ampal, together with Psagot we led the struggle and never hesitated to take control of the company. We have no problem in taking control of other companies."

What is your attitude toward controlling shareholders that refuse to repay debt?

"We rate them differently than other shareholders. It all depends on how they behave on the way to reaching a debt agreement. There are controlling shareholders with egos who commit the sin of pride. Often they aren't ready to admit they have a problem at all. They insist on thinking they know better than everyone else and live a life of denial until things blow up in their face.

"In the first stage, they say there won't be a restructuring. Zisser said it, Dankner said it. Then they move to the disillusionment stage. If the controlling shareholder comes to recognize the fact quickly, I can relate to him differently. It's a point in his favor. A lot depends on whether the crisis is due to external factors that were impossible to predict, or whether the controlling shareholder took [excessive] management fees and pulled large sums of money from the business."

What about shareholder meetings where votes are taken on management compensation and dealings by controlling shareholders?

"We have also paid a price for our voting. There were even portfolio management clients that left us because we voted against them at shareholder meetings of companies they controlled. We had one client who was told that we were voting against his salary, and he warned us that he would leave. That was pretty problematic, but [consulting firm] Entropy advised us to say no and we decided to vote against it.

"He called us and threatened to close his account, which was quite large. And in fact he did close it. Avner and I went to meet him and explained to him he had to respect our decision …. I hope he'll come back."

It's safe to say that over the last two years the markets have worked against the interest of their clients. You gave money to people who didn't deserve it – people who took excessive salaries and bonuses and in the end didn't repay their debt.

"This is what we want to change. Now we have more power, but you should know we have no skeletons in our closet."

But how did you come to give money to people like that?

Barkat: "We came to talk about what we'll be doing in the future. You're exhausting Zvi. He won't have any strength to invest."

Stepak: "Investment management is not an exact science. One principle is to diversify your investments, but no lawyer wins every case."

But are there lawyers who always lose?

Stepak: "We most certainly haven't always lost. If 80% or 90% of our decisions are correct, that's good. The test is the return. Diversity creates return."

Is there any reason to be investing in the holding companies?

Stepak: "In the future, there won't be holding companies structured as pyramids. The market won't allow them to exist. Also, the business concentration law that will be approved in the future won’t enable them .… I look at a portfolio and test whether it can generate good returns to investors.

"Every investment is valued from the perspective of risk. If a bond of a particular company pays 10 percentage points more than a government bond, I investigate whether it is appropriate or not; that is, I check its risk profile and decide whether to invest accordingly."

Zvi Stepak and Eli BarkatCredit: Eyal Toueg

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