All That Glitters / When Will Institutionals Wrest Control From Israel's Tycoons?

Eytan Avriel
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Eytan Avriel

Market failure is a prominent feature of economic theory and of real life too.

What does it mean? That the allocation of products or services in a free market is inefficient. Or, as Investopedia puts it, it's when consumer demand isn't met by the quantity supplied.

As a rule, market failures happen when certain people pursue their own interests while not considering economic inefficiency. Resources are not allocated optimally, to the detriment of society at large.

What does this mean in practice? Take information asymmetry, in which one party in a transaction has more or better information than the other party does. In the context of market failure, the information-rich party could use this advantage to secure results that are good for it but bad for the general public. The economists George Akerlof, Michael Spence and Joseph Stiglitz won the Nobel Prize in Economics in 2001 for identifying this type of market failure.

And now, finally, we get to the economic reality so familiar to everyone who lives in the State of Israel: When a large company undergoes a crisis and the controlling shareholder conducts negotiations with bondholders on debt restructuring, the asymmetry effect creates an abysmal market failure. The controlling shareholder knows exactly what is going on in the company: what's good for it, what's bad for it, how much it's worth, how much money it's worth paying out of pocket to retain control and who would be a worthwhile partner.

The public, by contrast, knows very little about the company's situation, and the small amount of information that is publicly known generally comes from the controlling shareholder – with whom the bondholders are negotiating. That is a total asymmetry, and it guarantees one result: The debt-restructuring plan that is ultimately signed will, of course, include a painful haircut and deferral of payment, and favor the controlling shareholder.

In effect, the public has no way of getting the upper hand on a deal like this. Why? It's quite simple: As soon as the controlling shareholder, who knows everything about the company, sees that the deal is not going his way, he simply won't carry it out. Even the Knesset has noticed this problem and has attempted to mitigate it by passing the so-called Haircut Law, which obligates companies to use a court-appointed expert to monitor debt-restructuring deals.

A parade of debt-restructuring plans

All this economic background is necessary to understand how the public should be responding to the recent wave of debt-restructuring plans that have washed up at its feet. One after the other, in a kind of parade that gets more bizarre every day, Israeli businessmen announce that they are unable to pay their debt and wish to conduct restructuring negotiations.

At first, nearly three years ago, it seemed like some kind of mishap, maybe even an act of God. While making arrangements to repay Africa-Israel's debt, controlling shareholder and chairman Lev Leviev told of how the global financial crisis had frozen the liquidity of the Russian real estate market, while the Ofer family described how its Zim shipping company had suffered from the drop in shipping rates and an overall shipping crisis.

But even after the situation stabilized, markets improved and serious companies began showing unheard-of profitability, the list of Israeli tycoons embroiled in difficulties kept growing, as did those seeking debt-restructuring plans and haircuts. The parade continued with Yitzhak Tshuva, who gave Delek Real Estate creditors a 70% haircut. Then there's a long line of tycoons who have already declared insolvency but have yet to implement the debt-restructuring plan: Ilan Ben Dov's Tao Tsuot and Sunny, Roni Elroy's Kaman Holdings, Gadi and Danny Dankner's Elran Investments and, as of this week, Moti Zisser's Elbit Imaging. Nochi Dankner's IDB is negotiating a debt agreement, but the gaps between the two sides are huge.

This list is by no means the end of the story. Over the past few months, the corporate bond market has been doing well, which makes it easier to identify troubled companies: Their bonds are continuing to offer double-digit yields, despite the high prices (some say too high) seen elsewhere.

Some cases in point include Rami Shavit's Hamashbir department store, Joseph Greenfeld's Kardan holding company, David Federman's Israel Petrochemical Enterprises, along with some smaller and less familiar businesses. Other big businessmen, like Eliezer Fishman and Shaul Elovitch, had previously been marked as being on the rocks, but for now their bond prices are signaling financial stabilization – perhaps thanks to the overall good health of the market.

If you take a look at just about any of the lists of Israeli tycoons, industry leaders or management experts that were so widespread in the financial papers over recent years, you would find that more than half of these businesspeople have declared insolvency, and this appears to be a record low in the international arena. Yes, we admit: Even this newspaper used to publish lists of "influencers," and those lists too have no shortage of people who are now looking for haircuts on public debt.

Like Lev Leviev and the Ofer family, tycoons tend to explain away their failures by invoking some sort of act of God: a surprising drop in real estate prices, regulatory changes, social protest, or contributors' reluctance to continue rolling over the companies' debts.

Tycoons: not always great managers

Of course, these excuses are not the whole picture. The downfall of Israel's tycoons is the result of serious managerial mistakes they made, such as over-leveraging and purchasing assets at the highest prices. In effect, it has become clear that some of these business leaders didn't actually manage anything: They simply succeeded in raising public funds for a set time, and immediately buying the assets that were being sold off the shelf, and not at the best price, with that money.

Nochi Dankner's IDB may represent the height of this poor management style; just about every deal done rapidly turned out to be an embarrassing failure. The purchase of a lot for a Las Vegas casino, Credit Suisse shares, Israir Airlines and the Maariv daily, along with the faulty management of pesticide manufacturer Makhteshim Agan and Clal Insurance – all get a failing grade.

How should the Israeli public deal with this wave of insolvency and haircut requests? Well, let's go back to economic theory, to market failure and the problem of asymmetry. Since it's clear that any negotiations over debt restructuring will end up benefitting the controlling shareholder, the only way to resolve the information imbalance is to take the controlling shareholder out of the equation. How? Very simple.

According to financial regulations, when a company does not pay its debts, creditors have the option of taking full control of the company. The process works by way of the court: Bondholders take over the company, get rid of the management (which is generally responsible for the crisis and the insolvency) and appoint new management. At that point, the information asymmetry no longer exists: The bondholders control the company, examine it in-depth, figure out how much it's worth and then put it up for sale in a bidding process. This is the only way bondholders will be able to get the best deal.

But wait a minute, the tycoons' representatives will no doubt say, what happens when the person at the top is willing to open his or her wallet and pour money into the company, as Leviev and Tshuva did? Would it still not be worth it to hold debt-restructuring negotiations?

The financial answer is: No. That's because, once again, the public will not get the best deal. The deal might even be worse than it otherwise would have been, because the public and its representatives could get blinded by that injection of money, and by attempts at persuasion like: "If you don't accept this offer, you won't get anything." In those cases, too, the right thing to do is to transfer control to the court and put the company up for sale. Then the tycoons could buy back control of their companies if they want to, but only if they make the highest bid.

But despite the financial logic at play, not a single company or debt-restructuring plan has gotten to the point of a bondholder takeover. In every case of the large Israeli companies we have seen so far (Maariv and Yossi Maimon's energy company Ampel are exceptions here), the tycoons have succeeded in their goals. They carried out haircuts, got debt deferrals and retained control. On the basis of these precedents, there is no doubt that the next cases, involving Dankner and Zisser, will aim for similar results. After all, it's already the practice in Israeli debt repayment.

The public and the institutional investors that represent the public and manage its money must change their tune. To get the most value, the institutional investors must stop negotiating with the bankrupt tycoons and controlling shareholders and demand control from those who don't meet their debts. No negotiations, no debt restructuring and no controlling shareholders funneling in their own money. If the controlling shareholders want to return to the company, they can try to buy it back from the court.

This is the only way the public will get most of the money it is owed. It is also the only way controlling shareholders will realize they will have to pay the ultimate price – loss of control over their companies and loss of the prestige and creature comforts those companies had given them – if they run their business negligently or unprofessionally. Logic dictates that if they knew they were risking everything, they would be significantly more cautious with the public's money.

מונופולCredit: AFP
Nochi Dankner.Credit: David Bachar

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