Star of the North: How Warren Buffett Bought the Best Industrial Firm in Israel

And what will happen when he retires

Warren Buffett speaks to the press as he arrives at the 2019 annual shareholders meeting in Omaha, Nebraska, May 4, 2019.
AFP

When the legendary investor Warren Buffett bought control of Iscar, the Israeli maker of machine tools, in 2006, he told TheMarker the acquisition was one of the most import deals his Berkshire Hathaway holding company had ever made. He said it wasn’t just the company’s products but its management team that would bring great things.

It was a historic deal for everyone involved. It was Buffett’s first acquisition outside the United States, and he celebrated it at his company’s annual meeting with 35,000 fans in Omaha, Nebraska, where Berkshire Hathaway is headquartered. It was also Buffett’s third largest purchase at the time. For Israel, it was one of the biggest foreign acquisitions — about $4 billion for 80% of the company, valuing it at $5 billion.

The deal left a lot of people stunned, their jaws hanging open. They wondered how a Galilee metal working tools company that very few people had heard of, and whose management no one knew about and no one interviewed, had grown into an economic monster that the most famous investor in the world was willing to pay so much money for. Later on, in 2013, Buffett bought the remaining 20% of Iscar for $2 billion more, an amount that represented a doubling of the company’s value to some $10 billion.

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Since then, Iscar has returned to its secret and anonymous ways. It may now belong to the publicly-traded Berkshire Hathaway, but Buffett does not provide financial details on its private holdings — unless he chooses to do so in his famous annual letter to shareholders. Over the past few years, he has not even mentioned Iscar. The company’s employees zealously keep their numbers close to their chests, as they have done for decades. Google searches don’t come up with much, except for technical information intended for the metalworking industry.

What happened with Iscar in the seven years between the first sale and the second one, and in the six years since then? Did Buffett’s predictions that Iscar would be one of the most important deals for Berkshire Hathaway pan out? The answer, like everything else about Iscar these days, is in the mind and hands of just one person: the company’s chairman, Jacob Harpaz. Since the sale, and after founder Stef Wertheimer and his son Eitan ended their involvement in the company, Iscar’s story became a dance between just two people: Harpaz and Buffett.

Back in 2006, and in the seven years that followed, during which the company doubled in value, Iscar was an unusual financial wonder on a global level that demanded closer examination and explanation. When Buffett received Iscar’s financial reports, he discovered something amazing: An industrial company in the unglamorous business of manufacturing drill bits and cutting tools for the metalworking industry, with its manufacturing facility near the not always quiet border between Israel and Lebanon, and it was showing profit figures similar to those of the finest high-tech companies.

As far as possible from Tel Aviv

As Buffett said, the management is at the heart of Iscar’s story — and it’s also the story of Harpaz, who served as CEO for 27 years, since 1992, until he was named chairman. Wertheimer and his family founded Iscar and led the firm to sales of hundreds of millions of dollars a year, but Harpaz is the one who turned it into the second largest company in its industry worldwide, with a 17% to 19% share of a global market estimated at some $8 billion. Iscar also seems to be the most profitable company in its business globally.

How did the management do it? The answer is complicated. Iscar develops innovative and advanced products for the metalworking factory market, and many of them have been patented — but they have no secret formula the way Teva had with Copaxone, its drug for multiple sclerosis, or Google did with its search algorithms. Iscar operates in an industry that benefits from knowledge developed by the Israeli army, in a similar manner as companies in the fields of cybersecurity, arms and aviation. It doesn’t have any special know-how developed in academia or in hospitals. In fact, Iscar’s location in Israel seems to be a weakness compared to its global rivals — from its distance from its customers to fears of a factory shutdown in case of security flare-up — which has happened a number of times in the past, including rockets hitting the plant.

But what appears to be an obstacle is actually one of the main explanations for Iscar’s success: It is not a company from Tel Aviv, and Harpaz, who lives in the town of Kfar Vradim near the Lebanese border, is not part of the club of CEOs from north Tel Aviv and vicinity. Iscar is one of the two largest employers in the north (the second is Rafael Advanced Defense Systems), and that is central to its entire story, both when it comes to management so respected by Buffett and to the company’s other 3,500 employees in Israel. More than 1,000 of them workers are Druze or other Arabs, an exceptional number for the Israeli labor market.

“When a company like Iscar gives an opportunity to a local resident, including a car, fancy meals and professional interest, he is willing to give his soul [in return]. People arrive at 5 A.M. and leave at 11 at night. They know they won’t get such an opportunity anywhere else,” said someone close to the company. “For the non-Jewish employees, who can’t work in a defense company such as Rafael, this motivation is even stronger.”

A long-time employee said that given the labor market in the Galilee, Iscar is what the Israel Electric Corporation once was all over Israel: An employer that gives you job security and will never fire you during difficult times. The company has almost no employee turnover and its professional knowledge base is constantly growing. Nearly all the senior executives have worked for Iscar for decades. (The newly hired CFO worked on the company’s account at its accounting firm for years). Those who retire — even the management — are replaced by someone from within the company, not by anyone parachuted in from the outside.

In comparison to companies in Tel Aviv or across the United States, Iscar does not recruit “talent” from MBA programs in Israel or around the world. It hires engineers from schools in the Galilee. Sometimes it finds new employees among those who never finished high school but have exceptional abilities and trains them for manufacturing, operations or sales jobs.

Today, the management team includes Harpaz; Ilan Geri, the longtime marketing manager who took over the role of CEO when Harpaz became chairman of Iscar and the president of its parent company, IMC Group; Haim Cohen, the global manufacturing VP; Ronen Zisser, the CFO; Dov Avraham, the VP of sales; and the VP for operations and personnel, Arie Ravhon.

No interest in exposure

Harpaz was born in 1951 in Kiryat Motzkin, a suburb of Haifa. He was wounded during the Yom Kippur War near the Suez Canal and lost his foot. Despite the injury, he treated his wounded comrades and managed to evacuate them from the battlefield — for which he received the army’s third-highest decoration, the Medal of Courage. He studied mechanical engineering at the Technion – Israel Institute of Technology in Haifa, worked in a metalworking lab and then joined Stef Wertheimer at Iscar. He was put to work in marketing, and from there, he rose all the way to CEO in 1992.

Harpaz never planned on working for Iscar full-time. He never thought he would work in manufacturing either. He thought teaching was a more appropriate career path for himself. He wound up working for Iscar because of how the company treated him after he was wounded in the war. Wertheimer, who was CEO at the time, came to visit Harpaz at the hospital. While he was recovering from his injuries, Harpaz decided to help out a little in development at Iscar, and he never left.

His first job was leading a development team that consisted of one person: himself. One day, Wertheimer walked by Harpaz and heard him reprimanding Iscar’s sales people for not knowing how to sell. Wertheimer had no idea who the young man was, but he called him over: “Come here, redhead. What do you do here? Development? Okay. From now on you’re in sales.”

After the company’s acquisition by Buffett, Harpaz was appointed chairman of all the companies in IMC, the metalwork division of Berkshire Hathaway, which includes a large number of companies similar to Iscar such as Tungaloy in China, TaeguTec in India and Ingersoll and Tool-Flo in the United States. Iscar may be the biggest producer of cash for the group — 40% of the total — but from the top floor of the company’s management building in the Migdal Tefen industrial zone, Harpaz controls 160 companies in 65 countries that employ 14,000 people. They have annual revenues of over $3 billion, with a phenomenal profit margin of over 30% — an amazing figure for an industrial firm.

Harpaz is pleasant and charismatic. No other Israeli executive can match his business achievements. He is excels in marketing, customer relations, understanding market needs and development requirements — even if his English is very “Israeli.” The real reason is rather simple: Harpaz has no interest in media exposure in any form.

Iscar has handed Buffett some $5 billion to $6 billion over the past 10 years, according to sources close to the company. This means Buffett has fully paid off his investment in Iscar, and Iscar still has another $1 billion in the kitty. Its sales have grown by hundreds of percent over this period, and it has a cash flow of $1.1 billion a year from operations — more than twice the figure at the time the company was sold to Buffett.

These incredible numbers explain why Harpaz has won the admiration — some sources call it worship — of Berkshire Hathaway management in general, and Buffett specifically. Harpaz can run the Iscar group however he wishes and make any acquisition he wants. No one will challenge his judgment. Berkshire Hathaway’s board of directors is barely involved in Harpaz’s decisions and always backs him up him, even when things go wrong.

The Chinese challenge

None of this guarantees that Iscar won’t face major challenges in the future and that the successes of the past 15 years, in terms of growth and profit, will continue for the next 15 years. Iscar’s core business is developing, manufacturing and selling cutting tools for the metalworking industry. Its main customers are manufacturers in the automotive industry (35% of its sales), aviation (15%) and energy (15%), and any slowdown in these industries can immediately affect Iscar, too.

Traditional manufacturers of internal combustion engines are huge Iscar customers, so a massive switch to electric engines — something that many expect will happen, but only at a slow pace — could be a problem for the company. The switch to assembly line manufacturing with 3D printing, at the expense of metalworking, will represent a challenge as well. Add to all this the question of Buffett’s age and his successors, who may change the management structure of Berkshire Hathaway and Iscar in the future, even if it doesn’t happen in the next few years. The challenges facing Israel, from security issues and to problems in the job market and the supply of engineers, are part of the equation, too. And because of its size and large global market share, Iscar would be exposed to almost every major economic crisis around the world.

Iscar has entered the field of information technology in recent years due to its business needs, and now employs over 300 people as programmers and other computer professionals. But like high-tech companies, the firm also faces the difficulties of recruiting qualified computer professionals, along with the rising costs of doing so. Because Iscar is part of Berkshire Hathaway’s group of large companies, it focuses on its traditional industry sector and doesn’t have its own corporate venture capital arm to invest in startups. That’s done by Berkshire’s top management in the United States.

Iscar’s answer to all these trends is the development of innovative and more expensive products, such as cutting tools that allow for faster production or are more durable, but no one is promising that the Chinese would not buy up development capabilities that will enable them to compete with Iscar in these areas sooner or later. In addition, Chinese firms enjoy the advantage that most of the main raw material in the industry, tungsten metal, comes from mines in China. Another challenge is the sales methods: Nowadays online retailers such as Amazon and Alibaba sell industrial cutting tools, and their share of the market is expected to grow.

Even the complete independence that Harpaz enjoys is a double-edged sword: He is free to act quickly, but at the same time, no one is pushing him to think about the long-term, to focus on strategy, free up other executives from day-to-day management or prepare the next generation of managers. As of now, Iscar is in good shape. Buffett’s acquisition and the company’s growth over the past decade have built it into a global brand. And because of Israel’s cybersecurity and weapons industries, the “Made in Israel” label has become a valuable symbol as well. But the question is how long Iscar can continue to be the economic wonder that Buffett discovered in 2006.

The answer depends on a different question: Who will leave first, Harpaz or Buffett, and what will follow? Neither of the two, who are both brilliant salesmen, have shown a great effort to invest into a new generation to take over after they leave.

The post-Buffett era

Buffett said that he expected Iscar to become an important acquisition for Berkshire Hathaway, but it seems this time, the guru was a bit off the mark. Iscar may be the most profitable company Berkshire Hathaway owns, but a corporation even generously estimated as worth $12 billion to $15 billion does not represent more than 2% or 3% of Berkshire’s total value, which as of now is $505 billion. Iscar is a wonderful and profitable business, but it can never be very important for Berkshire Hathaway, which focuses on insurance, railroads and stock holdings in companies such as Coca Cola and Apple. The holding group is not abandoning the metalworking industry. Four years ago it bought Precision Castparts, which makes parts for the aerospace industry, for $37 billion, but its future and share price will be influenced mostly by its other holdings.

When either Buffett or Harpaz finally leaves, anything could happen at Iscar. At the time of the acquisition, Buffett expressed his total opposition to selling or issuing publicly traded stock in any of the private companies Berkshire Hathaway owns, including Iscar in particular. When asked by TheMarker 10 years ago how long he planned on owning Iscar, he said: “I don’t sell.” He promised he wouldn’t take the company public either, something he has never done before. No one doubts Buffett will keep his promises, but no one knows how long he will be around and what those who follow him will do.

A large number of diverse scenarios are possible for Iscar’s future. Buffett can continue to run Berkshire Hathaway for five more years, Harpaz can remain where he is for another 10 years, the cutting tools market can remain stable and even grow moderately. Because of its special organizational culture and loyal management, Iscar could very well continue to operate the way it has until now.

In a different scenario, Buffett or Harpaz could retire and the new management could decide to be more involved in overseeing Iscar and IMC. It could then transfer the management of the non-Israeli companies to the United States, making Iscar a more American and less Israeli corporation — less agile, less daring and less profitable. Today, Iscar spends much more time on compliance processes than in the years before the sale to Berkshire Hathaway, and it has been forced to forgo sales to countries such as Iran and Cuba.

An infinite number of scenarios exist in between these two possibilities, but one thing is clear: If Harpaz stays on, it will not be because of the money. Harpaz is estimated to have received a bonus of tens of millions of dollars at the time of the sale to Buffett in 2006, and again in 2013. Since Berkshire Hathaway bought the entire company, Harpaz has been receiving a compensation package according to American standards, and in good years his salary reaches seven figures. What may be surprising is that all this money has not changed him, does not motivate him and has not caused him to modify his historic decision: that Harpaz and Iscar will remain almost an enigma for the Israeli public.