The Israeli CEO Who Routed Web Traffic Around the World

The story of EZchip founder Eli Fruchter, who’s now retiring, is like the story of Israeli high-tech.

EZchip founder Eli Fruchter
Gil Eliahu

Last Monday it was hard to miss the mixed emotions at EZchip Semiconductor in Yokne’am near Haifa. One after another, employees filed into the offices of the company Eli Fruchter founded 16 years ago.

“Usually when there’s an exit, people are happy,” says Fruchter, who had already taken the pictures off his office walls and said his calendar for the rest of the week was free.

“But it’s a very tough feeling. I’m sad. But that’s a big ‘but.’ EZchip is a company where it was a lot of fun for people to work, and these people are very sad. There’s a sense that a very good thing is ceasing to exist.”

The 200 workers in Yokne’am and the 80 in the United States turned in their employee badges last week. A small group of employees, mostly top managers, are out of a job entirely. For others, the logos on their company cars are being replaced and work email addresses are being changed to feature the name Mellanox, which bought EZchip and whose offices are just across the road.

This huge acquisition for the Israeli high-tech sector involves two veteran firms in a segment that’s not particularly sexy, but which is vital to global communications. It took place after a turbulent period in which it appeared the transaction was far from happening.

Shareholders did battle; this included a famous investment guru and his followers who held about 30% of EZchip’s shares. Also in the mix was an activist hedge fund that thought the $811 million price tag was too low.

Ultimately, in January, EZchip shareholders approved the sale and last week the stock was delisted from the Tel Aviv Stock Exchange and the Nasdaq. The company fell into Mellanox’s hands after failing to meet its own financial targets.

In 1999, analysts expected EZchip’s market, communications processors, to grow to $7 billion by 2005. The forecast was never met and the number is now only at around $400 million, most of it controlled by EZchip.

“Now, when you send something via the Internet – a movie or email – it goes through about 15 routers along the way until it gets to America, and in each of those routers there are EZchip chips,” Fruchter says.

“We route the traffic around the world. Does anyone know us?”

People are end users – through Facebook, for example – but they’re not familiar with the infrastructure, says Fruchter, who admits that he and his people have been a bit frustrated with that.

Present at the creation

In large part, Fruchter and EZchip’s story is the story of Israeli high-tech. In the early ‘90s, when Fruchter became an entrepreneur, there was no concept of a startup. Israeli venture capital was in its infancy and Israeli tech firms were developing communications and hardware infrastructure.

But then Israel became the Startup Nation and investors from around the globe began investing in the country, particularly in the high-profile Internet, mobile and software sector. In the meantime, Israel’s communications and hardware sectors have shrunk and stumbled in their efforts to attract investors.

So Fruchter experienced it all – the rise of Israeli high-tech, the bursting of the dot-com bubble, and the global economic crisis of 2008.

He studied electrical engineering at the Technion technology institute in Haifa and began his career at Fibronics, which dealt with data communications and became a breeding ground for entrepreneurs. One study found that Fruchter was just one of 30 serial entrepreneurs to come out of Fibronics – as of 2012, these people had founded about 85 tech companies.

In 1990, Fruchter and Eli Ha’ari – the two had worked at Adacom – established LANOptics, out of which EZchip ultimately grew. One LANOptics investor was Comverse Technology, which also spawned a raft of entrepreneurs.

LANOptics initially made connectivity products for IBM’s Token Ring, a communications protocol that predated the Internet. LANOptics had little money; Fruchter recounts how it raised $330,000 from three investors.

“Our first customers were in Germany – an airport that they built at the time in Munich, and Deutsche Bank,” he says. Within six months LANOptics was turning a profit and within two and a half years it was trading on the Nasdaq at a company valuation of about $70 million.

“We were among the first Israeli companies to issue shares in the United States,” Fruchter notes – and investors reaped $100 for every dollar they invested.

But as is often the case, LANOptics was in a market where demand would decline. Communications protocols changed and other companies forged ahead of LANOptics. EZchip, in its final years as an independent company, faced similar challenges.

LANOptics, for one, took the plunge in 2000, just before the dot-com bubble burst. It got into the communications processor sector and competed with big players such as IBM and Intel.

The new venture was called EZchip, founded as a subsidiary of LANOptics, which during that stretch wasn’t developing new products and whose sales were slumping. At that point, Ha’ari left LANOptics.

Swimming with the fishes

EZchip was a David in an industry of Goliaths, but Fruchter says he and his people realized how to develop better technology, and some competitors quit because they saw that the market was limited, “but also because our technology was a lot better.”

Since then, EZchip has developed network processors for network routers, directing data packages to their addresses. The company takes factors into consideration such as high demand, cost and distance.

EZchip was founded when it was already possible to raise venture capital in Israel – at the height of the dot-com bubble. In its first funding round, it raised capital at a valuation of about $18 million; a few months later in its second round, that number was at about $100 million.

But after the dot-com bubble burst, it became difficult to raise venture capital. Investors pressured the company to curtail operations, but Fruchter says he and his colleagues headed these efforts off and came out of the crisis stronger.

Initially EZchip functioned as a startup and only became profitable in 2007, seven years after its founding. Unlike startups that seek an exit and don’t consider issuing publicly traded shares, EZchip had an eye on the capital markets early on. Since it was a LANOptics subsidiary, EZchip could reap funds when investors put money into LANOptics, whose operations were shrinking.

One of the first investors was tech guru George Gilder, to whom EZchip owes much of its success. Gilder had been a tech adviser to U.S. President Ronald Reagan and recognized the Internet’s huge potential early on. Gilder developed a following among investors who were eager to follow his lead, so a nod from Gilder could boost a company’s share price.

Fruchter says Gilder thought EZchip would be the next Intel. “We really did what he said, but we didn’t become Intel,” he says. “From the standpoint of market share, we don’t have competitors and really are like Intel, but the market is much smaller than what was thought.”

In 2002, LANOptics began dual trading on the Tel Aviv Stock Exchange and six years later began trading as EZchip rather than LANOptics. At its peak, the company had a valuation of $1.2 billion and even became part of a leading Tel Aviv-index. Over the past decade, the stock provided an average annual return of about 10%, compared with the Tel Aviv-100’s 4.5%.

Now, after experiencing nearly 100 quarters of financial statements, first with LANOptics and then with EZchip, Fruchter is leaving the club of CEOs of listed companies. For his 2% stake in EZChip, Fruchter will reap $16 million in the sale to Mellanox – and that comes on top of the tens of millions of dollars he made over the years.

When he announced his departure, he joked he’d now clean his home aquarium daily – the largest home aquarium in the world, where he also goes diving.

But apparently even swimming in 30,000 liters of water with fish won’t fill the void in his schedule. Fruchter says he doesn’t plan to run another company; he’ll be “classic high-tech retiree” – advising startups and small firms, serving on corporate boards and making small investments.

Either way, Fruchter stresses the role EZchip’s employees have had in the company’s success. “We managed to create a pleasant, family-type place to work. The board members, who know other companies, call EZchip a nature preserve,” he says.

“We’ve always treated employees as partners and distributed shares to employees at every level. Most of the department heads and team leaders started at the company as college students, and I don’t remember any team leader coming from the outside.”

Over the years, EZChip and Mellanox competed for the same employees, most of whom were star graduates of the Technion. So now competition for engineers in Yokne’am will be a little less fierce.

EZchip won’t exist as a separate unit – its employees will toil at Mellanox’s various departments. We’ll see if that proves traumatic for people used to working in a small, family-style company.