The Legal Corruption That Lets Israeli Business Giants Stay Powerful

The good news: Public Security Minister Gilad Erdan is the latest leader to target the likes of landline monopoly Bezeq.

Bloomberg

On January 20, 2014, Deputy Attorney General Dina Zilber wrote an opinion for the deputy finance minister, Mickey Levy. It was about his potential conflicts of interest.

Levy had disclosed, Zilber noted, that from 2008 to 2013 (shortly before he joined Yair Lapid’s Yesh Atid party), he had been CEO of the haulage and logistics company Egged Taavura. That firm is owned by the government-owned Egged bus company, the Livnat family, the Nesher cement monopoly and the billionaire Len Blavatnik.

Levy had also disclosed, Zilber wrote, that he had social ties with the Livnats. Zilber’s conclusion: For two years, Levy should recuse himself from any matter regarding Egged Taavura or its shareholders, and any companies that its shareholders owned. Also, since Levy was still friends with the Livnats, Levy’s recusal should last throughout his term at the Finance Ministry.

Her letter arrived three weeks after Levy, with the rest of Yesh Atid and a rainbow coalition of politicians, voted in favor of a bill that very much affects the parties listed in Zilber’s opinion, including Nesher, the Livnats and Blavatnik.

According to a bill passed in the Knesset in December 2013, the weight of cement sacks would drop to 25 kg from 50 kg. The explanation: 50 kg was too darn heavy. Yes, the only thing the politicians cared about was the little man with a cement sack on his back.

Emil Salman

But the Finance Ministry firmly opposed the bill. After all, 25 kilos is the perfect weight for the Livnats and Blavatnik, who don’t want foreign cement to compete with Nesher’s.

Nesher is a powerful monopoly that commands a nearly 100% share of Israel’s cement market. Cement sacks weigh 50 kilos everywhere around the world, but now the Zionist one weighs 25.

Ironically, one of the first targets the Finance Ministry set when the social protest erupted in 2011 was to break the Nesher monopoly and its auxiliaries, including Egged Taavura.

The bill weakening competition in cement — a clear example of regulation that serves companies, not the public — passed eight months after Levy’s party,Yesh Atid, did really well in the national election. It joined the government after promising to boost the middle class.

Fourteen months after Levy voted for the bill, tailored to suit Blavatnik and the Livnats, he stood shoulder to shoulder with Lapid at a press conference designed to convey Yesh Atid’s determination to fight corruption.

Ahead of this year’s March general election, Lapid raised the flag of fighting corruption, replacing the flag of fighting perks for the ultra-Orthodox, which seemed less of a vote-winner this time around. But Lapid was talking about corruption that clearly breaks the law, not legal corruption.

Daniel Kaufmann, now president of the Natural Resource Governance Institute and previously an economist at the World Bank, once admitted the biggest story that he and many others had missed over the years: legal corruption. He defined this as "efforts by companies and individuals to shape law or policies to their advantage, often done quasi-legally, via campaign finance, lobbying or exchange of favors to politicians, regulators and other government officials."

When writing commentary for the popular daily Yedioth Ahronoth, Lapid didn’t show any particular interest in corruption, certainly not legal corruption. One column he did publish on the subject, in May 2008, bore the headline “Investigationocracy.” That was when a family friend of the Lapids and the Mozes family, the publisher of Yedioth, was being investigated — Prime Minister Ehud Olmert.

Lapid wrote: “If you want publicity, you submit a complaint. If you’re a political rival, you find somebody to submit a complaint . Every frustrated macher, arrogant bureaucrat or publicity-hungry Internet journalist can disrupt the government system . A regime under investigation is a weak regime that can easily be squeezed.”

Mafia movies often have a scene where the good guys give a victim a cement bath; one reason is to send a message not to mess with them. There are lots of tycoons who in consultation with their lawyers and machers are experts on cement baths.

Olmert was also a friend of the Livnat family, which has controlled Israel’s cement and trucking business for decades and has dozens, if not hundreds, of friends in the government, the Knesset, the municipalities, the police and the army.

When Olmert was minister of industry and trade, the ministry continued to serve the interests of the Livnats. No regulator even tried to break its monopolies. When Olmert resigned from the premiership in 2008 as the investigations swirled, the Livnats named him chairman of Taavura, a part-time phony job for which he reaped a salary that 95% of Israelis can only dream about.

Enter Bezeq

What have we learned from the story about Levy, cement sacks and the law to protect the groaning worker? Well, let’s first hear what new Public Security Minister Gilad Erdan has to say.

In recent days, Erdan has come out swinging against economic concentration and tycoons, aiming straight for the high windows and highly complex reforms. He declared his intention to dismantle Bezeq’s landline monopoly through legislation, based on the British model for breaking up British Telecom into two companies, one for infrastructure that sells its services to all comers, and BT Services, which sells telephony, Internet, content and other services.

“In recent years Bezeq has used all means to stall the execution of reforms that will lower costs to the public by dozens of percentage points,” Erdan said. “I’ve concluded that the right way to deal with a monopoly this powerful is to force Bezeq to sell all its holdings in content and services and to remain an infrastructure company.”

Wow. With that Erdan did three big things. First, he marked Shaul Elovitch, one of the strongest tycoons in Israel. Second, he proposed that Israel break up Elovitch’s B Communications; a breakup is usually the most effective way to handle monopolies. Third, he hinted that Elovitch’s power was based not only on controlling one of Israel’s biggest companies, but on owning a stake in a powerful media outlet.

Erdan thus joined the small group of fighters against the pyramid system of doing business: Elovitch controls Bezeq through a financial pyramid, like the one through which Nochi Dankner controlled IDB. Is this the same Erdan who served as communications minister for more than two years?

But Erdan’s chances aren’t great to break up Bezeq the way AT&T was broken up 40 years ago in the United States. They would be a lot greater if he’d pursued the move as communications minister. But he didn’t try.

He did introduce broadband reform, but the legislation was a lot less aggressive than what he’s proposing to do now. So Bezeq remains a monopolistic cash cow, making higher monopolistic profits from the landline market than the mobile operators made before the cellular reform when Moshe Kahlon was communications minister.

So it seems that during the 72 hours between Erdan learning that Benjamin Netanyahu wouldn’t give him the portfolios he wanted in the latest government, and his declaring a bill to break up Bezeq (making the prime-time news shows), he achieved new insight into the best structure for the telecom industry, insight he didn’t have when he was communications minister. Or maybe his dramatic announcement was just a spontaneous, political and visceral reaction to being humiliated by the prime minister.

Why would Erdan’s reaction in his battle against Netanyahu take the form of breaking up Bezeq and hitting at Elovitch? Why would Netanyahu particularly care?

Just as strange is the declaration that content should be separated from Bezeq. Just a year ago, Erdan supported an unprecedented move in Israeli media. He let satellite TV company Yes (which belongs to Elovitch’s pyramid) and cable TV company Hot set up news channels, a move that would strengthen the pyramids’ political power and make it all the harder to regulate them.

But this is politics and we shouldn’t be examining Erdan’s kishkas under a microscope. Just a few months ago Erdan was one of the people closest to Netanyahu and was privy to all moves being made in the telecom market, which is very dear to Netanyahu’s heart. The attack on Bezeq and especially the call to sever it from content — including the popular website Walla — was not entirely coincidental. Erdan wanted to shine a light on Elovitch’s political power thanks to Bezeq’s profitability and control over Israel’s most popular website.

The pyramid game

As for the Bezeq pyramid that Erdan wants to break up, Bezeq’s revenues are about 9 billion shekels ($2.3 billion) a year, operating profit is 3.2 billion shekels and cash flow about 4 million shekels. Its market cap is 18 billion shekels, a highly impressive sum. Now for the pyramid game.

This is how Elovitch owns Bezeq. He owns 100% of the shares in Eurocom Telecommunications, which owns 65% of Internet Gold, which owns 66% of B Communications, which owns 30.7% of Bezeq.

Bezeq’s market cap is 18 billion shekels and Elovitch’s stake in the company is worth just 250 million. So what about the other 17.75 billion shekels?

Welcome to the world of pyramids and leverage. Elovitch can control a company worth 18 billion shekels with a stake worth just 250 million shekels because of two types of leverage. The first is the pyramid: a company owning a company owning a company. The more levels the pyramid has, the greater the dissociation between the equity investment and control (which in Elovitch’s case, is absolute: He appoints all the directors).

The second type of leverage is loans. Each holding company in the pyramid leverages its investments, borrowing billions from the banks and the public, to which it issues bonds. Bezeq, at the bottom of the pyramid, owes about 13 billion shekels. B Communications above it owes a net 2.5 billion and Internet Gold in the next tier owes 800 million shekels. Eurocom is private so we don’t know how much debt it owes, if any.

How is that debt financed? By the cash cow at the bottom — Bezeq, which the state privatized 10 years ago. It sold the controlling stake to a group consisting of Haim Saban (more on him below), the Apax fund (which took a ride on Tnuva, jacked up cottage-cheese prices and sold the company to China) and pharmaceutical baron Mori Arkin. They paid the state 4.2 billion shekels, financed mostly with loans from banks Hapoalim and Leumi, as usual.

The entry of Saban and Apax marked the start of the great soak. Olmert and communications ministers Ariel Atias and Dalia Itzik protected the telecom monopolies. Bezeq printed money that it gave as dividends to repay the Elovitch-pyramid loans.

After five years Saban and Apax decided that it had been fun but they wanted to move on, so they sold Bezeq to Elovitch. They had made returns of 30% a year, about double the norm for deals of the kind.

Elovitch financed Bezeq’s purchase the same way, loans, but his timing wasn’t great. Along came a new communications minister, Kahlon, who decided to do the unaccepted, irrational thing: He allowed competition into the mobile communications market. Elovitch could no longer rely on Bezeq’s profitability to finance dividends. He had to make an unusual move of his own and reduce equity in order to soak some more billions from Bezeq.

So a decade after Bezeq’s privatization, the company has paid 23 billion shekels in dividends, much of which has gone to service interest payments and principal of loans taken to buy the company in the first place.

That 23 billion shekels naturally came from customers of Bezeq, Bezeq International, its Pelephone mobile phone operator and Yes. Until 2012, Pelephone’ customers were the main cash source. Since the Kahlon reform, it’s customers of Bezeq’s landlines and Internet — on which Erdan suddenly had that brainwave.

Would the public have saved 23 billion shekels if Bezeq hadn’t been privatized? That can’t be said; Bezeq’s management has improved since it parted ways with the government. We can assume that at least part of that sum would have wound up with the company’s workers and suppliers.

It’s true that the public can also own shares in Bezeq and Elovitch’s pyramid, but most market holdings are concentrated in the hands of the top 20%. And the great damage by a monopoly  — transferring wealth from consumers to shareholders  — lies in the inefficiency it creates, partly because prices remain high. Bezeq proved that the only thing worse than a government monopoly is a private one.

Bezeq, Nesher and Taavura managed to shape the regulations to their advantage. Politicians came and went, but the tycoons soldier on. Now there’s a new star at the Finance Ministry, Kahlon, who has declared war on the cost of living.

So let’s see what happens. Democracy isn’t just about election day, it’s about quality, integrity and the independence of politicians and regulators.