Is it time to start saying kaddish for Israel's tycoons and their corporate pyramids?
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The tycoons are fighting for dear life. Hungry for cash as regulation bites down, they're imposing haircuts on bondholders, turning to the courts for bankruptcy protection and calling in rabbis to mediate cash infusions. But their efforts seem futile in the face of the bigger trends working against them. In the past two weeks alone the U.S. firm York Capital Management has been revealed to be attempting a hostile takeover of IDB Development Corporation, one of the biggest holdings groups in Israel; and Haim Saban is reportedly in talks to seize control of Ilan Ben-Dov’s key asset, the mobile operator Partner Communications.
Along the way, bits and pieces of these business groups are being broken off and sold, and this trend will almost certainly continue because the tycoons have no other way of raising cash in the current distressed state of the bond market. Further in the future awaits the so-called Economic Concentration Law, which will make it less pleasant and profitable to rule over a stack of companies.
This legislation and the overall trend toward deregulation and de-monopolization is a fraught process still in its early stages. But if it is even partly successful, it will act as a disincentive to acquiring and holding onto companies that operate in the hidebound industries of the sort tycoons love to be in.
The risk remains that this generation of tycoons will simply pass their pyramids on to another generation of tycoons. It's happened before. In another era, the tycoons were the government, the Histadrut, the Jewish Agency and families like the Recanatis and Eisenbergs. The economic gyrations of the 1980s, the bank shares crisis, family quarrels and the privatization of state-owned companies caused the old guard of tycoons to give way to a new guard even though economic logic should have dictated another trend.
The persistence of pyramids and family-owned businesses in Israel after two decades of impressive expansion in the economy and capital markets is bizarre, to say the least.
The dominance of business groups puts Israel in the third-world league rather than the club of the richest and more advanced economies. In a paper published by the Koret-Miliken Insitute, Stanislav Sokolinski looked at data on the extent of business-group control as measured by their share of total stock market capitalization in 45 countries. In Israel, he found that 55 companies controlled a total of 43 percent of publicly traded shares, a figure that was only exceeded by Peru, Colombia, Thailand, Indonesia and South Korea. Israel also stands out for the complexity of its pyramids – second only to Colombia – with some groups having seven layers of companies.
South Korea has its family-owned chaebols (which coincidentally are under attack as the country goes to the polls in December to elect a president), but as anyone who drives a Hyundai car or uses a Samsung phone well knows, the chaebols for all their faults are globally competitive businesses. Here, it’s another story entirely. Israel may be a start-up nation for some, but most of us are more familiar with a country of crony capitalism and cozy, uncompetitive markets controlled by business groups.
Why has it been so hard for us to shake the tycoons? With one hand, the government tried to starve them with laws and regulations, such as those distancing banks from non-financial companies and barring dual-classes of shares. But with the other hand, the government encouraged them. A big opportunity was lost in the 1990s privatization drive, when instead of encouraging broad share ownership though public offerings, nearly half of all the companies sold by the government went to tycoons of one sort or another.
The fact is that it has been too profitable to be a pyramid-owning tycoon. The opportunity to use business groups to offload lousy businesses onto minority shareholders, use other people’s money on risky investments and funnel cash up to the apex of the group was such a lucrative business that a study by the Israel Securities Authority found tycoons were prepared to pay a premium of 19 to 30 percent of companies' net value to acquire them. That so-called control premium compared with 8 to 10 percent in Europe and a measly 2 percent in the United States. In any event, opportunities to invest vast amounts of capital in Israel's small economy are very limited. Bets on start-up companies are only tens of millions of dollars apiece, infrastructure projects are few and far between and big, internationally competitive companies are rarer still. What’s a tycoon to do but pay top dollar for a monopoly?
History may repeat itself, with a new generation of tycoons coming to assume control of the pyramids, but the odds of that happening look slimmer than in the past. If York takes control of IDB Development, it won’t be to perch itself at the top of the pyramid that was once Dankner’s but to sell it off in parts. Saban is also likely to look at Partner as a short-term investment, as he did Bezeq.
Who will buy the pieces of these pyramids? Aspiring pharaohs may emerge, but it's hard to imagine institutional investors financing new pyramids any time soon. In any case, running them is likely to be less fun in the future. Yigal Toledano, a partner at the accounting firm BDO Ziv Haft, told a conference held by the Tel Aviv Stock Exchange last month that the control premium in Israel is likely to narrow to 15 percent, 10 percent or even less, reflecting the constricted freedom of action tycoons now have vis-a-vis their holdings. These companies will likely be sold to the public via initial public offerings.
Will Israel be a better place without its pyramids? Not as much better as you might think. The real problem is not the pyramids, but what they're made up of, namely monopolies that generate cash and profits as dominant players in uncompetitive markets. These monopolies will continue to pose problems of their own, regardless of whether or not they're stacked atop one another.