The Dream Merchants |

Startups With No Revenues, but Big Plans, Take Tel Aviv Stock Exchange by Storm

The last year has seen a wave of IPOs by startups with no revenues, much less profits, but promises of a brilliant future

Yosef Harash
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A view of the Tel Aviv Stock Exchange, in September.
A view of the Tel Aviv Stock Exchange, in September. Credit: Eyal Toueg
Yosef Harash

They are called “dream companies,” firms that have gone public on the Tel Aviv Stock Exchange either through an initial public offering or by merging with a listed shell company. Many of them have no revenues, much less profits, but they are trading at heady valuations anyhow. That’s because they offer investors rosy forecasts, in other words a dream of a brilliant future lying ahead for those with patience.

Most of the dream companies are in high-tech sectors, such as food-tech, fintech and renewable energy, which since the dot com boom has had a tradition of loss-making stars going public. Many of them are pharma and biomed companies that need years and tens of millions to develop their first product that could end in failure or a fortune.

Another category is natural resources, partnerships that are exploring for oil or gas, which requires lots of capital for seismographic testing and drilling that the stock market can provide. But like pharma and biomed, it could end with a dry well as easily as a gusher.

Dream companies have emerged hand in hand with the IPO fever that has infected the TASE. Last year, some 30 companies completed IPOs and more went public through the shell-company route. The trend is showing no signs of letting up this year, with scores of new companies having already filed to issue a prospectus. About 10 have already gone public.

A typical dream company is SavorEat, which is using 3D-printing technology to produce fake meat. Without any revenues yet, the company is trading at a market capitalization of 340 million shekels ($103 million).

A vegan hamburger developed by SavorEat, in July.Credit: SavorEat

Another is GenCell, which makes ammonia and hydrogen fuel cells used to generate backup power and in remote locations. It went public at an 800 million shekel ($246 million) valuation (counting the money it raised in its IPO) and today trades at close to 1.8 billion ($554 million). BladeRanger, whose robots are used to clean big solar panels, completed its IPO at a 90 million shekel ($28 million) valuation in December despite having no revenues. Today it trades at 215 million ($66 million).

Israel has long been recognized as the startup nation, but for years tech companies that chose to go public preferred the U.S. stock market over the TASE .”Until last year the market was all but closed to tech companies,” said Ori Keren, chief investment officer at More Provident Funds.

“If someone wanted to list a tech company, nearly the only way to do that was by merging with a shell company. Several companies did this and saw their valuations rise quickly and significantly,” he said.

“But the situation has changed. Entrepreneurs discovered that investors had an appetite for tech and you didn’t need a shell company, you could also do an IPO,” he said.

Tables turned

Indeed, the tables have turned. “The companies that are coming [to the TASE] are those that in fact have struggled to raise money in the private market through venture capital funds,” said Keren.

The TASE’s dream companies got a big boost from pioneers such as Augwind, which has developed an energy-storage solution using compressed air, and Electreon Wireless, which has developed a system to power electric vehicles under the roads they travel and went public by merging with a shell company.

Strictly speaking, neither of the two count as dream companies because they are well advanced in developing their businesses and beginning pilot installations. But they are in tech and their shares have soared since they went public.

Dream companies may be an Israeli term, but the phenomenon is global. With money pouring into stock markets in the era of low interest rates and COVID, companies with only a brilliant future to offer have seen their valuations soar.

That’s especially the case in green and other technology, where there’s often a good story to tell, especially amid predictions that the coronavirus will lead to a digital revolution of remote services. The most famous of these companies is the electric-vehicle maker Tesla, which is trading on the Nasdaq at a price-to-earnings multiple of 1,600.

The interior of a Tesla Model 3 electric vehicle is shown in this picture illustration taken in Moscow, Russia, in July. Credit: EVGENIA NOVOZHENINA/ REUTERS

The valuations may ultimately prove to be justified, but in most cases these dream companies will struggle to build businesses equal to their inflated market caps. But many investors regard it as a stock market bubble waiting to be burst.

“If you look at the technology sector in Tel Aviv, you’ll see a strong correlation with the U.S. technology sector. The world is becoming less geography focus and more sector focused,” said Amir Kahanovich, chief economist at Excellence Investment House.

“The coronavirus year has prompted several structural changes in the economy, of which the biggest is in technology adoption. We’re seeing big gains for tech companies and that’s raised valuations for everything around them. Without a doubt, expectations have risen accordingly and at a certain point they became excessive.”

Along with startup companies, another component of the dream phenomenon is research and development partnerships. These are a kind of publicly traded venture capital fund that use the money they raise in IPOs to invest in early-stage startups.

To date, six such partnerships, including Millennium Food-Tech and Smart Agro Investments, have gone public raising a combined 350 million shekels, and four others are in various stages of preparing for an IPO. Market players are divided about R&D partnerships as a quality investment.

Some laud them as a way for the general public to get a piece of the startup action, which is usually the preserve of big investors with the money to invest in VC funds. But others warn that the partnership partner will have trouble succeeding because even the most skilled tech investors rarely succeed in picking future startup winners.

In the meantime, however, the partnerships’ managers collect generous management fees from their investors. Moreover, unlike energy partnerships, R&D partnerships don’t allow investors to use their losses for tax purposes.

The shares of most of the R&D partnerships have left investors with losses since their IPOs, but that may change. “Only now are they making their first investments, so time will tell,” said one investment manager, who asked not to be identified. “Some of them have strong management teams with a lot of knowledge while others look more opportunistic. In the end, these partnerships are a bet on their management.”

As happens during any period of IPO fever, companies that really shouldn’t be going public take advantage of the sentiment. They sell a theoretical potential based on shaky business forecasts that small investors can’t adequately assess and reach an objective valuation for.

Even institutional investors, whose expertise is focused on more non-tech companies and conventional business models, aren’t equipped to deal with dream companies in the tech sector. But they are starting to develop the tools and hire specialist analysts. The TASE has a program to subsidize equity research of small tech companies.

But one market source said the institutions were still incapable of evaluating tech companies and that they would need another five to 10 years to get up to speed.

“Investors are very slowly learning the ropes. It’s knowledge you can’t simply buy, you learn from life – experience and mistakes – so it will take a long time,” said the source. “Investors have to learn which management teams are good and the companies themselves have to learn what’s the right investor mix between VCs and the stock market investors.”

Nevertheless, he remains optimistic that in the long run the TASE’s emerging tech sector will prove to be a good bet, in contrast to the previous wave of IPOs by U.S. property companies.

That still leaves the problem of generous valuations at the time that these companies go public. Unlike in the past, IPO pricing is done through single pricing, a system in which underwriters build an order book with anchor investors. Under this book-building system, which is used in the U.S. market, the IPO price is effectively set between the underwriters and a small group of institutional investors.

Public piles in

The public is left with what little may be left over. Thus, when the new stock begins trading there is often huge demand and the price soars in the first days of trading.

The Israel Securities Authority said this week it was looking into this phenomenon, telling underwriters to provide it with information on valuations and communications with big investors. Right now the ISA has limited powers to curb the IPO market, for example by policing how companies present risk factors in their prospectuses.

Eliav Bar-David, CEO of Leumi Partners Underwriters, defends the system. He noted that there are 80 companies today that have filed to go public, but not all of them will pass the test needed to raise capital from the public. “For every kind of company, there’s an economic model and estimated valuation,” he explained.

“In the first stage, we examine the product, the technology and the company’s story, its team and its shareholders. We look for companies with the potential to disrupt an industry. Then we build a model to arrive at a company valuation – we examine the firm, its market, business environment, competition, competitive advantage and forecast. We build a business model based, as a rule, on a five-year forecast. Then we do a discount and get an indication of the company’s value right now. Assuming the company passes these filters and others, we market it to institutions, which act as another filter,” Bar-David said.

Bar-David said that what has changed is investor sentiment, and companies that would not have stood a good chance of going public a year ago can do so today. That said, the sentiment may be changing again. Over the next year, he sees more big companies – those with valuations of 500 million shekels ($154 million) or more – issuing shares and fewer smaller ones.

“A year ago, the market was much more welcoming to small-cap companies that had aggressive growth stories,” he said. Despite the popularity of dream companies, the fact remains that institutional investors put the lion’s share of their portfolios in big-cap companies.

Another market source, who spoke on condition of anonymity, said he didn’t think underwriters were doing enough to separate the wheat from the chaff. The fat commissions they get from managing an IPO are deterring them from safeguarding the investing public, he asserted.

“Underwriters aren’t being selective. They aren’t setting high standards, so that with the flood of IPOs there are likely companies that are not appropriate for a stock market listing – which doesn’t mean that these companies won’t be a success,” said the source.

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