Analysis |

Apax Learns There’s a Difference Between Fund Management and Cottage Cheese

The private equity fund lost big in its deal to sell Psagot Investment House because financial services is a competitive market; It did much better when it sold the dairy monopoly Tnuva

Eytan Avriel
Eytan Avriel
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Apax CEO Zehavit Cohen.
Apax CEO Zehavit Cohen.Credit: Moti Milrod
Eytan Avriel
Eytan Avriel

On Friday, Altshuler Shaham Investment House informed the Tel Aviv Stock Exchange that it had reached an agreement to buy Psagot Investment House. The announcement confirmed once and for all what everyone long knew: The 11 years that Psagot had been owned by the Apax Partners fund, for much of that time closely managed by Apax’s CEO Zehavit Cohen, were one big failure.

Cohen led Apax’s purchase of Psagot from the York and Markstone funds, paying 2.5 billion shekels ($777 million at current exchange rates). She had tried in recent years to sell it for more than 3 billion shekels, but never got the price she was looking for. Last week, Cohen settled for 910 million shekels from Altshuler, adding up to a 50% loss for Apax even after taking into account the dividends it collected over the years and the parts of the Psagot business it didn’t sell.

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The deal will leave Altshuler managing 271 billion shekels in assets, making it the Israeli industry’s third-largest player. However, Altshuler plans to divest much of the business, leaving it only with Psagot’s provident fund and pension management businesses.

For a private equity fund like Apax and the investors who back it that’s a huge loss, especially taking into consideration that the past decade has been a good one for the Israeli economy in general and for the financial services industry in particular.

Three things explain what happened: management, management, management, When Cohen bought it, Psagot was – under the leadership of Roy Vermus – Israel’s biggest and fastest-growing investment house. A little over 10 years later its situation could be described as treading water at best, after losing ground as rivals such as Altshuler and Yelin Lapidot grew quickly, sometimes at the expense of Psagot itself.

Cohen’s first mistake was the overlay generous price she paid at the start.

The second was the CEOs she chose to run it and her relations with them. Executives came and went quickly. Vermus was replaced by Ronen Tov, who learned from the newspapers that he was about to be summarily dismissed after just 18 months. His successor, Hagai Badash, left after four years and after a leadership interregnum was replaced by Barak Soreni, who in turn was replaced by Reuven Kaplan. Vermus, meanwhile, struck out on his own, forming Noked Capital and successfully raising lots of capital.

Raising fees

Cohen’s third mistake had to do with her strategy. The first policy Psagot pursued after it was acquired by Apax was to raise its mutual-fund management fees, which caused investors to withdrew their money and take it to different managers. Mutual funds under Psagot’s management dropped from 190 billion shekels to 175 billion (as of July), while the company ceded leadership of the provident fund segment to Altshuler Shaham.

There is no way to look at Psagot’s past decade as anything other than a dismal failure. In a period during which the total financial assets held by the Israeli public grew by 70%, to 4.3 trillion shekels, the investment house’s funds under management actually declined slightly.

“All it had to do was manage the money in an ordinary way and Psagot would have had more than 200 billion shekels in assets. The capital market has generated very high returns over the past decade, but at a time when the market took off, Psagot went into reverse,” a source in the capital markets told TheMarker last summer. Indeed, not only did Psagot charge higher fees, but its funds performed poorly for its clients, relative to other Israeli investment houses.

“Raising management fees hurt them. It created a situation in which money left the investment house and that undid its reputation. Apax didn’t understand that raising fees isn’t like raising the price of cottage cheese, as they did at Tnuva,” said one former Psagot executive.

That provides another insight into Apax’s management style. Managing a monopoly, like Tnuva with its grip on the dairy market, is different from managing a company like Psagot that has to contend with real competition.

Cohen, has done three big deals in Israel over the years – besides Psagot and Tnuva, also the telecommunications company Bezeq. Bezeq and Tnuva were (and still are) monopolies, and Apax earned big profits when it sold them. Bezeq and Tnuva were in easy positions to raise prices, but Psagot didn’t have that option.

Fact: In its statement to the TASE Friday, Altshuler Shaham revealed that in the first nine months of 2020, Psagot lost 153 million shekels. Altshuler, which manages far less money than Psagot overall, earned a profit of 94 million shekels.

Failed model

Beyond the story of Psagot and Apax themselves lies a bigger one about the failed business model of many private equity funds, if not all of them. They come with bags of money, buy businesses in highly leveraged (debt-financed) deals and then do everything they can to boost the business’ profits quickly to cover the financing costs. How?

Elizabeth Warren, the Massachusetts senator and legal scholar who campaigned for the Democratic presidential nomination last year, explained it in a Medium post.:

“The firms can use all sorts of tricks to get rich even if the companies they buy fail. Once they buy a company, they transfer the responsibility for repaying the debt they took on to the company that they just bought. Because they control the company, they can transfer money to themselves by charging high ‘management’ and ‘consulting’ fees, issuing generous dividends, and selling off assets like real estate for short-term gain. And they slash costs, fire workers, and gut long-term investments to free up more money to pay themselves,” she said.

Cohen and Apax operate according to this model. Bezeq and Tnuva had considerable real estate assets that were sold quickly. Tnuva retained the services of the U.S.-based global management consulting firm McKinsey & Company, which recommended raising the price of cheese, including cottage cheese – and thereby helped set off a wave of consumer protests in the summer of 2011. At Bezeq, Apax collected fat dividends instead of investing in upgrading infrastructure. Two years after Apax sold Bezeq, the Organization for Economic Cooperation and Development said that Israel had one of the least-advanced telecommunications networks in the developed world.

On top of that, private equity funds don’t always pay taxes: As far as anyone knows, ordinary Israelis didn’t see a shekel of the profits Apax earned from Bezeq and Tnuva, because it is a foreign fund registered in the Isle of Guernsey tax haven. The 2018 annual State Comptroller’s report severely criticized the Israel Tax Authority for allowing that to happen.

It doesn’t always happen that way. There are funds that operate differently and manage to create value in the companies they buy and exit profitably. FIMI, which is managed by Ishay Davidi, is one such fund: It doesn’t buy monopolies, but rather mainly export companies that cannot dictate prices. FIMI upgrades them with sustainable models, which is evidenced by the fact that many of its former portfolio companies continue to grow after the fund has sold them.

By contrast, Apax’s former portfolio companies have subsequently gotten into trouble. Shaul Elovitch, who bought Bezeq, became ensnared in Case 4000 and lost control of the company. Tnuva was forced to grapple with the effects of the social-justice protests. Its buyer, the Chinese company Bright Food, was ultimately disappointed with its purchase. If Psagot’s new owners enjoy a better outcome, it will because Apax lost a bundle to rid themselves of it.

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