Banking on the Boss

Israel’s capital market tends to hold company owners in high esteem. But recent events show some are willing to protect only themselves.

Ishay Davidi, founder and CEO of FIMI Opportunity Funds, is highly revered in financial circles. When he decides to invest in a public company, its share price usually rises. There are times when just a hint that he intends to invest is enough.

Davidi could be said to deliver what’s known as a “management premium.” Investors believe that, as the person in charge, he’ll know how to improve the company and add shareholder value.

Ayala Tal - 28122011
Ayala Tal

The value of the management premium varies based on the esteem attributed to the head honcho. Many investors subconsciously factor in the premium based on the character of the person in control, his track record, his behavior in past crises, and his ability to support the company financially if it runs into trouble. Owners who give their companies money from their own pockets enjoy higher regard.

Some investors believe certain owners can reduce the company’s risks. But this way of thinking is dangerous. Ignoring or trivializing risks often leads to unpleasant surprises.
Such investors may suddenly discover, for example, that the real estate market is more volatile than they thought, as property prices drop and homes become difficult to unload. They’ll turn to the owner, hoping he’ll save them with his wiles, or at least his cash. But is relying on the person in the corner office to bail you out a good strategy?

The Israeli capital market could generally be said to hold company owners in great respect. Many hold a large portion of their company’s capital and maintain sole responsibility for how the firm is run. Managers at institutional investors may hope one day to go work for them and land themselves a lavish pay package, so they try not to annoy them too much.

The owners of Israeli companies know how to work their magic when recruiting capital from the public. They know how to convince investment managers that they’ll support the company in every way imaginable. Three years ago, for instance, Ilan Ben-Dov reassured creditors of his company Tao Tsuot. He tried to convince them that the chances of Tao not meeting its obligations were lower than they thought, and depended mainly on the state of the capital market. Some were reassured.

But while Israel’s stock market went on to flourish, Tao languished until Ben-Dov finally admitted the company couldn’t pay its debts − and asked creditors for a settlement.

When an owner decides to give his company financial support, he isn’t doing this just for moral reasons − concern for creditors or to protect workers’ jobs. He usually has a purely financial motive − reducing the cost of raising capital for the company, or other companies he controls.

This affects how secure bondholders feel. If bondholders can be persuaded that the owner will help the company during a crisis, they will feel the company has a lower risk profile and will let the company pay them less interest on the money they loaned it.

The connection between trust in companies and the identity of their owners becomes particularly clear in times of crisis. That’s why Elbit Imaging bonds, for example, lost value and saw its yields skyrocket to 20% to 30% when the market discovered that Moti Zisser, the controlling owner, was in trouble over personal debts to Bank Hapoalim. Another example was provided by Lev Leviev, owner of Africa Israel Investments, when he pumped NIS 800 million into his company to complete its debt settlement. The infusion enhanced Leviev’s reputation and has helped him maintain control.

But these cases are the exception, not the rule. Debt settlements and bankruptcies by companies on the Tel Aviv Stock Exchange in the past few years are forcing investors to change how they see company owners. For one thing, don’t forget that the controlling owner’s interests often clash with those of public shareholders and bondholders. The controlling owner could be interested in diversifying the company’s activities, for example, in order to minimize his overall business risk. That’s how real estate companies like Alrov came about, with a large portion of their assets in Israeli bank shares.

Or some owners sometimes have a stake in several companies, and this could tempt them into insider deals that don’t necessarily serve the public’s best interests. One example was the IDB group’s acquisition of Israir, which involved the transfer of heavy personal commitments taken on by Nochi Dankner, Israir’s controlling owner, to the publicly-traded IDB, which he also controls.

Another issue is a controlling owner’s thirst for huge dividends. But if dividends are too large, it could undermine the company’s financial stability and make it difficult for the firm to meet its obligations when faced with a crisis.

Investors in a company or its bonds must weigh all these considerations. A company should be evaluated primarily based on economic parameters. The identity of the person in control is less important than the company’s business environment, cash flow, threats and management strategy.

If the owner’s identity must be factored in, it may be best to assign it a negative premium: This way investors can avoid unpleasant surprises when the company runs into trouble.