Bottom Shekel / The Pyramids Are Crumbling Before Our Eyes

Africa Israel is making last-ditch efforts to reach a debt arrangement with public bondholders, to whom it owes NIS 7.5 billion.

Africa Israel is making last-ditch efforts to reach a debt arrangement with public bondholders, to whom it owes NIS 7.5 billion. These efforts include a promise by Africa Israel that if the public agrees to forgo part of the debt, the company will exchange the bonds for shares plus bonds with better terms. What are the guarantees that the new bonds will be repaid?

The same guarantees provided for the original bonds: the sale of assets, of course, but mainly dividends that will be paid by Africa's subsidiaries to Africa Israel. Since Africa Israel is a holding company, most of whose activities are conducted by subsidiaries, the company's main sources of income are the dividend payments transferred to Africa Israel by those subsidiaries. Africa Israel's recent financial statement includes a forecast that the company's subsidiaries will transfer NIS 350 milion-NIS 540 million a year until 2011, and that money will be the main source for paying its debts.

"It must be stressed," notes Africa Israel's financial report, "that the disbursement of a dividend is subject to approval by the relevant organs in the subsidiaries, and there is no certainty that they will approve [the dividends]."

There is indeed no certainty and never will be. Africa Israel, as a holding company that derives a significant portion of its income from its subsidiaries, depends on the good-heartedness of the subsidiaries' boards of directors. Without dividends, Africa Israel would have very few sources from which to pay its billions in debts.

How nice to discover that all our pension funds purchased NIS 7.5 billion worth of Africa Israel bonds, practically without anything on which to rely, except "the good-heartedness" of the board members at Africa Israel's subsidiaries. How nice to discover that this story is the same for all Israel's pyramid-structured corporate holding companies. They all have a single controlling shareholder, who with a miniscule holding in the mother company manages to control a vast pyramid of companies. In all these holding companies the mother company has practically no independent income, but this did not prevent them from selling massive sums of bonds to the public. Still, the institutional investors queued up to buy tens of billions in bonds from all these companies, with practically no guarantees for repayment, not even the cash flow from the companies that sold the bonds.

Now that Africa Israel is collapsing, the pyramid structure is crumbling in front of the Israeli public's eyes. Suddenly it turns out that when a holding company is in financial distress, it has no actual sources of income of its own to repay the public. Suddenly it turns out that the entire structure of the Israeli capital market is based on slapdashery and conflicts of interest.

Slapdashery, because all the financial institutions used money from all our pension funds to buy bonds that had no real economic basis. This, by the way, is in complete contrast with other institutional investors around the world, which avoid investing in holding company bonds for this very reason.

Conflicts of interest, because the very structure of the Israeli holding company forces the subsidiaries to be recruited to the service of repaying their mother company's debt. Let's suppose a certain Africa Israel subsidiary, which is traded on the stock exchange independently and whose shares are owned by the Israeli public, is presented with a particularly large and promising investment; or that the subsidiary's board fears the global credit crunch is looming again. What are the chances that such a board would consider not approving a dividend? We would not be accused of excessive cynicism if we figured the boards of all Africa Israel's subsidiaries would not miss a single dividend payment in the next few years - not as long as the mother company needs the cash from the subsidiaries' dividends to meet the debt arrangement it is offering.

True, the boards of the subsidiaries are obligated, by law, to serve only the best interests of the mother company that runs it. But we would again not be over-cynical if we figured the good of the subsidiary is an important consideration - even though the good of the mother company is also important. Or to be more precise, it is the good of the mother company's controlling shareholder, who if he gets stuck without the cash flow from the dividends is liable to lose his control of the mother company.

Now the true picture of the Israeli capital market is revealed: There are dozens of companies, in many of which the Israeli public is a partner, and their ultimate goal is to make sure the controlling shareholder can continue holding the reins. Thus sizable chunks of the Israeli economy are recruited to serving the controlling interest of the people at the top of the pyramids of the huge companies: the tycoons.

What makes this whole picture even more encouraging is that the institutional investors, which are supposed to be safeguarding the public's pension money, are allowing all this to happen, by investing in the holding companies' bonds and not watching out for the public's interest when they also invest in the subsidiaries of the holding companies. We must not forget that in most cases, the institutional investors own both shares and bonds in the holding companies, as well as shares and bonds in the subsidiaries - to the point where even they are incapable of discerning whose interest, among this sea of interests, they are supposed to be serving.