The Arab You Don't Know May Be About to Change the Market

Pitango venture capital's co-manager, Nechemia "Chemi" Peres, credits Israel's rapid economic growth over the last two decades to the Russian wave of immigration, which came just as Israeli high-tech was starting to makes its mark, but the next breakthrough won't come from a wave of immigration, he says. "Look for it, he says, in the Arab population." Pitango has won a tender for a joint government-private sector fund to invest precisely there.

His job isn't to right historic wrongs; it's business, Peres says. He foresees the fund, Al-Bawadir ("buds" in Arabic) repeating the success of the government venture capital fund Yozma, which nurtured high-tech and created a breakthrough not only in deed but also in awareness.

Avishay Braverman, minister of minority affairs, has heard skeptical reactions to this first such effort here. The accountant general's office at the Finance Ministry said it didn't stand a chance, he recalls, because the private sector wouldn't come on board. To avert failure, the tender offered unusual terms. The state undertook to invest NIS 80 million. To win management of the fund, the investor would have to match that - raise NIS 80 million, too. The state's contribution to other government-private sector funds set up to contend with the global economic crisis is 25%.

Also, after the state gets back its investment plus a minimal return, the private investors will get priority for surplus returns and priority if there are losses: The state will take 70% of the loss on itself.

The Finance Ministry had a point. The tender aroused keen interest. Twelve investment groups competed, but 11 couldn't raise the requisite pledge. Only Al-Bawadir pulled it off, securing NIS 97 million from private investors.

The Al-Bawadir group is run by Pitango, which is headed by Peres and Rami Kalish, together with two prominent investors in the Arab Israeli sector, Jimmy Levy of the Jewish-Arab company Galil Software and Habib Hazan, a former manager at McKinsey & Co.

Peres probably succeeded where others failed by virtue of the high esteem in which he's held in venture capital circles, as the son of Shimon Peres and bearing his faith in the mission. He had decided to go for it whether Pitango won the tender or not.

"The moment we began to study the topic of investments in Israel's Arab sector and we realized the business potential, we decided the government tender is just the trigger, not the reason. From our perspective, the fund is Al-Bawadir No. 1. We're already planning the sequel funds."

Recruiting investors wasn't easy, he says, because Al-Bawadir was the first fund of its kind. "We contacted investors overseas. They asked for back history, such as profit proportional to investment (profit multiple). But there's no data, which turned off a lot of people. The reason we managed to raise the pledges after all is that we, and Levy and Hazan, put all our resources of time and Pitango's reputation behind it - and it worked."

Backers include leading Israeli and Arab businessmen, foreign investors and Israeli banks and insurance companies.

Peres' optimism may raise eyebrows, given the statistics on minorities - Arabs, Druze and Circassians. Israel has 1.5 million minority citizens, 20% of the population, but their contribution to output is just 8%. Only 40% of the adults work and among Arab women, the figure falls to 20%. A third of the Arab women with higher education are jobless. Household income is 57% below that of Jewish households, and 50% of the families fall into the category of poor. It's improving, though - two years ago that figure was 54%.

Behind this miserable showing is poorer education, inferior infrastructure and cultural barriers. Also, Jews don't really want Arabs, Druze and Circassians in their economy.

"The Jews don't know the Arabs," says Braverman. "They think Arabs are low class, or that they're fanatic Muslims who hate Jews. Both [ideas] are wrong. Ninety percent of them are loyal citizens, who just didn't get the right opportunities. Israel's culture is one of friend recruits friend. Arabs don't have a chance to break in."

In some sectors, such as medicine, Arab doctors receive equal treatment and prove highly successful. In areas such as high-tech, equality isn't there. An Arab engineer has almost no chance of finding a job in high-tech here, because nobody knows him or recommends him, and because of a preconception that the technological ability of the Arab sector is inferior.

Jimmy Levy has been managing Galil Software for years, where Jewish and Arab engineers work together. But even he can't shake that prejudice. He doesn't buy an idea that Braverman is trying to promote, of inducing companies to set up R&D centers in the Galilee rather than in low-cost but distant and high-risk India.

Braverman points out advantages, government subsidies for the periphery, the support of the new fund and "the fact is that the Arab engineers are more loyal to their workplace than Indians or Jews." Better to set up R&D centers at a drive's distance from Tel Aviv than hours away by plane, he urges.

Levy isn't the only one who thinks otherwise. "We have no intention of seeking substitutes for Indian engineers," Chemi Peres says. "We aren't looking for cheap labor in the Galilee, but quality work. Companies that Pitango backs use Galilee Software's development teams and get excellent, convenient work. It saves them the trouble of recruiting the development teams themselves. Pitango specializes in everything involving brainpower and innovation with high growth potential and talented entrepreneurs. In our opinion, there's unexploited growth potential."

He knows whereof he speaks, Peres argues, as the group has already identified potential investments. "Levy's been among the Arabs for years because he founded Galil Software, and Habib also knows the Arab economy well. We already have investment ideas."

TheMarker: In what areas?

Peres: "Internet, cellular, life sciences and energy."

These are all areas in which Israel excels.

"Yes. Why should that be a surprise? There's no difference between the expertise of Israeli Arabs and that of the Jews."

In practice, the business potential that Peres expects Al-Bawadir to realize extends far beyond the borders of Israel. He relates a story of two high-tech companies, which both grew from Pitango's portfolio and both conduct extensive business in Saudi Arabia and Iran. "There are no barriers in business," says. "There is tremendous opportunity in the Arab world. They're especially hungry for Internet, cellular and health-care services. A fund like Pitango invests in Israeli companies from the exclusive viewpoint of exports, because the Israeli market is too small. We really do export to the whole world, but not to the Arab market right next door, with its 400 million consumers. Therefore, we believe Al-Bawadir's potential for success could open the Arab market for us, and therefore present an important advantage to Pitango's companies as well."

The joint government-private sector fund for investment in the Arab sector is the fruit of two years of work, led by Iman Saif, head of the Authority for the Economic Development of the Arab, Druze and Circassian Sectors, which operates under the auspices of the Prime Minister's Office, together with the accountant-general at the Finance Ministry, the director-general at the PMO and the minister of minority affairs. Braverman, who holds the portfolio, talks in terms of righting wrongs that Jews did to Arabs and sees the fund as a great opportunity for Israel.

He says: "Righting the historic wrong perpetrated on Arab citizens is an important signal to the Arab world. There's no doubt that the way Israel treats its Arab citizens affects its image in the Arab world. If Israel wants sustainable growth, it has to invest in the Arabs. There isn't going to be another massive aliya from Russia. Israel's future growth depends on the integration of the Haredim (ultra-Orthodox) and the Arabs in society."

He says things must move, success must be demonstrated; Israeli companies must start hiring Arabs. "We aren't seeking affirmative action, just an opportunity for excellent workers. Equal partnership isn't just justice, it's also excellent for the economy. The last prime minister to act on it was [Yitzhak] Rabin, and it's a paradox of history that Benjamin Netanyahu is the one who has to continue in Rabin's path," Braverman says.

Al-Bawadir will invest in a range of companies belonging to minorities, from startups to mature firms, from technology to industry. "We'll look for interesting technologies or unique know-how that an industrial company might have that would enable it to develop," Peres says. He expects the fund to invest about NIS 185 million in 20 to 30 companies over five years. The fund would mature in 10 years.

If anything, its main difficulty may be to find enough portfolio companies, in view of the scarce business awareness in the Arab sector, not to mention little awareness of the fund's existence.

Arab companies have great difficulty in raising money, says Saif. Israeli banks don't operate in the sector except in retail banking. "When an Arab businessman wants credit, he gets sent to the bank's main district branch, where nobody knows him or the sector."

There are also problems with transparency and guarantees. The Arab sector faces a terrific problem of land registration. Much of the land isn't registered and can't serve as collateral for loans. Moreover, the banks argue that land in the Arab sector can't easily be sold in the event of default on debt, so even if a piece of land is registered, it gets a low appraisal.

The fund's very raison d'etre is to help Arab businesses overcome the barrier of borrowing, Saif explains. That's also why the state agreed to put up half the money, he adds.

Braverman and Finance Minister Yuval Steinitz are hammering out a plan for the state to increase guarantees for minorities, making it easier for them to borrow. However, the main obstacle that Saif sees in the business development of the Arab sector has nothing to do with capital. It's opportunity and know-how. "It isn't just the money," he says. "The advantage that the fund brings is, first and foremost, knowledge. Businesses in the minorities sector are managed amateurishly. Now they'll have a chance to get advice from leading businesses." That is the vast importance of the Israeli business sector's show of faith - through investment.