How Will Israel Fare When the Nasdaq Jet Finally Runs out of Fuel
Wall Street just had its strongest decade of gains. Should it crash, would the tech-dependent Israeli economy survive unscathed?
The Nasdaq Composite jumped approximately sevenfold between the low of 1,284 points recorded in March 2009, at the height of the financial crisis, and the then-record high it reached in the final trading days of 2019, when it passed the 9,000 points mark. All analyses show that the last decade was the longest period of gains in Wall Street's history.
The tech industry has also risen to unprecedented heights over the past decade, boosted by Nasdaq and fuelled by global minuscule interest rates. Unimaginable amounts of money have been poured into the sector, and the FAANG heavyweights—Facebook, Apple, Amazon, Netflix, and Google—replaced oil and gas companies and automakers on the indices.
Supposedly, in an era when an initial public offering is no longer the ultimate objective and companies can remain private for 10 years or more, Nasdaq should no longer be the holy grail. So why is the exchange still so important to the tech sector? Even if only as a security blanket, venture capital funds and private tech investors still depend on Wall street; even if they have no intention of IPOing one of their portfolio companies in the near future, they still want to know the option exists. There is currently a lot of readily available private money, and low interest rates mean investors are always searching for greener pastures in order to net higher returns. Still, Nasdaq is like home—they need to know it is there, stable and ready to welcome everyone with open arms.
Israel is no different, and its reliance on the tech sector, and thus on Nasdaq's continued prosperity, should worry its policymakers.
As long as Nasdaq is thriving, the tech festival—mega-rounds for young companies that metaphorically rise to unicorn status and multi-billion exits for companies with no revenue or profit—can go on. Israel, of course, is one of the main beneficiaries of these huge deals. According to a December report published by accounting firm PwC Israel, 587 private Israeli tech companies were acquired for a total of $70 billion over the past decade. Including acquisitions of public companies like Mobileye and Orbotech Ltd., the total sum of Israeli exits reached $108 billion.
It is well-known that tech is, and has been for many years now, the main growth engine of the Israeli market. But it is also the savior of Israel's balance of trade: in the services sector, for example, the tech industry contributes half of all export, but the entire sector grew by 12% in 2019 while the tech sector's total export increased by 16%. At the same time, according to data published by the Israeli Bureau of Statistics (CBS), the deficit in the export of goods reached a record high of $25.7 billion in 2018, and Israel's balance is only saved by the surplus of its services export—and by the tech industry's part in it.
These numbers are certainly a cause for pride, but one should not ignore their drawbacks. "Israel's economy has become an option traded on Nasdaq," Gilai Dolev, a veteran investment analyst who weathered the recession of the early 2000s, told Calcalist. A common complaint regarding the local tech industry is that lack of skilled tech personnel is holding the industry back, but the market share of people employed in the industry, 9%, is already the highest in the world, he said. "Even the positive figure of a surplus in the balance of trade is on the rise, and it is mostly based on the tech sector."
To paraphrase, if Nasdaq grinds to a halt—certainly a possibility considering it is currently experiencing its longest period of gains to date—the impact on the Israeli economy and the strong shekel will be dramatic.
The 2008 financial crisis mostly skipped Israel, because at the time the country was a small-time player in high-risk financial products. When it comes to technology, however, Israel is all-in—second only to the U.S. in terms of scope, and first in terms of economic dependency. The effect of a bubble burst could be worse than that of the dot.com bubble, because back then, fewer companies operated in the sector, and fewer people derived their livelihood from it.
Dolev is not looking to rain on everyone's parade; he wants decision-makers to be aware that the success of the tech sector, and the vast amounts of capital it draws, have created a new reality. The undisputed upsides of this reality are fast growth, lowered unemployment, and increased quality of life, but there are a few side effects, too. One is the widening inequality caused by significantly above-average tech wages. Another is that while the tech engine rushes forward, the rest of Israel's industrial sectors are left far behind.
According to Isracard Ltd. Chairman Eyal Deshe, who held senior positions at Scailex Corporation Ltd., Check Point Software Technologies Ltd., Mobileye, and Teva Pharmaceutical Industries Ltd. throughout his lengthy career, the growing presence of multinationals that break the employment market with their wages requires further regulatory oversight.
"On the one hand, it is clear that development centers contribute greatly to the advancement of the local tech sector," Deshe told Calcalist. "On the other hand, Google and Amazon pay according to the Silicon Valley benchmark, and that may be weighing down local startups." While he is not a big believer in government interference, he said, increasing the income tax when one crosses a certain threshold is a possibility. Another option is to require companies to register intellectual property developed in Israel in-country instead of overseas, which will increase their contribution to the local economy.
Beyond the social gaps, the main risk of Israel's growing dependency on multinationals is that they hold no sentimentality for the country. If and when Nasdaq starts a correction course, the flow of money currently funneled into the local tech sector could slow down, and investors would likely move on to the next big thing. While local startups would probably attempt to tighten the belt and maybe cut nonessential personnel, multinationals may carry out significant layoffs or even close local operations altogether. Giant tech companies like Intel or Microsoft are already so deeply entrenched that their local offices survived even in the early 2000s. But the fashionable visitors—those companies that opened local outposts in recent years because Israel was the place to be—their foothold is more precarious.
Israel's Ministry of Finance is starting to wake up to the threat. In a recent review published by the ministry's chief economist Shira Greenberg, she referred to the cyclical nature of private investments in tech. Private funding for innovation in Israel—just like in the U.S.—tends to rise sharply during peak periods and fall sharply during recessions, she said, calling it a market flaw that tends to lead to a closure of startup companies during crises due to temporary financing problems.
Greenberg's review highlights the main failing of investments in tech compared to investments in industry: the lack of tangible assets that could help ground foreign companies in Israel.
The ministry also stressed that beyond the presence of multinationals, a significant share of local venture capital funding comes from non-Israeli investors. In 2018, for example, U.S. venture capital investors accounted for 35% of all investors in Israeli tech, while in 2019, that percentage was even higher due to a large number of mega-rounds led by non-Israeli funds. There is an almost direct correlation between the growth of Nasdaq and the scope of investments in Israel, the review stated.
An additional aspect that should be considered is the impact of the tech sector on the shekel-dollar exchange rate, on which the Bank of Israel is waging a losing battle. Some attribute the bank's inability to manage the strength of Israel's currency to speculants that move its valuation every which way, but there is another significant contribution—the dollars infused into Israeli economy on a regular basis, by and into the tech sector. The fact is, if one compares the Nasdaq Composite to the shekel-dollar exchange rate, the pattern of change is nearly identical.
Besides exits, venture capital investments play a large part: such investments in Israel amounted to $8.3 billion in 2019, up from $6.4 billion in 2018 and $5.3 billion in 2017, overall $39 billion in the last decade. The more mega-startups, the more capital venture funding.
The strong local multinational activity is also one of the main engines converting large amounts of dollars into shekels. Many of the tech M&As lead to the buyers' establishing an Israeli research and development center, resulting in around 400 local R&D centers belonging to multinationals today. Amazon, Facebook, Google, Microsoft, and Intel all have local centers, with Intel being the largest private employer with 13,700 people, but there are hundreds of smaller companies, too. Out of the 300,000 plus tech employees in Israel, between 60,000 and 80,000 are employed by multinationals—depending on whether one counts only research and development personnel or the sales and marketing teams as well.
According to a CBS report from November, multinational R&D centers contribute high above the rest of the market—in 2017, they paid on average around NIS 499,000 (approximately $144,000 at the time) a year per employee, compared to Israeli startups, which paid NIS 336,000 on average (approximately $97,000 at the time). Half of those employed by multinationals work in R&D, meaning those multinational centers today contribute around half of the total R&D expenditure in Israel's private sector.
$3 billion—that is the sum multinationals and startups pay each month as wages for their Israeli R&D employees, rent, and the leasing fees for the cars these employees drive. Annually, that is around $40 billion, based on the number of employees and their wages as reported by the CBS, the average real estate leasing prices at areas preferred by tech companies, and additional expenses such as flights and paid lunches.
That is a significant sum even compared to the heaps of dollars the Bank of Israel is hoarding, which stood at $124 billion at the end of November 2019, double the amount it held at the beginning of the decade. Those reserves are, by now, around a third of Israel's gross domestic product (GDP). The Bank of Israel has invested immense sums in efforts to stabilize the shekel and prevent further damage to non-tech Israeli exporters, but this battle is far from even.
Aharon Aharon, the CEO of government investment arm the Israel Innovation Authority, was one of the first to point out the problems caused by the country's R&D bubble. In an interview with Calcalist in late 2018, he said multinationals snatch talent that could have otherwise become the next generation of local startup founders. "If you're asking me whether we should be happy to if another giant like Microsoft, Apple, and Amazon decides to open a local operation, the answer is no," he said at the time.
As long as Israel acts as a drawing stone for multinationals, it should be leveraged appropriately—mainly through taxation. Today, multinationals contribute around 18% of the country's total income from direct tax. A recent report compiled by Tel Aviv-based research firm IVC Research Center Ltd., Israel-based GKH Law Offices, and umbrella organization Israel Advanced Technology Industries (IATI) found that overall, multinationals paid around $8.85 billion in employment taxes to the Israeli government in 2019. Despite the fact that multinationals pay a minuscule corporate tax rate of 2%-3%, they are already paying an unusually high percentage of Israeli taxes overall, further highlighting the country's dependency on its tech sector.
According to Pitango Venture Capital managing partner Ayal Itzkovitz, a Nasdaq crisis could provide Israeli companies with an opportunity to counterbalance the expected impact a potential reduction in multinational presence will have. "After almost a decade with no new big Israeli companies, in recent years, a new generation has been established of solid companies that will continue to grow quickly and hire Israeli engineers," he said. "Companies like Wix.com, Via Transportation Inc., Appsflyer Ltd., Taboola, and Outbrain—together they hire thousands of people a year, and in light of the difficulty in recruiting Israeli employees, they set up centers in East Europe and Asia. If multinationals limit their exposure to Israel, weakening the shekel as a result, these companies will be happy to return and boost their Israeli presence at the expense of their other centers."