ISRAEL AT WARWill Israeli tech save the Israeli economy?
ISRAEL AT WAR
Will Israeli tech save the Israeli economy?
There are many reasons to be optimistic about the resiliency of Israel’s tech sector right now, however the prolongation of the war could discourage investors and drive away multinational companies
Can the high-tech industry save the Israeli economy, which is heading towards a tough crisis? With the collapse of most assumptions upon which life in Israel was based until October 7, there are many questions about the resilience and stability of one of the key and most critical sectors in Israel.
The war hit Israel when its economy - like the rest of the world - was not in the best shape, especially the tech sector. This was due to a global shift in investor preferences following the rise in interest rates and the attempted judicial overhaul by the Netanyahu government, which caused many investors to distance themselves from Israel.
However, contrary to our concerns, the high-tech sector is thus far demonstrating resilience. This is evident by the announcement of several transactions, such as Next Insurance, which yesterday announced a $265 million funding round, the largest for an insurtech company in the world since the beginning of 2023, which follows Palo Alto's acquisition of cybersecurity startup Cybereed for $410 million. The resilience is also reflected in the generally positive forecasts provided by leading tech companies, such as Mobileye and Check Point, two of the largest employers in the Israeli tech sector, both of whom employ thousands of workers. These companies, which have hundreds of employees called to military reserves, are still growing in the fourth quarter, despite the nearly complete suspension of work in Israel. They note that they are continuing to work despite the security situation.
If we analyze the Israeli high-tech industry, we can see a glimmer of hope and a potential anchor for the recovery of the economy in the future. There are several reasons for this:
1. Not dependent on the Israeli market
At times, this can be a source of frustration and criticism. However, local high-tech companies, since their early days, have been targeting international markets. This is especially true for fintech and insurtech companies that often do not even bother getting licenses for the Israeli market. Now, when the local economy is almost at a standstill, tech companies’ sales are hardly affected by it. Due to their reliance on international markets, even the youngest startups often have employees abroad. In most companies today, some of the tasks are outsourced to workers outside of Israel. Even if there are delays in project execution, they can compensate for that during relatively calm periods of missile attacks, unlike businesses in the service sectors that may struggle to make up for the weeks they were closed.
2. No physical factories and a hybrid model
Most high-tech companies, except for a few such as Intel or Tower, do not have physical factories that may be damaged by missile attacks or cannot function because of their proximity to the northern or southern borders. Most high-tech workers worked from home. Many companies have tried in recent months to bring employees back to the offices, but it was only partially successful and most companies still continue to employ a hybrid model, working from the office up to twice a week.
3. The mass call-up of employees to the military could reduce expenses
Ironically, calling up tech employees for reserves may lead to cost savings for startup companies. In startups, the workforce is typically characterized by younger employees who are more willing to take more risks in contrast to older workers who prefer more stable companies. In larger and more established companies, the percentage of reservists drafted ranges from 5-10% on average. In startups, the percentages are much higher, averaging around 20%. There are extreme cases, like a young cybersecurity startup where 13 out of 15 employees are in the reserves. The absence of these employees naturally affects the company’s ability to function, especially smaller ones. However, it also reduces their expenses because their salaries are paid by the state. Thus, startups can actually prolong the time until the next funding round and postpone it to a better time.
4. The strong dollar improves performance
It's impossible to discuss the cost structure of tech companies without considering the exchange rate. The jump in the dollar's exchange rate against the shekel, which began before the war but has strengthened since, is enhancing the performance of tech companies. This is already evident in the financial results of most companies in the second and third quarters of the year, and the impact of this factor will only grow with the weakening shekel. Tech companies benefit from this more than regular exporters, as the lower shekel makes their products more competitive. Not only are their revenues in dollars and labor costs in shekels, but their funding is also in dollars. This has become even more crucial since the tech sector's own crisis during which funds were transferred from Israel abroad, holding them in dollars.
5. The government’s attempted judicial overhaul is off the table
There is another optimistic point that is being discussed in the tech sector - the assumption that the reform in the judicial system has finally subsided. Since the beginning of the year, the decline in fundraising for Israeli startups has been more significant than in the United States and Europe. There was concern that even when recovery begins abroad, this wouldn’t happen in Israel because many froze investment in Israel as long as this policy was on the agenda.
Alongside these reasons for optimism, we must not ignore the many risks that hang over the tech sector, and are particularly characteristic of it. The first one is the disillusionment of investors due to Israel’s geopolitical risk, especially those who have only started working in Israel in recent years. The last significant war in Israel was Operation Protective Edge, almost a decade ago. In its aftermath, a generation of venture capital and risk capital investors and investments that were not exposed to the coping of portfolio companies with reserve duty, missile attacks, and civilian evacuations grew.
These are not just investments by Israeli funds and private equity funds in Israeli companies, but also a willingness to invest in Israeli venture capital funds or foreign funds with a significant presence in Israel, such as the American Insight or the European Index. These funds have a large presence in Israel, and in the coming months, they will face a significant test in their abilities.
Another risk is a boycott of Israeli products. In the tech sector, there are reports that companies have not encountered it so far, except for isolated events that were not even on the management's agenda. However, the continuation of the fighting and the intensification of the humanitarian crisis in Gaza may increase anti-Semitic and anti-Israel sentiment worldwide.
But the most tangible and threatening risk lies in the continuation of the war. In addition to the significant damage that will be caused to the development of companies as a result of the prolonged absence of their employees, the biggest concern is in the large multinational companies. About a third of the Israeli tech sector works in 400 R&D centers of foreign giants such as Intel, Microsoft, Google, NVIDIA, Amazon, and Meta. Intel has already experienced major conflicts in Israel, including the Second Intifada, the Second Lebanon War, and Operation Protective Edge. However, for companies that do not have large capital investments in Israel like Intel's factories, and those that have not experienced wars in the past, the temptation to flee may be significant if the war escalates.
The Start-Up Nation Policy Institute’s chief economist Dr. Asaf Patir and senior policy fellow Danny Biran prepared a report on the resilience of the Israeli tech sector to war, shared with Calcalist. They analyzed the behavior of the sector in the two years following Operation Protective Edge in 2014. In every aspect, including the size of investment, number of exits, and number of employees in the sector, a consistent increase was recorded in 2015 and 2016. During Operation Protective Edge, 75,000 reservists were called up - a much lower number than today. The war lasted 50 days and cost around NIS 7 billion ($1.7 billion) in direct costs.
"The tech sector has demonstrated great resilience, and no harm to activity has been seen following the operation," the report states. They emphasize that the main reason for the sector's resilience is that investment in tech is mainly in intellectual property, which is not affected by such events and has very low risk compared to physical capital investment. SNPI writes that, on the one hand, the situation today is more complex than in 2014 because the war hit the sector during its peak, but on the other hand, Israeli companies have gained extensive experience in the past decade, and even coronavirus taught them to function in crises and work remotely.”
According to SNPI, as part of the economic recovery after the war, the tech sector can play a significant role in two important areas. The rehabilitation of agriculture in the Gaza periphery will enable a broader adoption of Agtech technologies, for which Israel is known worldwide, though they are not always implemented here. The second arena is the treatment of government information systems exposed in their vulnerability and their inability to cope quickly with the crisis. Information systems processes and the creation of fast databases carried out as part of the volunteering of tech executives can promote the modernization of government systems in Israel after the war.