Israel's Hi, tech--Bye Tech

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SKOPJE, Macedonia, Jan. 25 (UPI) -- During the 1990s, the number of Israeli firms on Nasdaq was the second or third largest (depending on the year) after American and Canadian ones. Israeli initial public offerings were hot. Israeli hi-tech was cool. The Internet was conquered by Israeli ingenuity and chutzpah.

Since then the market has matured. Dotcoms bombed. Nasdaq is down 60 percent even after the post Sept. 11 bounce. Israel's main export markets are in the throes of a global recession. Israel appears to be suffering from the Singapore syndrome -- over-dependence on a single sector. High-tech products constituted 22 percent of Israel's $7.7 billion in exports in 1991 but more than 36 percent of the $18.7 billion it exported nine years later.

The signs are decidedly mixed. In a single week, VocalTec, a voice-over IP technology developer and manufacturer, reported a year on year drop of 53 percent in revenues in the fourth quarter. Versity, a verification software company, boasted its first profit on revenues up by 50 percent.

Manpower Israel announced that the number of high-tech want ads (a fair proxy for employment in the high-tech sector and for investment in research and development) fell by 52 percent in 2001 to 1996 levels. Demand for high-tech managers and programmers was down by about 64 percent. Manpower attributed these developments to Sept, 11, global recession, the collapse in the equity markets and the 15-month-old intifada. Very few foreign investors bothered to attend Ernst and Young's Journey 2001 October conference. Even its sponsor, Silicon Bank of California, didn't show up.

These are bad news for the recession-hit Israeli economy. High-tech has been a net contributor of jobs, a generator of small to medium enterprises, a leader of export growth, and, in short: Israel's economic engine. The government has already reacted by abolishing the capital gains tax on foreign venture capital investments in Israeli firms and by tightening collaboration with other casualties of the global downturn in the technology markets, notably with India. Israel intends to get involved in the telecommunications, medical technology, and software production sectors in India. A ministerial committee recommended that the government invest $450 million over 5 years in biotechnology projects. It is a sign of the times that this interventionist suggestion is seriously considered.

Coupled with low inflation, the shekel's 10 percent depreciation in the last few weeks to 4.60 to the dollar, will boost Israeli exports by $1 billion, said the Israeli Export Institute. Most of this windfall will accrue to export-orientated high-tech firms. It will boost their competitiveness by increasing their shekel proceeds when they convert their foreign exchange revenues and by allowing them to discount their products.

But the malaise of Israel's hi-tech sector has deeper roots. Israeli firms are research and development champions -- innovative and daring. But they are weak when it comes to marketing and sales. Many of them are badly managed, still run by the entrepreneurs who established them. Israeli addiction to venture capital and equity financing fostered a strong image of Israel as a high risk emerging economy based on dotcoms and their "creative" financing and accounting methods. In many cases, maverick Israeli startups failed to position themselves as market leaders, which develop and produce for mature markets.

The good news is that venture capitalists have invested more than $6 billion in more than 500 promising products and technologies in Israel, 50 percent of it in 2000 compared to $1 billion last year).

However, of 2,500 high-tech firms, at least half are bankrupt or poised to close their doors. Still, between $1.2 billion and $2 billion are available for VC investment. Israeli VC funds do not publish return on investment figures but rumors are that they managed to outperform the American benchmark of 43 percent per annum. If this is true, they will probably re-enter the fray.

This cushion of selectively available financing may prevent a total meltdown of the sector. Investments in companies backed by VC in their first round of financing actually increased by 16 percent in the fourth quarter, though 36 percent of local VC funds made no investment at all. Investment by foreign sources of financing dominated the fourth quarter scene.

According to the Money Tree Survey, conducted by a leading Israeli accountancy firm, Kesselman & Kesselman PriceWaterHouseCoopers and quoted in Israel's business daily, "Globes," there is a shift from software, Internet and the biomedical sciences back to the hitherto discredited telecommunications, semiconductors, and networking fields. Almost no seed money is available -- but despite the Internet's fall from grace, financing of Internet-related ventures remained unchanged compared to the third quarter, though more than 70 percent down on 2000. The average size of a typical VC investment is down 50 percent on 2000 -- to $3.6 million.

In other words: financiers are more careful and more choosy -- not necessarily bad news, except for "exit speculators."

Actually, more money is available for mature, market dominant, high potential, fully developed products. The dearth of seed capital may adversely affect the future growth rates of the technology sector in Israel -- but, in the short to medium term, it is likely to stabilize this mercurial Bedlam.

Israel's ace may be the biotechnology sector. Startups are well capitalized and gradually becoming profitable. About 20 percent of Israel's 160 biotechnology firms made money this year, another 25 percent are expected to do so next year.

With close to $1 billion in sales and less than 4,000 workers - their value-added and total factor productivity are enormous. According to Ilanot Batucha, a brokerage firm, there are 300 drugs in phase 3 FDA-mandated clinical trials. If 200 of these are approved -- they will join more than 100 drugs already approved and selling, no small coup for Israel's pharmaceutical minions. In 2001, the number of deals declined -- but the average size of the deals increased. Biotechnology may well be Israel's old-new horizon.