Israel on Cloud nine

Most big technology companies today are grappling with two problems: how to deliver earnings growth other than through cost reductions; and how to develop a suitable strategy for ‘the Cloud’ (the catch-all term for the delivery of computing resources via virtual networks). The good news is that with so much cash sitting on balance sheets as a result of all these cost-cutting efforts, many are looking for acquisitions that will boost growth – and one of the biggest beneficiaries is likely to be Israel.

The hi-tech sector is hugely important to the Israeli economy: it accounts for about 15 percent of GDP and over 40 percent of exports, attracting billions of dollars in investment from venture capital funds (both local and international) every year. In the US and Western Europe, attention has largely been focused on the consumer internet space – but Israel is making hay in some slightly less glamorous areas.

For example, in May this year EMC bought XtremIO, an Israeli storage specialist. The US-listed IT giant reportedly paid over $400 million for a company that was still pre-revenue, providing a huge win for Xtremio’s Israeli and US venture backers (who included Lightspeed Venture Partners and Battery Ventures).
“With the amount of data out there now, people are looking for ways to store it more cheaply and access it more easily,” says Alan Feld, founder and managing partner of Israeli fund-of-funds Vintage Investment Partners. Israel is very strong in internet infrastructure and data management, he says – not to mention security, wireless technology and medical devices

So how did a relatively small country obtain this competitive advantage? The military angle is clearly significant in several of these areas: Israel has had a strong motivation to invest in data security and wireless communications, for instance. Government support has also been crucial – both in terms of providing tax breaks and incentives to the hi-tech sector, and in the development of excellent engineering schools like the Technion, the Israel Institute of Technology in Haifa.

Feld also suggests that shifting demographics have played a part. “In the 1990s and early 2000s we had a very substantial immigration from the former Soviet Union, and over 50 percent of these people had some kind of university or technical degree. That’s an enormous brain influx.”

The result is that virtually all the big technology companies (including the likes of Google, Oracle, Facebook, Microsoft and Apple)  now have R&D centres in Israel, as they look to tap into this supply of talent – which provides a fertile ground for entrepreneurial start-ups and facilitates M&A activity.
Says Feld: “Many of these companies are sitting on a fair amount of cash, and often they can’t repatriate it to the US without it having tax implications. So it’s natural they use some of it to buy growth.”

Over 70 big tech companies have already made acquisitions in Israel, Feld says. And given how small the country is, it’s not hard to bolt-on additional ones. “If you take all the companies in the R&D space, their offices are at most two or three hours apart – so you’re not going to lose people. For a lot of companies, it’s a pretty low risk way of adding new products to their pipeline.”

In common with most of the sector, Israeli VCs have had a tough few years. But the current environment is looking 1
more positive than it has for some time. ?