2021 was a bumper year for Israeli tech. What will 2022 bring?

2020 was the year of technology, as COVID lockdowns spurred remote work and a global transition to online work, commerce and school. This year, 2021, was arguably “the year of the unicorn.” So 2022 will likely be a year of reckoning, with investors sitting back to see if the hype around their investments was justified and tech firms having to prove that they were worth their massive cash injections.

“Startups that raised a lot of money in the private market, or those who raised funds via an initial public offering of shares or a SPAC deal, will be very active in the M&A market,” said Mike Rimon, a partner at Meitar, one of Israel’s largest law firms, which works with Israeli tech companies. They will use the funds raised in the past two years to buy companies and spur growth, he explained.

“My estimate is that we will see the IPO market easing up but a significant jump in M&A” activity, in which Israeli firms will buy both other Israeli and foreign firms, Rimon said in a phone interview earlier this month. “Israeli firms are not afraid to go and do big M&A deals around the world.”

2021 has been a bumper year for Israeli tech, and it came on the heels of another bonanza year in 2020. Israeli tech firms raised a whopping $25.4 billion in January-November this year, up 136% from 2020, itself a record-breaking year in which $10 billion in capital was raised. Israeli tech funding in 2021 surpassed the average 71% rise in global tech fundraising, according to a report published earlier this month by Start-Up Nation Central (SNC).

Israel also is home to 79 Israeli-founded unicorns, or privately held companies valued at over $1 billion, as of December 15, with 41 of them born this year, compared to 19 new ones in 2020, according to Tech Aviv, which tracks the industry. Thirty-three of these unicorns, or some 42%, are based in Israel, with the rest in New York, 19; Silicon Valley, 15; five in Boston; three in London; two in Los Angeles; and one each in Singapore and Chicago.

Israel’s tech firms also saw “exits” jump an astonishing 520% in 2021 to an unprecedented $81.2 billion in value, shattering all previous funding records and up from $15.4 billion in 2020, according to an annual tech exits report published last week by consultants PwC Israel. Exits are defined as merger and acquisition deals or initial public offerings (IPO) of shares.

In 2021, Israeli firms held a record number of IPOs on the US stock markets and in Tel Aviv. According to the PwC report, 2021 saw 72 Israeli IPOs (including SPAC deals), 45 of which were done on the Tel Aviv Stock Exchange.

These IPOs and SPACs amounted to a value of approximately $71 billion, according to the PwC report, up significantly from 19 offerings in 2020 at a total value of $9.3 billion. Notable IPOS include that of cybersecurity company SentinelOne at a valuation of $9 billion and Monday.com at a $6.8 billion valuation.

“2021 was an unprecedented year for IPOs,” said Meitar’s Rimon. “We can’t remember a similar year ever, both for IPOs in the US and in Tel Aviv.”

Merger and acquisition activity also surged in 2021, and totaled a record $11.5 billion in 2021, up 189% from 2020’s $6.1 billion, the PwC report showed.

A trend that stood out this year was a surge in Israeli firms buying other Israeli firms: according to Start-Up Nation Central data, there were 39 such deals – the highest number on record, up from 21 in 2020. This is a sign of the maturation of the Israeli innovation ecosystem, the report said.

Among the most notable acquisitions by Israeli firms this year was that of Avanan, a cloud-email security vendor, reportedly for some $300 million by Israeli cybersecurity giant Check Point Software Technologies Ltd in August. DevOps Tel Aviv-based firm JFrog, which held its IPO on the Nasdaq last year, bought Israeli startup Vdoo for $300 million in cash and shares in June, using some of the money raised in the IPO for the acquisition, and in September it bought the Israeli startup Upswift for an undisclosed amount.

And, just a month after completing its Nasdaq listing through a SPAC merger, Israel’s Taboola, a web recommendations company, in July said it would acquire Los-Angeles based Connexity for some $800 million in a cash and shares deal.

This M&A activity by Israeli companies is set to grow next year, said Itay Frishman, also a partner at Meitar.

“2022 will be characterized by a record number of Israeli companies buying other companies,” he said. “It will be in numbers we have never seen before and it stems from the fact that these companies will be under huge pressure to prove the valuations at which they raised money. To grow faster, they will want to grow — not just organically — and thus they will undertake many acquisitions” to further boost their activities and workers.

A global tech surge

Tech firms globally were given a boost by the coronavirus pandemic with a surge in demand for technologies as people hunkered down at home during lockdowns, businesses shifted to remote work, and activities from food orders to yoga lessons migrated online.

Record-low interest rates, along with the injection of liquidity by central banks to keep global economies afloat amid the pandemic, caused stock markets to boom, with investors flocking to tech shares in search of returns.

“Tech stocks have been somewhat disconnected from economic developments and have not been affected by the pandemic,” said Sergey Vastchenok, a senior analyst at investment banking firm Oppenheimer. “They have even thrived in the pandemic.”

The tech-heavy Nasdaq Composite Index and the S&P 500 reached record highs in November this year, on signs the US economy was recovering amid strong company earnings and jobs creation.

The Nasdaq Composite index has gained some 18% year as of December 17, and the S&P 500 index has surged 23%. The Nasdaq gained around 43% in 2020.

“Everyone needs tech, whether the end consumers, companies in legacy, and/or new industries,” said Yifat Oron, who heads the newly set up Tel Aviv office of US investment giant Blackstone, which is seeking to tap into the Israeli startup ecosystem. “So, the need for tech will continue, potentially with increasing volume.”

Also, she said, VC firms, growth funds and private equity firms globally have raised a massive amount of money this year, part of which will be invested in tech firms going forward. “There is a lot of dry powder looking for investment.”

In the first nine months of this year, VCs in the US raised a record $96 billion across 526 funds, topping the $85.6 billion raised for 665 funds in all of 2020, according to data compiled by PitchBook-NVCA Venture Monitor.

“At this rate, the $100 billion VC fundraising mark is well within reach for the first time,” PitchBook said.

Private equity fundraising has also surged, with funds worldwide, including VC vehicles, closing on $459 billion this year through June, according to data from Prequin. That figure is 51% higher than the $303 billion raised in the same period a year earlier.

“The money is there and it is not going to be depleted in the near term,” said Oron. “Even if everybody stopped raising new funds tomorrow, there is still a lot of money in the system looking for investments.”

Even so, as global economies hiccup toward recovery amid the emergence of successive virus variants, there are signs of cooling in the stock markets, and maybe even a correction looming, as surging inflation levels raise concerns of higher interest rates and curbs on quantitative easing. Inflation in the US surged 6.8% in November, year on year, the highest level since 1982.

The US Federal Reserve System (Fed, for short) policy is seen as a main risk for equity markets next year, and is already causing a flutter and volatility in global shares, alongside the shadow of the new and highly infectious Omicron variant. On December 16 the Fed signaled there could be three rate hikes in 2022 as it strives to fight inflation, and said it would end its pandemic-induced bond purchases in March. Last week the three main US stock indexes ended with declines for the week, after the Fed announcement.

“Forecasts for next year are very much dependent on what the policies of the central banks, and especially the US Fed, will be,” said Oppenheimer’s analyst Vastchenok.

“The US Fed will have a more aggressive policy and move toward normalization of its monetary policy – so not so much cheap money at zero interest rates will be on the market.”

A rate rise is a sign of confidence in the recovery of the economy, he explained, but it will also cause investors to move their preferences toward more traditional stocks, like consumer products or financial stocks, diverting funds from technology stocks.

“A normalization of the economy will be less beneficial for tech firms, which tend to thrive in times of crisis and pressure and when economies are weak,” he said.

“I don’t know if we are talking about a correction – it could definitely be that shares will continue to rise. But they will rise either at a lesser rate, or stop rising. We won’t see the sharp rises we saw in 2020 and 2021, but I don’t think we will see a bear market. ”

A stock market that falls by 20% or more from a 52-week high has become a bear market, marked generally by investor pessimism. A bull market is when financial markets see prices rising or expected to rise.

If the market turns, said Vastchenok, then “newly issued shares on the Nasdaq or on the TASE are always more volatile and tend to get hit first, because they are new to investors. To create a strong base of investors when you are new is not easy. The new entrants are the first ones to get sold when there is a fire sale. But sometimes that is also an opportunity for investors.”

Israeli economy rebound

Israel’s economy rebounded in 2021, after contracting some 2.4% last year amid the pandemic. The economy is projected to grow 6.3% this year and 4.9% in 2022, according to an OECD report published earlier this month. The authors of the report warned that the nation’s economic recovery could be slower if the health situation deteriorates again, or if the increase in inflation is stronger or more persistent than previously assumed.

The tech industry has been instrumental in the nation’s economic recovery, as it not only kept going but even thrived during the pandemic, with workers plugging in from home and deals — from sales to mergers and acquisitions and investments — clinched over Zoom.

Inflation in Israel in 2022 is expected to decline to 1.4% from some 2.5% this year, as supply chain bottlenecks open up again and transportation and logistical costs stabilize, analysts at Leader Capital Markets, an Israeli investment banking and financial advisory firm, said in an annual report to investors.

Leader analysts forecast Israel’s economy will grow 4.8% next year, and that the Bank of Israel will raise interest rates by some 0.25% during the third quarter of next year. The rate is at a record low of 0.1%.

The shekel, which was among the best-performing currencies globally in 2021 and reached a 26-year high in November, will continue to strengthen next year, with Leader analysts forecasting the currency to be at NIS 3.05 to the dollar by the end of 2022.

The shekel representative rate was set at NIS 3.1150/$ on December 17.

“The continued recovery of the global economy, the low-interest-rate environment and the high level of liquidity in the markets will continue, in our estimation, to support the capital markets in Israel and around the world,” the Leader analysts wrote. “There is no doubt the coronavirus is still here and it can continue to shake the world economy in the coming year as well, but the high effectiveness of vaccines alongside the development of effective antiviral therapies are evidence that it is on its way to turning from a pandemic to an endemic” phenomenon.

Israeli tech firms will continue to be an attractive target for foreign firms, said Meitar’s Rimon. But the already high valuations of these firms will make them harder to buy – and focus will be on the acquisition of smaller companies that are easier to digest, he said.

The trend of IPOS will continue next year, but likely not at the breakneck pace of 2021, he added. Special purpose acquisition company (SPAC) deals will also continue next year, Rimon said, if only because so many SPAC firms have been already set up and raised funds that have to be used for a merger with another firm within 18 months.

“SPACs are still a sort of a not-straightforward animal that raises some questions,” said Rimon of Meitar. “But I don’t think the trend will stop significantly, given the fact that there are many SPACs that raised money and they have 18 months to do M&A otherwise they will have to return money to investors. Thus, the phenomenon will continue.”

SPACs, which were one of the hottest items on Wall Street earlier this year, saw a jump in investor redemptions in September, signaling they had fallen out of favor. Now, however, new deals are cropping up once more, with numbers up in October and November, according to data compiled by the Financial Times.

When looking at specifics of tech investing, the sectors that drew the most capital in 2021, like in 2020, were enterprise IT and data infrastructure, cybersecurity, and fintech, according to data compiled by Start-Up Nation Central.

These sectors will continue to draw interest in 2022, said Blackstone’s Oron, along with a few other emerging technology sectors like food tech.

In addition, all technologies that allow businesses to increase output are expected to thrive, she said. These include tools to boost productivity and help shift a business to the cloud.

Technology to help screen, recruit and train talent, as the industry suffers from a shortage of skilled workers, will also be hot, she said – like products that automate employee screening, recruitment and communication along with easing of salary payments.

This employee shortage will also be a key driver to adopting technologies that allow for automation and digitalization of simple or processes along with those that are deemed very tough, like coding for cybersecurity, Oron added.

In line with the rise in awareness of climate change, tools to measure, track and prove the environmental, social and governance record of firms will also find favor with investors. “This field is in its nascent stage,” she said.

Some of the most active investors this year were foreign-based VCs that are among the globe’s largest tech investors, Start-Up Nation Central said in its report. These include Insight partners, which took part in 49 investment rounds in Israel, Bessemer Venture Partners at 23 rounds, and Tiger Global Partners at 16 rounds.

“VCs don’t set trends, we don’t predict trends,” said Eden Shochat, a co-founder of the Tel Aviv-based Aleph venture capital fund. “We see founders with the vision and the foresight to go into business, and there we go.”

“Disruption will occur where there is inefficiency, when companies can disrupt incumbents. It is not about specific fields,” Shochat added.