The face of Israel’s future economy will be completely different from that of previous decades, experts say, because of a critical mass of billion-dollar tech companies, or unicorns, that have flourished within its borders.
“What we have seen since October 2020, when the surge in valuations of Israeli tech firms started, will lead to a seismic change of Israel’s economy in the coming 10 to 20 years,” Sagi Dagan, VP and head of the Growth, Finance and Strategy Division at the Israel Innovation Authority, said in an interview. The Israel Innovation Authority is in charge of fostering the nation’s tech ecosystem and setting out government policies.
The onset of the COVID-19 pandemic, which has underlined the importance of technology and innovation for the survival of businesses, coupled with record-low interest rates and governments propping up their economies with cash injections, has triggered record investments in tech firms globally and has prompted a surge in the global creation of tech unicorns, privately held companies worth at least $1 billion.
Israeli-founded tech unicorns account for some 8% of this global phenomenon, as its entrepreneurs, once known for creating technologies and selling them off quickly to the highest bidder, are now holding on to their fledgling firms in a push to create large and hopefully profitable businesses.
“Israel accounts for some 8% of global unicorns, but for just 0.1% of the global population. So, we are punching some 100 times our weight in the world,” said Aharon Aharon, a former CEO of the Israel Innovation Authority, in a phone interview.
Many of these Israeli founded unicorns are being set up in Israel and managed from Israel. “Twenty years ago, when Israeli startups got big investments from foreign investors, they would get a US manager and they would move their headquarters to the US to be close to their market and their investors,” said Dagan. “Today, this is not the case.”
The pandemic has shown that the closing of business deals and funding can be done completely remotely, and so founders are staying in Israel and growing their companies from here, employing not only core research and development teams of engineers and programmers but also sales and marketing staff, accountants and lawyers.
“This is very different from what was before, and very positive,” Dagan said. There is now a “critical mass” of giant tech firms in Israel, he said, the likes of which not many countries have. “You have the US, China, Israel, the UK, Singapore, and Tokyo. This concentration of firms in Israel will help draw even more unicorns, who will choose to set up their HQ locally. This is leading to the development of a whole new ecosystem, which specializes in providing services to these large tech firms – from managers to lawyers to consultants and banks.”
Foreign companies, like global banks, lawyers and advertising agencies, who want to have access to these giant tech firms will set up offices in Israel, he said, which will lead to even further globalization of the local economy that will, in addition, “trickle down” to other, non-tech sectors.
“This change is happening as we speak, and this will impact the economy for the coming 10-20 years,” Dagan said.
Almost a unicorn a week
In the first half of this year, as of June 15, 2021, some 291 new tech unicorns were created globally, compared to 175 in the whole of 2020 and just 16 in 2011, according to data compiled by Crunchbase.
As of the end of October, there were 878 unicorn companies worldwide at a total cumulative valuation of almost $3 trillion, according to CB Insights, a New York-based data firm that tracks the industry.
According to Tech Aviv, which tracks the industry in Israel, as of October 27, there were 74 Israeli-founded unicorns with a combined value of $201 billion. Of these, 31 had their headquarters in Israel, 18 in New York, 15 in Silicon Valley, with others in Boston, London, Singapore, Chicago, and Los Angeles.
Companies like cybersecurity Wiz, with a $6 billion valuation; Melio, a fintech firm with a $4 billion valuation; and Papaya Global, with a valuation of $3.7 billion have their headquarters in Israel.
Publicly traded companies like Wix, the maker of a website building platform, ironSource and Monday.com, have also maintained their headquarters in Israel, along with veteran firms Check Point Software Technologies and NICE, with valuations of some $16 billion and some $18 billion, respectively, on the Nasdaq as of October 28.
According to a September 2021 report by Viola Ventures, the number of new unicorns in Israel is continuing to grow at an “unprecedented rate,” with 24 new ones — almost one a week — announced in H1 alone.
“This is twice the number of new unicorns announced in China in H1’21 and only 2nd to the USA,” the report said. Israel created 16 new tech unicorns in the whole of 2020, nine in 2019 and four in 2015.
Boston-based biotech firm Immunai and Fabric, a robotics startup, were the two latest Israeli-founded companies to join the unicorn club on October 27.
In Israel, tech firms raised a staggering $17.8 billion in the first three quarters of the year — 71 percent more than the amount raised in all of 2020, itself a record year — according to data released by the IVC-Meitar Israel Tech Review, published by the IVC Research Center and the law firm Meitar.
The unprecedented amount was due in part to a significant number of funding rounds of over $100 million — 53 such deals — which accounted for a 51% share of the total sum for the three quarters, according to the report.
Israel’s tech industry, which as of end 2020 accounted for over 50% of the nation’s exports, has been instrumental in fueling the nation’s economy over the past few years and was key to mitigating the blow of the pandemic, as the tech engine not only kept ticking but even flourished amid the havoc, with businesses, schools and health systems turning to digital tools to keep afloat.
“What is happening is way beyond Israel’s status as the startup nation,” said Yifat Oron, who heads the office in Tel Aviv for Blackstone, a New York City-based investment giant. “This is about technology taking over the world. It is happening in Israel and everywhere else. Just like we had the industrial revolution, we are now in a technology revolution.”
To continue to exist, companies need technology, she explained. And this means that existing companies will need to adopt technologies to remain relevant, and new companies will be built from day one as tech firms, with the potential to grow to be very big.
But whereas once the Israeli tech industry was known for bringing in foreign investors and multinationals that would snap up its technologies, the nation is moving from being a startup nation to a so-called scale-up nation, in which companies are growing bigger and bigger.
Israel is “no longer growing companies that sell tech to other businesses,” said Oron. The nation is growing companies “that are themselves the businesses.”
Valuations are not that important at the end of the day, she said. The key is whether the entrepreneurs have identified and are solving a real problem, have set up the right business, and are growing their business correctly, creating sustainable firms.
“Once that happens you have revenue, you have people earning salaries and paying taxes,” she said. And you also have the spillover effect on all of the businesses that service the tech industry, like car leases or restaurants or real estate, she added.
Looking ahead to $10 billion and $100 billion mark?
Oron forecasts that Israel is just at the start of its mega-business journey. In 10 years, she said, there are going to be “much bigger companies than we know of today” in Israel.
“If once our threshold was unicorns — $1 billion companies — now there are already a bunch of companies crossing the $10 billion, and in 10 years’ time I think there will be $100 billion Israeli companies. If you are working correctly and building the right executing machine, there shouldn’t be a reason why there won’t be companies that cross the $100 billion market value.”
These multi-billion-dollar firms have the potential to impact the economy in a far greater manner than anything Israel has seen in the past, affecting everything from the nation’s growth to its tax revenues, its balance of payments and possibly even its credit rating, which will allow the nation to raise funds at cheaper interest rates.
“The tech engine is leading to a horizontal improvement in the second and third circles of employment: starting from restaurants that serve the workers in the industry to lawyers, accountants and other staff,” said Modi Shafrir, the chief strategist at Mizrahi Tefahot Bank, in a phone interview. “Salaries are also on the rise, and all of this is positively affecting a whole variety of professions and not just the engineers and programmers that are at the heart of the industry.”
Shafrir said that already now, the tech workforce, which accounts for some 10% of the total workforce, accounts for 25% of the nation’s direct tax revenues, according to Finance Ministry data. These revenues help the government lower its budget deficit and invest the money in other areas, like in education and healthcare, he said.
In addition, the mega businesses will help improve employment levels and boost salaries, not only for those engineers and programmers that work at the core of the tech industry but also for a larger group of professionals and employees that help service the industry. These tech firms will also create new kinds of jobs and positions, and gradually even populations that have been sidelined by the tech boom, like Arab Israelis, ultra-Orthodox Jews and women, will need to be drawn into its fold to satisfy the industry’s employment needs.
Exports will thrive, affecting the nation’s growth trajectory and creating a surplus in the current account, which records a nation’s net trade in goods and services with the world and net earnings on cross-border investments. This in turn will further strengthen the shekel, helping lower the cost of living as the cost of imports will decline, Shafrir explained.
Israel’s balance of payments, an accounting of a country’s international transactions, made up of the current account and direct foreign investment, will be positively affected as well, Shafrir said. “The tech [sector] has a huge impact on the surplus of the balance of payments of Israel.”
Credit ratings firms such as S&P put a strong emphasis on the balance of payments data when rating a nation, Shafrir said. “All of this could definitely lead eventually to a rise in Israel’s rating,” he said, which will allow the nation to borrow money internationally at cheaper rates.
S&P currently rates Israel at AA- (Stable); Fitch at A+ (Stable), and Moody’s Investor Services at A1 (Stable).
Bumps in the road ahead
There are challenges ahead, however. Even if in the long run these mega tech firms will help spread the wealth, in the interim the gaps between Israel’s rich and poor are widening since the tech industry accounts for just some 10% of the total workforce. In addition, the tech industry suffers from an acute shortage of engineers and programmers, which could hamper the industry’s growth, affecting the whole of the economy as well.
Furthermore, a rise in interest rates inside and outside of Israel is looking increasingly likely due to the surge of inflation levels, and that could put a damper on the bonanza, with others warning of a tech bubble that could blow up.
The global supply chain issues are pushing up the cost of products and inflations levels, noted Ilan Paz, the CEO of Barclays Israel. “Central banks will not have a choice but to raise rates to curb inflation, and history shows that once rates go up, valuations and multiples that are pushing the market higher, drop.”
The question today isn’t whether rates will go up, but “when will they go up,” he said. “A breakout of inflation that will lead to interest rate hikes could spoil the party.”
Prof. Niron Hashai, the dean of the Arison School of Business at Reichman University (IDC Herzliya), warns of a tech bubble that is likely to burst.
“The value of the unicorns, which has increased dramatically in the last few years, is probably not realistic,” Hashai said. Many of these companies that are worth billions in valuations still just have a few tens of thousands or millions of dollars in sales, which are a “realistic and measurable indicator” of how a company is performing.
“We are certainly not seeing sales in the hundreds of millions and certainly not billions, unlike the giants we see in the US and Europe,” he said. “I would like to see Israeli firms selling for a few billion dollars which is rarely the case. Companies like Check Point Software Technologies and NICE and a few other firms that are selling in the billions are the exception, rather than the rule.”
Annual revenue for cybersecurity giant Check Point Software Technologies was $2.1 billion in 2020. NICE, a maker of software solutions for enterprises, had revenue of $1.65 billion in 2020.
Wix, a website-building firm with a valuation of some $16 billion on the Nasdaq, had annual revenue of $989 million in 2020, up 30% from 2019, and posted a loss. Wall Street newcomers SentinelOne, a cybersecurity firm, had a market cap of $17 billion on the New York Stock Exchange on October 27, with sales for fiscal year 2021 at $93 million, and posted a loss. Monday.com, a developer of a work operating system, with a market cap of almost $17 billion on the Nasdaq, had sales of $161 million at end 2020.
“Today there is still a lot of hot money chasing startups. This will stop. We cannot say when, but it will happen. Valuations are too high and will be slashed,” Hashai said.
Even if there is a correction in the markets, said the Innovation Authority’s Dagan, Israel has crossed the Rubicon regarding large tech firms, which will not go away. “There are cycles, good years and bad years. But once you have passed a certain critical mass, a few bad years won’t change the trend. If you look at the long-term trend of the global economies, there will be continued demand for new technologies, agility, more globalization, and more security.”
Since the start of operations in Israel earlier this year, Blackstone has invested in Israeli companies including Wiz, the cloud security firm that reached unicorn status just over a year after its founding in January 2020.
“Speaking as a growth investor, we value companies we invest in according to their future business potential,” Blackstone’s Oron said in the interview. “A current business and its growth should be mainly used as an indication of what we believe will be the business down the road.”
Unlike traditional companies, startups grow at much faster rates, and the valuations reflect the potential of the companies rather than their current performance, she said.
“I see companies growing 400% a year” with regard to revenue. Because when you are that young in the evolution in your business, if your growth graph doesn’t grow like a hockey stick, there is an issue with your product.”
And yes, said Oron, there may be a “small correction” coming for tech firms, but “I don’t think it is a bubble. If we didn’t think, as an organization, that Israeli companies can be worth tens of billions of dollars, we wouldn’t be here.”
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