8 August 2011 | By Dale McEwan
Corporate break-ups, a big energy discovery, web entrepreneurs and a legal sector opening up to foreign firms. All are driving the Israeli market forward, says Dale McEwan
Flick through any recent Israeli newspaper and you will encounter a story touching on the overconcentration of the country’s business market.
“Israel is marked by the fact that a small collection of corporations control about 75 per cent of the market,” says Alan Sacks, head of Herzog Fox & Neeman’s international practice and banking and finance team. “Most of the wealth has been creamed off by a few families. Too few people have too much control here.”
Sacks adds that the current environment has led to the manipulation of market prices. A recent public revolt over the price of cottage cheese illustrates this point. Following a consumer boycott in June this year Israeli dairy giant Tnuva slashed the price of its 250g tub of cottage cheese from 8 to 5.90 shekels (£1.45 to £1.05). Food and beverage company Strauss and dairy processor Tara also dropped their prices, giving the impression that companies were getting together to set market prices rather than relying on competition.
“It started with mass protests and a boycott of cottage cheese,” says Simon Jaffa, partner at Barnea & Co. “We now have campsites in the heart of the cities - Tel Aviv currently looks like Glastonbury.”
Students and the middle classes are also protesting against the rising cost of housing and perceived economic inequality.
“The government we have at the moment is particularly close with big business,” adds Jaffa. “There’s a feeling that what’s happening is a sign that people are waking up and saying ’hang on, this isn’t right’.”
Overconcentration in Israel’s business market has become so prevalent that the government has established a committee to review the issue.
“What will happen in September, I imagine, is that recommendations will be delivered, then by the end of the year we’ll see legislation that will set a timetable to split up the groups,” Sacks says. “This will lead to M&A activity, which will mean work for firms.”
Law firms representing the reigning Israeli monopolies would no doubt seek legal means to prevent any selloff programme requested by the state, says Jaffa.
“Our typical clients are overseas investors and mid-sized Israeli companies. Any break-up of large conglomerates would offer some interesting and attractive investment and acquisition opportunities to our clients,” he says.
There are signs that, knowing they may eventually have to split their groups, Israeli corporations are already beginning to take the necessary steps. This kind of activity is providing work for law firms.
IDB Group is in talks to sell all or part of its 55 per cent stake in Clal Insurance to private equity firm Permira. IDB also controls Cellcom, Israel’s largest mobile phone operator, as well as Shufersal, the country’s largest supermarket chain.
“We’re consulting with companies about how they should be behaving,” says Sacks.
Following the discovery in 2010 of trillions of cubic feet of natural gas off the coast of Israel, there are concerns that the same small group of corporations will retain control. The value of the gas is close to £300bn and initial estimates suggest that the discovery could provide as much as 200 years’ worth of energy.
“We always thought we didn’t have any natural resources,” says Sacks. “The fact that Israel will now be a major player in gas will have a big effect on the economy.”
On a domestic level, Israel continues to be a strong player in the technology sector, not least when it comes to onlineactivities.
Rick Mann, managing partner at Gross Kleinhendler Hodak Halevy Greenberg & Co (GHK), says that Israel continues to produce innovative ideas, and these are of great value to investors.
“Because of the tremendous success and high valuations of companies such as Facebook, LinkedIn and Groupon there’s strong competition to find innovative internet technologies and ideas,” he says. “That’s encouraged many entrepreneurs to focus on internet-related business and technologies, and fuelled strong growth in Israel in these areas.”
“Because of the traditional Israeli presence in the industry, there’s a huge amount of start-ups focusing on the technology that underpins existing gaming companies,” adds Jaffa. “If you’re a small start-up asking yourself what direction to go in, developing payment or security systems for gaming is one way to go. It continues to be popular.”
Although gambling remains illegal in Israel, some of the top operators still rely on Israeli law firms for day-to-day advice. Playtech and 888 were both founded by Israelis. Gambling outfits have research and development centres in Israel, but operational activities are based in other jurisdictions such as Costa Rica, Gibraltar, and Malta.
Gil White, a partner at Herzog Fox, notes an “explosion” in e-commerce over the past five years. He pictures a larger number of internet gaming companies being set up.
“The big development is towards increased licensing,” says White. “In the past people licensed in offshore jurisdictions. Now, they license in onshore jurisdictions. There’s a move away from Gibraltar towards France and Germany. We’re seeing a huge amount of business in this area.”
The future of online gambling is still an open issue, which will ultimately be decided by the Supreme Court of Israel, says Dotan Baruch, partner at Barnea & Co.
“There’s still a debate over whether online gambling is covered by Israeli penal law,” says Baruch. “Currently, we have a case where Israeli police tried to order some internet service providers to block access to certain online gambling sites. There’s the argument that such an order contravenes Israeli penal law.”
Baruch adds that there are constant talks and initiatives to try to change the law to allow the establishment of an offline casino, but currently there are no state-backed plans to allow such activity.
“Gambling has many grey areas,” says Ruth Loven, partner at Yigal Arnon & Co. She notes that there have been some developments with regard to the theories that underpin certain games - although they have been historically perceived as games of luck, some now argue that they are actually based on skill.
“Israeli authorities are quite concerned with this theory and are unwilling to have it discussed in court - they’re worried it may lead to unprecedented activity,” she says.
If these ’games of luck’ were to be recategorised as ’games of skill’, any entity would be allowed to launch any activity either online or offline, claims Loven. “We’d see a very different atmosphere,” she adds.
A new law soon to be implemented in Israel that seeks to license online financial trading activities will be of particular relevance to online gambling operators trying to increase their portfolios, says Baruch.
“These financial trading services are interesting for these operators because they are a chance to tap into new markets,” he adds. “I think this field of law is yet to evolve significantly in many jurisdictions, but it will probably be the next big thing in terms of expanding gaming.”
In other legislative changes, regulations were introduced at the start of this year to allow foreign law firms to open in Israel. The regulations have not yet been fully implemented and are still a work in progress.
“This could present a challenge to local firms in the future,” says Sacks. “International firms could challenge local firms for domestic work, but I’m not sure international firms would be that interested in domestic work. I’m sure a lot of international firms will be fighting to get the international work.”
Herzog Fox has, in recent times, developed its international capabilities.
“We were, for many years, an inward-looking firm,” says Sacks. “But in the past few years that has turned on its head. We’re well-positioned to do international work. Perhaps 25 per cent of our revenue now comes from international work. We want to leverage our capabilities - it’s a strategic goal.”
The firm is currently advising Israeli banks as a result of recent changes in regulations.
An order by the Bank of Israel that became effective at the start of July imposes reporting obligations on market activity in foreign exchange derivatives, treasury bills and short-term government bonds. The order covers both Israeli residents and non-residents who engage in such activity, as well as domestic and foreign financial intermediaries. Citibank in-houser Irit Roth is due to join Herzog Fox as a partner this August.
Over at Asserson Law Offices, which has offices in Tel Aviv and Jerusalem, expansion is very much on the agenda. The English law firm recently hired a senior equity partner from Pinsent Masons and is looking to bulk up further.
“We’re talking to two senior lawyers from magic circle firms,” says senior partner Trevor Asserson. “We’re about to take a junior lawyer from a magic circle firm - he’s starting in September.”
Asserson adds that the English legal market is beginning to recognise that a firm in Israel can perform quality work. The firm claims to provide City-quality legal advice from a low-cost base in Israel.
“We encounter an increasing number of lawyers who want to take the same approach,” says Asserson. “The concept of the outsourcing market is quietly finding its feet here.”
But the trend towards offshoring does not come without challenges.
“If other firms develop in the way we’ve managed to there will be competition for local work,” adds Asserson. “But they’ll demonstrate more credibility and visibility, which can only be a gain.”
Indeed, Israel’s legal market is becoming more sophisticated, according to Joeri Kreisberg, partner at Yigal Arnon.
“The more sophisticated it becomes, the more difficult it is to keep your unique position in the market,” says Kreisberg.