‘People in high tech are very aware that Israel – compared to its small size – has some amazing technological achievements’ – Bill GatesISRAEL – A POWERHOUSE FOR TECHNOLOGY

Ask any expert how Israeli high tech has been doing over the past five years and you will get a big smile and an enthusiastic reply. With the same sense of wonder, energy and excitement of the “bubble” period of high tech growth in the 1990s, but with the wisdom of having gone through the bursting of that bubble in the first years of the new century, the companies that survived are leaner and meaner. And the newcomers on the scene have benefited from the experiences of those who went before them. But don’t take our word for it – just take a look at how leading international investors are betting their money on Israel’s future success.

By Nicky Blackburn

Ask Yossi Vardi, the father of Israel’s Internet industry, to describe the mood of Israel’s high tech industry today, and he says it’s one of “sober exuberance.” Sober, because nobody can forget that just five years ago the industry was in a serious recession with no end in sight, but exuberance because the industry has now come full circle and is stronger and more successful than ever before.

“There’s a better understanding of what’s going on today, and players are more solid, but we still see lots of enterprise,” says Vardi, who was the founder and chairman of ICQ, the Israeli instant messaging service purchased by America Online for $400m. “We are in a very good period, which will continue. The industry now is celebrating.”

Vardi is not alone in his excitement. Ask any industry expert how the country’s high tech industry is faring today and you will be greeted with enthusiastic replies.

“The last five years have been recovery years,” Eli Reifman, founder and CEO of Emblaze, told ISRAEL21c. “When the bubble burst, people found themselves without jobs, moving their careers from high-tech to completely new areas. Now it’s all coming back in a dramatic way. High tech is hiring once more and people are exploring new frontiers. The high tech industry still has its child-spirit, which it needs to be creative, but there’s experience as well now. People are doing things differently. They are basing decisions on what they know works.”

“Those companies that survived the recession learned a lot about how to behave in the good times so as not to fall into the trap in the bad ones,” adds Yossi Sela, managing partner at Gemini, citing companies like Starhome, Mellanox, Pcube, and Saifun as examples. “Today they are stronger, more agile and more interesting than usual. It’s survival of the fittest.”

Certainly interest in Israeli companies from abroad is higher than ever. Foreign investment in Israeli companies is growing every year, as are mergers and acquisitions. Since the start of 2006, foreign investors have acquired more than 30 Israeli companies, including startups, at a value of more than $10 billion. The Manufacturers Association of Israel expects that direct foreign investment will grow to between $12-13 billion by the end of the year, compared to $5.6b. in 2005.

In July, in the middle of the Lebanon war, personal computer giant, Hewlett-Packard purchased Mercury Interactive for $4.5 billion in the largest ever acquisition of an Israeli high-tech company. This was followed almost immediately afterwards by the $1.55b. purchase of Kfar-Saba based M-Systems, a pioneer in flash disk technology, by SanDisk Corp. EMC purchased three Israeli start-ups this year, Kashya ($153m.), nLayers, and Proactivity. While Xerox acquired XMPie for $54m.

Vardi quotes figures that show that in 2005, venture capitalists invested $1.34 billion in Israeli companies, making the country the second highest destination for VC capital after the US. The UK, for example, a country of 60 million, compared to Israel’s seven million, came in at third place with $1.29b. in VC investment.

The World Economic Forum recently published its yearly 2006-7 report in which it ranked Israel first for availability of scientists and engineers, second for venture capital availability, third for technological readiness, and seventh for innovation.

In addition, over the last few years an increasing number of international technology giants have opened or expanded development centers in Israel, names like Microsoft, Motorola, and Intel, which developed its next generation microprocessor at its Israeli facility.

Earlier this month, Google and IBM both announced that they are expanding their R&D operations in Israel. Google plans to open a new R&D center in Tel Aviv, to compliment the one it has in Haifa, while IBM is opening a software lab dedicated to advancing the computer-maker giant’s search, metadata management, and collaborative real-time technologies.

In an interview with ISRAEL21c, Meir Nissensohn, general manager of IBM Israel, said the company’s latest move “is a strong vote of confidence from IBM for the software development capabilities existing in this country.”

Software giant Microsoft, which recently purchased Israeli start-ups, Gteko for $120m. and Whale Communications for $76m., now employs over 400 people in Israel, in its largest development center outside the US.

On a visit to Israel in October 2005, Microsoft chairman, Bill Gates, said: “Israel is a major player in the high tech world… We’re super-satisfied with the contributions of our R&D center in Haifa. The quality of the people here is quite fantastic. People in high tech are very aware that Israel – compared to its small size – has some amazing technological achievements. There is a greater concentration of talented high tech manpower here in comparison to other countries – almost to the extent of Silicon Valley.”

In March, US healthcare giant, Johnson & Johnson announced plans to invest in Jerusalem’s Hebrew University. “We were attracted by the outstanding research and researchers here,” David M. Bowser, J&J vice president, corporate office of science and technology, told ISRAEL21c during a seminar at HU. He described J&J’s initiative as “a small seed” at this stage with the potential to “grow into a long-term partnership.”

Foreign VCs have also flooded in, opening offices and hiring permanent staff. Today top tier US and European funds like Sequoia (who opened offices in March 2001), Benchmark Capital (May 2001), Greylock, Battery Ventures, Accel Partners and Hyperion have all set up offices here. “You can be sure they are not operating for patriotic or Zionist reasons,” says Sela. “These are the top tier of US and European investors. Some are coming for the first time, others to increase their commitment to Israeli high tech. Clearly Israel holds a very serious place on the map of high tech investment globally.”

Israel’s real strength lies in its innovative technologies. Today Israeli innovations are being used by Americans in every sector of their lives, from health to defense, homeland security, the Internet, communications, biotech, medical devices, and semi-conductors.

Americans suffering gastroesophageal reflux disease are now diagnosed using a miniature camera on a pill developed by Israeli company, Given Imaging. New York City police are helping to protect the streets of Manhattan with cameras developed by Vigilant Technologies. The American military uses Israeli technology to protect them in the field, and to dress their wounds after an attack. Israeli expertise is protecting airports and strategic locations across America. You can mow your lawn with an Israeli robotic lawnmower, or shop online with the help of comparison shopping site, Shopping.com, an Israeli start-up purchased by eBay for $620m.

Israel is an expert is stem cell research, hosting actor Christopher Reeve who visited Israel to explore the developments taking place here. It is a mini powerhouse in diabetes research. It pioneered Voice over Internet Protocol, and its technologies are enabling the new world of mobile communications.

“Israeli companies are creative, ingenious, and offer cutting edge technologies,” says Ranan Grobman, a principal at Jerusalem Global Ventures.

With the notable exception of Checkpoint and Amdocs, however, Grobman believes that Israeli companies prefer to stay small and sell their technologies to industry giants rather than take the risk of selling worldwide. Even M-Systems, which emerged strongly in the last five years and looked as if it might join the ranks of international giants, opted for acquisition, while optical communications solutions developer Passave Technologies abandoned plans for a NASDAQ IPO in favor of being sold to PMS Sierra.

“Israel’s strength is in developing creative, cutting edge products. But when it comes to sales distribution and marketing, they need the skills of large international companies,” explains Grobman. “They can go to IPO, but there is so much risk and added dilution that many think ‘what’s the point?’ Competing technologies may not be as good, but if a large international giant like IBM purchases them, you suddenly wake up to discover IBM in your back yard and you simply cannot compete head-to-head.”
He also believes that staying small suits the Israeli mentality. “Israeli CEOs aren’t in it for the long run. They set up a company and then five to six years later move on to something else. It’s like they’ve got ADD. They aren’t interested in the stodgy corporate world. They are interested in a quick commando raid.”

This mode of operation suits the US giants. “Giants like Motorola and IBM realize they can’t compete with VC money. It’s a no-brainer for them. They will pay a huge premium to get an edge in the market,” says Grobman.

What is particularly interesting about Israel’s high tech success in the last five years is that it comes against a backdrop of extremely difficult times in the country’s political life. For the first few years, the intifada was in full swing, and this summer the country was at war with Lebanon. “High tech is a world on its own,” explains Reifman. “It has no geographic boundaries. Problems at home were never an inhibitor. We live with it, we are used to it. This is just the way we are.”

“One of our advantages, and also one of our disadvantages is that we have no home market,” adds Sela. “Our companies are selling just samples in Israel. Their real markets are abroad. What’s happening here is almost irrelevant to the success of our companies. We really like it when there’s peace and quiet here, but there’s a big difference between home and business. Our companies were affected in a worse way when there was the SARS epidemic in Asia. Our companies are mini-multinationals from day one.”

So what comes next?

Internet, internet, internet,” says Reifman categorically. “We have barely scratched the surface of this new way of life and communication. Nothing else will be as hot as this. For five years investors stayed away, but now it’s the hottest item on the table.”

Sela agrees. So much so, in fact, that Gemini has set up a new Internet lab with Silicon Valley VC firm Lightspeed Venture Partners. The lab is intended to support 7-10 emerging Internet companies from Israel with an initial investment of up to $1m. each. Sela also believes that companies in the medical equipment and healthcare fields, and those in the consumer technology sector are likely to see huge growth. “These companies are mushrooming,” he says.

Grobman believes that Israel will see more development in the area of clean and green technologies like solar power and water. He also believes that homeland security will continue to develop as the war on terror and threat from terrorism grows, citing Camero a company that has developed technology that can see through walls, as a company to watch. In addition, he believes growth will come in semi-conductors and mobile technologies.

“These have been good years and I think it’s going to get better as the markets get better,” says Grobman. “Large international players are looking for good technologies to give them an edge and Israel has a great track record for creativity. This market will continue to be a good target for M&A exits and IPOs.”

“If we continue working on the trajectory that we have maintained over the last five years, the future will be very good,” adds Sela. “We have overcome quite a few difficulties and the market is good and interesting. There will be many interesting innovations coming out of the Israeli high tech scene in the next five years.”