10 days ago, Israeli company Orbotech Ltd. (Nasdaq: ORBK) announced that its acquisition by US company KLA-Tencor for $3.4 billion, which was agreed in March and slated for completion by the end of 2018, was being held up by a delay in obtaining approval from the Chinese antitrust agency. The reason for the delay is believed to be the trade war between China and the US.
Orbotech, which has operated in China for 30 years, is one of Israel's largest exporters to the country, which accounts for 30% of Orbotech's revenue. As of now, the two companies are not calling off the deal and are pursuing approval for the deal. The signals to the high-tech industry, however, cannot be ignored. Every startup, large company, investor, and party in the high-tech industry must start taking the trade war into account, understanding it consequences, and taking judicious measures in order to avoid paying the price later.
Orbotech is not the only one hit. The US is imposing a boycott on Chinese company Huawei and is pressing its allies to join it. Harming Huawei, however, also means harming companies like US companies Intel and Qualcomm, Huawei's strategic partners. Qualcomm was also affected when it was unable to obtain Chinese approval for the acquisition of Dutch chip manufacturer NXP. Bill Gates announced this week that his nuclear energy business was terminating its cooperation with a Chinese company because of new regulatory restrictions.
These cases are the result of the struggle between China and the US over the past two years, led by US President Donald Trump. The two countries have already imposed $50 billion in customs duties on each other, and the amount is expected to increase. In addition, two years ago, China made it more difficult to conduct foreign currency transactions in China and to take money out of the country, thereby making it more difficult for Chinese companies to acquire or invest in high-tech companies outside China. In recent months, the US has also legislated a number of restrictions that will affect mainly high tech.
At a time when the trade war between the US and China is escalating, Israel is fostering close ties with both powers. Simultaneously with its close relations with the US, especially with the Trump administration, the Israeli government has marked China as an important target for development of economic relations. Stationing commercial attaches in China, opening a joint innovation center, the visits to Israel by Alibaba chairperson Jack Ma, and the Chinese vice president's presence at the launching of Israel's innovation are examples of this.
The rivalry between China and the US ostensibly does not concern Israeli companies. Israeli high tech, however, is a global industry, and Israel's relations with both China and the US benefit it. Most of the money invested in Israel startups comes from the US. The US market is the one at which many of the ventures aim, and US concerns account for the acquisition of more Israeli startups than concerns from any other country.
At the same time, Chinese concerns have become more prominent in Israeli high tech in recent years. Figures published in October by "Globes" show that Chinese investors are involved in one quarter of all financing rounds of $20 million or more in Israel, and in one third of all rounds of $50 million or more.
How Israeli high tech is affected by the trade war
Israelis are worried about offending the US. The trade war is too recent for significant figures on it to have accumulated. Some hope that the waning of Chinese investment in the US will make Chinese investors divert their money to Israeli high tech. Others believe that Israel will lose from the rivalry between the two powers, because Chinese investments in Israel will dwindle. Various sources in the Israeli high-tech industry believe that the effects of the trade war will increase in the coming months. If the wind keeps blowing in this direction and the hostility between the two powers continues to escalate, Israeli high tech may have to choose sides.
Adv. Tehila Levi Lati, who heads the China desk at the ZAG-S&W law firm, detected a change over the past year, which she says is making commercial ties with both China and the US more difficult. She told "Globes," "Many of our companies are in both China and the US, and held IPOs on Nasdaq. There was a change in mood and regulations over the past year.
"Today, I see a strong movement of investors and companies from China to Israel, because Chinese investors are having more trouble in the US. On the other hand, it became clearer last year that it is harder for companies with Chinese investors to raise money in the US. Following the regulatory changes in the US, US investors in the past year were less eager to invest in ventures in which Chinese companies have invested. They asked more questions and thought twice before making deals in which Chinese concerns were involved."
"We feel more caution, more anxiety, but deals aren't failing because of this," says Maria Ginzburg, managing director of the Israeli branch of Asia Direct, which has engaged in investment banking for almost 18 years. In the past, it engineered the deal with SQream and Alibaba and the sale of IOPtime to Chengdu Kanhong Pharma.
Ginzburg adds, "In negotiations, the Israelis had to list the components in the product, so that the Chinese could understand which parts were manufactured in Israel and which in the US. As long as the sensitive parts, such as a motherboard or chips, are produced in Israel, the Chinese feel confident in the investment, and it doesn't bother them. The Israelis, on the other hand, are expressing the US objections, because they are liable to get in trouble there if they receive Chinese investment."
Amit Karp, a partner in Bessemer Venture Partners, says, "We don't want our companies to come with Chinese money, and I don't think we're the only ones. Only recently, one of our companies spoke with a Chinese strategic investor who wanted to invest in it, and we told them to forget about it.
"The company's sector is related to data and sensitive matters, and we realized that if they have a Chinese investor, one day, when the company wants to be acquired and we'll have to get regulatory approval, the Committee on Foreign Investment in the US (CFIUS) will be more aggressive."
Karp says that the risk in adding a Chinese investor to the company is not worthwhile. "Meanwhile, this is an Israeli company, and US regulation doesn't apply to it, but it is only beginning, and it can develop in a lot of directions, so there's no reason to take a risk," he explains.
Karp believes that foregoing Chinese money is a fairly small matter. "Up until now, Israeli companies enjoyed the privilege of the US as a first market, while also being able to sell in China, where there are actually very few Israeli companies selling. As a country, we think that we're more independent than we are, but as in the past with defense deals with India, in which the US told us to back off, today they consider China as a partial enemy, and as a client state of the US, we have to do what they say."
Cancelation of deals using national security as an excuse
The trade war between China and the US shifted into high gear in November with the taking effect of a new reform empowering CFIUS to cancel investments in and acquisition deals for technology companies if they give foreign concerns access to US technological know-how or critical infrastructure. In addition, the supervisory regulations on exports were extended to include critical and breakthrough technologies.
CFIUS's new reform is the most recent factor likely to have a significant effect on Israeli high tech, and events appear headed in this direction. The economic-commercial department in the Israeli embassy in Washington says that it is regularly following developments in this legislation that will affect Israeli industry.
Yifat Alon Perel, Minister of Economic and Trade Affairs in the Israeli embassy in Washington, explains that in addition to overseeing foreign investments, new export supervision regulations are also likely to have an effect. She says, "When an Israeli company wants to import components from the US, such as electronic components, if the component is defined as dual purpose for both civilian and military uses, it is likely to put on the list of components to be supervised.
"This means that an Israeli company that buys supervised components from the US has to undertake that its product will not reach countries like China, North Korea, or Iran, even if it doesn't sell them to those countries directly - it has responsibility for the chain. When we talk about companies that are in both Israel and the US, the picture is more complicated, because it affects the ability to both import and export.
"'National security,' the concept underlying all of this legislation, is being used by the current administration more than in the past, and we want to make sure that it is not being used unfairly. This process is open for public comments until January 10, and not just by US citizens - something that is common in US legislative processes. I want to encourage Israeli industry to make comments in this matter. Israeli companies are invited to state what the negative effects for them will be, and to mention the technologies that they are producing and the markets to which they are selling."
Sources familiar with US regulation and the discussion of it in Israeli government ministries told "Globes" that the US administration was exerting pressure on US allies, including Israel, to take the same action as the US, and to examine foreign investments in Israeli high-tech, especially from China.
Israel Innovation Authority head of business operations division Aviram Zolti, who is responsible for grants and taxes, told "Globes" that the Innovation Authority was unaware of any pressure and prefers to refrain from any action. "We aren't part of the trade war, and we don't want to be part of it. If we see that it's having a substantial negative impact on Israeli or other companies, we see what can be done to solve the problem, but when the government intervenes, mistakes can be made. As we see it, the right thing to do is to see what's happening and to correct policy only if there's a real need," he said.
Chinese encouraging technology imports
In the past two years, since 2016, regulation in China has changed to make taking money out of the country more difficult. As a result, Chinese investments in the US plummeted 92% in the first half of 2018, compared with the preceding year, and amounted to a mere $1.8 billion, compared with tens of billions of dollars in previous years. Financial investments in Israel and acquisition of Israeli companies by Chinese concerns are subject to the same restrictions that reduced Chinese investment in the US.
At the same time, the Chinese administration encourages bringing technology into the country. Chinese investors continue to visit Israel, but investments from China in Israeli companies are being made under stringent terms corresponding to Chinese government policy. Levi Lati says, "In the coming years, the Chinese will make fewer and smaller investments, with the financing being received in China, not Israel. As part of the investment, they will ask a company to found a joint venture in China with them, to which the Israeli company will bring the technology. The US regards this as stealing technology and exploitation, while the Israeli companies that I work with regard it as an opportunity to enter the Chinese market together with a Chinese partner."
Published by Globes, Israel business news - en.globes.co.il - on January 7, 2019
© Copyright of Globes Publisher Itonut (1983) Ltd. 2019