I OVERVIEW OF M&A ACTIVITY
Significant levels of M&A activity were seen in the Israeli marketplace during 2015, with 163 requests for merger approval having been received by the Israeli Antitrust Authority (Authority). This represented an increase of approximately 9.4 per cent as against 2014. The Authority approved 96.9 per cent of the 163 requests in 2015, and conditionally approved only 0.6 per cent. Of the requests, 1.8 per cent were not considered mergers by law, and only 0.6 per cent of the requests were rejected. Similarly to last year, there was an increase in the value of M&A transactions, and 2015 set a new record for average M&A deal size (excluding deals above US$1 billion).
As to the types of acquisitions, just as in 2014, Israel remains a technological giant. Most of the Israeli companies acquired during 2015 were in the high-tech field and high-tech-related industries; this is no surprise, given the encouragement of the development of this field by successive governments. Such encouragement is chiefly provided via the Office of the Chief Scientist (OCS) of the Ministry of Economy, which is responsible for implementing the governmental policy of encouraging and supporting industrial research and development in Israel, pursuant to the Law for the Encouragement of Industrial Research and Development 1984 (R&D Law). The OCS provides a variety of support programmes that operate on an annual budget of about US$377 million, which programmes have helped make Israel a major centre of high-tech entrepreneurship (Israel has one of the highest rates of research and development investment in the world) and additionally primes the pump for private sector investment in technologies by signing on as an anchor lender. The Israeli high-tech industry has been the source of many technological breakthroughs: Pillcam, the gold standard for intestinal visualisation (Given Imaging), drip and micro-irrigation systems (Netafim), the cross-platform mobile messaging app, Whatsapp, BreezoMeter, an air pollution monitor app, and a wearable robotic exoskeleton that provides powered hip and knee motion to enable individuals with spinal cord injuries to stand upright and walk (Rewalk), are just a few examples of technologies that Israeli companies have pioneered or were among the first to commercialise. Today, Israeli start-ups continue to drive innovation globally across all major technology sectors. More than 90 Israeli companies are currently traded on NASDAQ, the third-highest number of companies listed for non-US countries, behind Canada and China. Israel has consistently been a leader in categories such as expenditure on research and development as a percentage of GDP (according to the OECD), and it has more researchers for every 1,000 people than any other country.
In 2015, 96 Israeli high-tech companies were acquired or merged, slightly fewer than 2014 but representing a 6 per cent increase on the 10-year average of 90 deals. In addition, the average M&A deal size (excluding deals exceeding US$1 billion) in 2015 of US$75.4 million was 29 per cent more than the previous record in 2013 with an average deal size of US$58.6 million, and 32 per cent higher than 2014’s average deal size of US$57.3 million. The 2015 average deal size was also up 58 per cent from the US$47.6 million 10-year average.
The number of high-tech initial public offerings (IPOs) in 2015 was lower than expected, as IPO markets across the globe did not offer favourable conditions for IPOs. Eight IPOs accounted for US$0.609 billion during 2015, compared to 17 IPOs totalling US$2.1 billion in 2014 and eight IPOs in 2013. Capital proceeds, however, exceeded the 10-year average of US$591 million. All IPOs were performed outside of Israel, with six of the eight, including the two largest, occurring on the NASDAQ. Novocure, an oncology company pioneering a novel therapy for solid tumours, raised US$165 million based on a US$1.84 billion valuation, and was the largest IPO of 2015. SolarEdge, inventor of an intelligent inverter solution that revolutionises the way power is harvested and managed in a solar photovoltaic system, came in at a close second, with US$165 million raised on a valuation of US$685 million. Half of the deals, accounting for 55 per cent of the IPO proceeds, involved life science companies.
As to fund investments, so far, Israeli venture capital (VC) funds have raised US$1.02 billion in 2015, which is expected to reach US$1.5 billion by the time capital raising is complete. If this amount is reached, it will be 24 per cent higher than the US$1.21 billion raised in the previous year. Four Israeli veteran VC funds each raised more than US$100 million each, accounting for 59 per cent of total capital raised in 2015. On the inward investment side, US$4.4 billion was raised by 693 Israeli high-tech companies, from both local and foreign investments, the highest amount ever recorded, outdoing the US$3.4 billion raised in 2014.
In the first quarter of 2016, VC investments amounted to US$1.09 billion, raised by 173 Israeli high-tech companies. This was a 10 per cent decrease from the US$1.2 billion attracted by 201 companies in the record fourth quarter of 2015, but represented an 8 per cent increase in the corresponding quarter of 2015 and was slightly higher than the quarterly average in the past five quarters of $US1.1 billion.
Four notable acquisitions in 2015 were the Canadian company DH Corporation’s acquisition of the financial technology global company, Fundtech, for approximately US$1.25 billion; global information content and technology company Proquest’s acquisition of Ex-Libris, a leading global provider of cloud-based solutions for higher education, for US$500 million; Pitney Bowes’s acquisition of the Israeli e-commerce company, Borderfreel for US$450 million; and Amazon’s acquisition of Israeli micro-electronics company, Annapurna Labs, for US$360 million. In early 2016, the acquisition of Valtech, the Israeli replacement heart valve maker, by the US company Heartware, a leading innovator of less-invasive, miniaturised circulatory support technologies, previously announced in September 2015, for approximately US$929 million, was cancelled by Heartware, which cited that its circumstances had changed.
II GENERAL INTRODUCTION TO THE LEGAL FRAMEWORK FOR M&A
Since it came into force 16 years ago, the new Companies Law 1999 (Companies Law) has become the main body of legislation governing almost every field of corporate activity, save for insolvency and debenture matters, which were left to its predecessor, the Companies Ordinance 1983. The Companies Law permits mergers without court approval provided that approval has been given by the board and shareholders (subject to certain exceptions). Complementary regulations dealing with acquisitions made by way of a tender offer were also enacted in the form of the Securities Regulations (Tender Offer) 2000.
On the public side, transactions are also governed by the Securities Law 1968 and the regulations enacted thereunder, including the Securities Regulations (Periodic and Immediate Reports) 1970, which include regulations concerning the reporting of mergers. Israeli corporate law also contains provisions applying to targets that are Israeli public companies, which mandate the making of a compulsory tender offer where an acquirer builds up a stake in the target over a certain percentage holding. Accordingly, under the Companies Law (with certain limited exceptions), an acquisition of more than 25 or 45 per cent of a target (where there is no shareholder holding more than 25 or 45 per cent in the target, as applicable) (including where the acquirer is already a shareholder but by way of the proposed acquisition it crosses the relevant threshold) must be made by way of a ‘special’ tender offer, pursuant to which existing shareholders are entitled to sell their shares to the acquirer in equal parts; and more than 90 per cent of a target must be performed by way of a ‘full’ tender offer, in which at least 95 per cent of the existing shareholders must agree to sell their shares, and in such case, even if the remaining 5 per cent are opposed to the merger, they may be ‘squeezed out’ by the acquirer via a statutory compulsory purchase mechanism. Relatively recently, another requirement was added to the effect that at least half of the offeree shareholders without any personal interest in the transaction must agree to sell.
As mentioned above, perhaps the most recent significant legal reform affecting M&A in Israel is the possibility of effecting an acquisition by way of a merger under the Companies Law. Although, as a result of the burst of the dot.com bubble in 2000, there was little use of the merger procedure at the beginning of the previous decade, that picture has since changed. In particular, as found in the United States, mergers are now typically structured in Israel by way of a ‘reverse triangular merger’.
This method has mainly been used by foreign companies wishing to gain full ownership of an Israeli company so as to avoid having to obtain the high level of acceptances required under the provisions of the Companies Law that would otherwise apply if an acquisition were to be made by way of tender offer. Pursuant to the tender offer route, the effecting by the acquirer of a compulsory purchase of dissenting minority shareholders would require the obtaining, where the target is an Israeli private company, of 80 per cent acceptances (or, if incorporated before 2000, 90 per cent acceptances), or if an Israeli public company, 95 per cent acceptances, as noted above.
By contrast, a reverse triangular merger will, subject to certain exceptions, only require, inter alia, the approval of a simple majority of the shareholders of the target.
In a reverse triangular merger, the acquirer will establish a wholly-owned special purpose subsidiary in Israel, which is then merged into the target company. The target company is the surviving entity and, as a result of the merger, the shares in the target are cancelled and converted into the right to receive cash or securities of the acquirer.
Concerns were initially expressed by certain academics and practitioners as to the efficacy of such mergers, given that they are not dealt with directly within the Companies Law, even while the reverse triangular merger was fast becoming the norm in structuring acquisitions by foreign (as well as Israeli) entities of Israeli public companies and Israeli private companies with a wide shareholding base. However, a ruling of the Tel Aviv District Court, which was not appealed to the Supreme Court, rejected claims against the legality of such mergers, and it is now accepted that reverse triangular mergers are permitted.
III DEVELOPMENTS IN CORPORATE AND TAKEOVER LAW AND THEIR IMPACT
Within the technology-transfer sphere, in an effort further to boost technological innovation and entrepreneurship in Israel, on 29 July 2015, the Knesset (the Israeli parliament) passed the 7th Amendment (Amendment) to the R&D Law. The Amendment came into effect on 1 January 2016. The purpose of the Amendment is to allow the state to effectively and efficiently continue to support various Israeli companies that promote technological innovation and address the current challenges the high-tech industry faces, bearing in mind the importance of the high-tech industry to the Israeli economy.
The Amendment establishes, as a replacement to the OCS, the National Authority for Technological Innovation, an institute headed by the Chief Scientist and entrusted with the managing of the provision of benefits (including grants, loans, discounts and guarantees) for the development of technology, establishing various incentive programmes and determining the terms and conditions of such benefits and incentive programmes. To such purpose, the Amendment abandons some of the existing provisions of the R&D Law and its regulations, including the provisions regarding the prohibition of the transfer of manufacturing and know-how outside of Israel. Prior to the introduction of the Amendment, the R&D Law prohibited the transfer abroad or the grant to foreign entities of rights in know-how as well as the transfer of manufacturing rights that are directly or indirectly connected to OCS funding. These provisions have been replaced with guidelines, the particulars of which are forthcoming.
IV FOREIGN INVOLVEMENT IN M&A TRANSACTIONS
Foreign companies have continued to be involved in most major transactions during 2015 and the first quarter of 2016, with foreign funds, particularly from the United States, continuing to lead, albeit by a hairsbreadth, in terms of the number of deals. In 2015, foreign funds made 178 investments amounting to 52 per cent of first investments, and the remaining 48 per cent comprised 166 investments made by Israeli VC funds. The most active micro venture capital fund in 2015 was Singulariteam, a medium-sized Israeli fund, with 12 first investments in total. Israel’s Carmel Ventures and American fund Innovation Endeavours were second, with nine investments each.
Foreign VC funds that feature at the top of the most active funds list year after year are mostly those with a strong Israeli presence. US funds Innovation Endeavours, Marker and Blumberg, which ranked in that list in 2015, all have a solid presence in Israel, and Israel-dedicated foreign fund, OrbiMed Israel, set up by American investors OrbiMed Advisors to manage their operations in Israel, also appears on the list.
Successful local private equity activity has, in recent years, attracted large global private equity funds and investment companies such as Berkshire (Iscar), Apax Partners (Bezeq, Psagot, Tnuva), Permira (Netafim), Francisco Partners (NSO and ClickSoftware), KKR (Alliance Tyre Group), Oaktree (Veolia) and XIO Group (Lumenis).
On the M&A side, as expected, North American companies led the charge, accounting for 53 per cent of the deals, up from 44 per cent in 2014, with 43 acquirers in 47 deals from the US and three deals for two Canadian acquirers. Israeli-acquiring companies were second, with 30 per cent, slightly down from 34 per cent in 2014. Companies from the UK and Europe placed third, with 10 per cent of the deals, and Asian investors were fourth, with 5 per cent.
V SIGNIFICANT TRANSACTIONS, KEY TRENDS AND HOT INDUSTRIES
Israeli high-tech and life science companies performed well in 2015, with 693 companies attracting US$3.4 billion, a slight increase of 3 per cent from the US$3.3 billion raised by 681 Israeli high-tech companies in 2013, but 3 per cent below the US$3.5 billion raised in 2012. The number of deals in 2015 set an all-time record, breaking the previous record closed in 2014 by 13 per cent. In the fourth quarter of 2015 alone, US$841 million was raised, a 13 per cent increase on the previous five-year average of US$747 million. Similarly to 2014, the major contribution to this was seen in the internet, life sciences and software sectors.
Exits and other M&A deals involving Israeli and Israel-related high-tech companies that were acquired or merged in 2015 totalled US$9.02 billion. This reflected an increase of 16 per cent from 2013 and was the third-highest amount in a decade, lower only than the US$9.74 billion in 2012 and the US$10.1 billion reached in 2006. While there were somewhat fewer deals in 2015 compared to 2014, the average M&A deal in 2015 was US$87 million, up from a US$62 million 10-year average.
IPO activity slowed in 2015, after a strong performance in 2014. Eight Israeli high-tech IPOs accounted for US$609 million, around 7 per cent of the exit proceeds in 2015, compared to 27 per cent in 2014. Nonetheless, the largest three IPOs of 2015 all performed on NASDAQ and all exceeded US$100 million, accounting for 70 per cent of the amount raised in IPOs. In the first quarter of 2016, 173 high-tech companies have raised a total of US$1.09 billion, although this high number was nevertheless a 10 per cent decrease from the record fourth quarter in 2015, when US$1.2 billion was attracted by 201 companies.
These widespread transactions demonstrate that the country provides an opportunity for virtually every company looking to expand.
VI FINANCING OF M&A: MAIN SOURCES AND DEVELOPMENTS
As in 2014, Israeli private equity funds invested in a wide range of Israeli industries during 2015. Israeli private equity funds intensified their activities in 2015, and the life sciences sector saw a significant boost compared to 2014. Life sciences technologies produced 15 deals in an amount of US$626 million in 2015, with 11 deals at only US$59 million in 2014. Overall, the software and life sciences sectors accounted for 22 and 19 per cent, respectively, of private equity deals.
Two notable buyouts in 2015 by foreign private equity funds were the Chinese multi-billion dollar alternative investment firm, XIO’s buyout of Lumenis, a global leader in the field of minimally invasive clinical solutions for the surgical, ophthalmology and aesthetic markets for US$510 million, and the European branch of Francisco Partners’ buyout of ClickSoftware for US$438 million. These two deals alone accounted for 28 per cent of the total private equity proceeds in 2015.
Israeli private equity funds accounted for 27 per cent of total private equity activity, with US$902 million, a 19 per cent increase from the US$760 million invested in 2014 and a significant 42 per cent increase from US$636 million invested in 2013, although still lower than the US$1.38 billion invested in 2012. In the fourth quarter of 2015, the US$841 million in private equity deals was twice as much as in the third quarter of 2015. The largest deal in the quarter, which accounted for 36 per cent of quarterly deal value, was the US$300 million investment in Bioenergy Infrastructure Group, a producer set up to invest in the greenfield construction of biomass plants in the UK.
The first quarter of 2016 saw 15 private equity deals, compared with 14 deals in the same period for 2015. Total deal value was US$265 million, 46 per cent below the US$488 million in the first quarter of 2015 and 69 per cent below the final quarter of 2015. The largest quarterly deal by a foreign private equity fund was by Providence Strategic Growth, although the total investment activity of foreign funds in the Israeli market declined. The US$151 million invested in the first quarter of 2015 represented a decrease of 51 per cent compared to US$307 in the same quarter in 2015, and was 64 per cent lower than the US$423 million in the last quarter of 2015. Israeli private equity funds accounted for 43 per cent of total private equity investments with US$114 million invested, 17 per cent less than the US$137 million invested in the corresponding quarter of 2015. The technology sector accounted for an impressive 94 per cent of deals, with 14 deals raising US$250 million, 67 per cent higher than the US$149 million invested in 13 deals in the last quarter of 2015 but still 23 per cent lower than the US$324 million in the first quarter of 2015.
VII EMPLOYMENT LAW
Labour protection laws in Israel regulate certain rights of employees regarding a new employer (such as preservation of seniority and the making up of payments into savings funds) in the event of a merger or an acquisition. In a merger or an acquisition involving only share transfer, the general rule is that the continuity of the employment relationship is maintained (as opposed to an asset acquisition, where employees are transferred from one employer to another). However, if as a result of the transaction there is a worsening of working conditions, or other circumstances arise in which the employee cannot be expected to continue in employment, he or she may resign with an entitlement to severance pay. In a merger or acquisition, the consequence of which is the transfer of employees to a new employer, the general rule is that an employee cannot be transferred without consent. If the employee does not consent to be employed by the new employer, he or she remains the employee of the original employer, and if the latter wishes to end the employment relationship, it must dismiss the employee, and pay such entitlements as are in accordance with the law.
In addition, whenever a transaction involving changes that may affect employees is contemplated, the employer must consult and negotiate with the employees’ representatives (where these exist), with a view to reaching an agreement with respect to the employees’ rights. For example, in a transaction involving the transfer of some, but not all, of the employees to a new employer, with the consequent redundancy of those employees who are not transferred, and there is an uncertainty as to the future of those employees who are transferred, it is not unusual to reach an agreement affording such employees special benefits such as retirement payments and retention payments, thereby securing their cooperation in ensuring a smooth transaction and preventing industrial actions such as strikes or slowdowns.
VIII TAX LAW
Over the past few years, major tax reforms have been implemented and adopted into the Israeli tax legislation, particularly in the areas of capital market transactions and commercial activities on an international scale. In light of these changes within its fiscal regime, Israel today offers a variety of tax benefits to foreign residents wishing to structure their business operations through, or conduct activities in, Israel. Such benefits include a reduction in the various income tax rates, and a variety of tax exemptions and other benefits specifically directed to attract foreign resident investors. For example, corporate income taxes were reduced from 36 to 26.5 per cent in 2014.
Likewise, taxpayers have the right to request a tax pre-ruling. Tax rulings are key in M&A transactions – especially as, under Israeli law, the acquirer is responsible for withholding from the merger or share sale consideration monies on account of withholding tax. Typical rulings that are required in an Israeli M&A transaction (a procedure that has been assisted by the new amendment to the tax legislation referred to above) include rulings on:
- a the tax treatment of the conversion of a target’s option scheme into an option scheme of the acquirers or, if option holders are to be ‘cashed out’, the tax treatment of cashing out of options that are still within their ‘restricted period’ (this being the minimum period that an option must be held by a trustee in order for the holder to receive certain tax benefits);
- b the payment and rates of withholding to be made by the acquirer from the merger or share sale consideration on account of Israeli income tax, and how such withholding is to be effected where the merger consideration includes securities;
- c in the event any of the merger or share sale consideration is to be deposited into escrow as security for the warranties or indemnities under the sale agreement or plan of merger, a ruling to the effect that no withholding on account of Israeli income tax need be made except on that part of the ‘escrow fund’ eventually released to the selling shareholders, and deferring such withholding until its release from escrow; and
- d in the circumstances of certain type of mergers (e.g., a merger in which the shares in an Israeli company are exchanged for shares of a public non-Israeli company), subject to certain terms determined by the law and the Israeli tax authorities, a ruling exists that gives a deferral of the tax event and an exemption from withholding liability during the date of signature and the date of closing of the transaction.
IX COMPETITION LAW
M&A are regarded as prima facie restrictive practices and are regulated by the Restrictive Trade Practices Law 1988 (RTP). All mergers with regard to which there exists a public interest in their review, as determined by the relevant thresholds based on market share or turnover of the merging companies, are notified to, and reviewed by, the Authority, the decisions of which can be appealed before the RTP Tribunal.
Mergers are defined under the RTP as either the acquisition of most of the assets of one entity by another entity, or the acquisition by one entity of shares in another entity that would give the acquiring entity more than 25 per cent of the nominal value of the issued capital; the voting power; the right to appoint more than 25 per cent of the directors; or the right to participate in more than 25 per cent of the entity’s profits. An acquisition that falls within this definition must be notified to the Authority (i.e., a merger filing is a mandatory requirement) if any of the following thresholds are met:
- a as a result of the merger, the merged entity would be regarded as a monopoly;
- b in the fiscal year preceding the merger, the aggregate sales turnover in Israel of the merging entities exceeded 150 million shekels, and the sales turnover in Israel of at least two of the merging entities exceeded 10 million shekels each; or
- c one of the merging entities is already a monopoly in any relevant (product and geographical) market.
The parties are globally barred from closing (and a carve-out is also prohibited) or carrying out any action that might be regarded as constituting performance of the merger until the transaction has been approved by the Authority.
There are two types of notification forms – a long form and an abbreviated one, which may be used if certain conditions are met.
Given that mergers between international entities fall within the purview of the RTP if these entities conduct business in Israel and meet any of the necessary thresholds (in relation to their activities in Israel only) as detailed above, it is not surprising that major cross-border mergers are notified in Israel.
In March 2015, the Authority published a proposed amendment to the RTP stipulating a general prohibition of mergers raising a reasonable concern of substantially harming competition. Such mergers would be prohibited regardless of whether they would be subject to prior notification obligations in accordance with the above threshold criteria. Parties would be required to determine among themselves if the merger would give rise to such reasonable concern, and if they were to decide to proceed with a merger that would not be subject to mandatory notification, the Director General of the Authority could challenge the merger and the parties’ decision retrospectively on the grounds that the merger gives rise to a reasonable concern of harming competition. Although the proposed amendment would create a dramatic change to the Israeli merger control regime, it has, however, not yet progressed.
Despite having the lowest overall average growth rate in 2015 of 2.3 per cent since 2009, the Israeli economy’s rate of growth has exceeded most other OECD countries for over a decade. The unemployment rate is decreasing, inflation is low and the external balance is in surplus, all of which are indicative of prudent monetary, financial and fiscal policies in a volatile environment. The economy is resilient and economic fundamentals are strong. Productivity performance, however, has been low. Substantial deficiencies in product market regulation and competition, such as in the food industry and the banking and electricity sectors, are dragging down economic performance and reducing incomes. Experts have pointed to the relatively recent low foreign demand from the United States and Europe, as well as the appreciation of the Israeli shekel, as reasons for the subdued growth seen in 2015.
Nonetheless, domestic demand is predicted to be the engine behind a gradual improvement of economic growth. New projects in the high-tech sector, which continue to attract sizeable foreign direct investment inflows, as well as government measures to stimulate house building, are expected to contribute to this gradual increase in growth. To the extent that a suitable arrangement for the development of the recently discovered offshore gas fields can be reached, this would also improve the growth of the economy. VC activity will seemingly stay high, with the Israel Venture Capital Research Centre forecasting that local VC funds will raise nearly US$1 billion in 2016, with US$700 million potentially available for first investments.
On the M&A front, low interest rates and the recovery of the US and European economies are encouraging factors for M&A in the Israeli market.
1 Clifford Davis is a partner and Keith Shaw is a senior associate at S Horowitz & Co. The authors would like to thank their colleague, Adam Levitan, for his significant assistance in preparing this chapter.