I OVERVIEW OF M&A ACTIVITY
There were significant levels of M&A activity in the Israeli marketplace during 2017, with 159 requests for merger approval received by the Israeli Antitrust Authority (the Authority). This represented a decrease of approximately 17 per cent compared with 2016. The Authority approved 94.6 per cent of the requests and conditionally approved 2.4 per cent. None of the requests in 2017 were rejected. Nineteen per cent of the requests were international deals, which was the largest share in more than a decade.
Israel is known as the start-up or innovation nation and it comes as no surprise that, just as in 2016, most of the Israeli companies acquired during 2017 were in the high-tech field and high-tech-related industries, in particular the software and technology sector and the pharmaceutical and life sciences sector. Industrial research and development (R&D) is hotly pursued in Israel, and chief among those encouraging this is the government-funded Israel Innovation Authority (IIA). The IIA, established and governed by the Law for the Encouragement of Industrial Research and Development 1984 (R&D Law), nurtures and develops Israeli innovation resources, while creating and strengthening the infrastructure and framework needed to support the industry.
Israel's high-tech industry has been the source of many technological breakthroughs, particularly in the fields of water irrigation, medicine and transport: drip and micro-irrigation systems (Netafim), Pillcam, the gold standard for intestinal visualisation (Given Imaging), WoundClot bandages, which stop severe bleeding within minutes, a wearable robotic exoskeleton that provides powered hip and knee motion to enable individuals with spinal cord injuries to stand upright and walk (Rewalk), and Mobileye, driver assistance technology to prevent accidents, are just a few examples of technologies that Israeli companies have pioneered or were among the first to commercialise. Israeli start-ups continue to drive innovation globally across all major technology sectors and more than 90 Israeli companies are currently traded on NASDAQ. Israel has also consistently been a leader in categories such as expenditure on R&D as a percentage of gross domestic product (according to the OECD).
In 2017, 94 Israeli high-tech companies were acquired or merged, slightly fewer than in 2016.2 The average M&A deal size (excluding the two largest – the acquisition of Mobileye by Intel for US$15.3 billion, and the acquisition of Neuroderm by Mitsubishi Tanabe Pharma for US$1.1 billion – which skews the data upwards) in 2017 of approximately US$51.8 million was 8 per cent higher than 2016's average deal size of US$47.8 million. Overall, including the two aforesaid outlying deals, total deal value reached US$23 billion, an increase of 18 per cent on 2016.
The number of high-tech initial public offerings (IPOs) in 2017 was substantially higher than 2016, attracting US$440 million. Thirteen high-tech companies conducted IPOs in 2017, up from five in 2016. Three IPOs were carried out in Israel, one in the United Kingdom and another three in the United States, with ForeScout raising US$116 million on NASDAQ. In what was an interesting development, six IPOs were carried out on the Australian Securities Exchange (ASX), which appears to have become a hotbed for innovative Israeli tech companies looking for new ways to raise capital.
As regards fund investments, the most active venture capital (VC) fund in 2017 was Vertex Israel, ranked at the top of the list with 12 first investments. In a close second, aMoon Partners, a life sciences fund managed by Check Point founder Marius Nacht, took on 11 new investments. Third place was shared by three funds – F2 Capital, IAngels Seed Fund and Mindset Ventures – each with 10 new investments.
Israeli VC funds raised US$1.3 billion in 2017 and four more funds with US$550 million were under management in early 2018. However, foreign VC activity slowed down during 2017 compared to previous years, as reflected in the ratio between Israeli and foreign funds, which decreased, with Israeli funds holding 48 per cent of total new investments, a new record in the last five years. On the inward investment side, US$5.24 billion was raised by 620 Israeli high-tech companies in 2017, an increase of 9 per cent compared to the US$4.83 billion raised in 2016, from both local and foreign investments; this is the highest amount ever recorded, exceeding the previous record of US$4.4 billion raised in 2015. The increase derived from four large deals (Cybereason, Via, Lemonade and Skybox) of more than US$100 million each, amounting to 12 per cent of the total amount raised. The average financing round has been increasing since 2013, from US$3.6 million to an average of US$8.5 million in 2017.
Six notable acquisitions in 2017 were:
- the acquisition by Intel of Mobileye, which specialises in cutting-edge driver assistance technology to prevent accidents, for US$15.3 billion;
- the acquisition by Mitsubishi Tanabe Pharma of Neuroderm, a clinical-stage pharmaceutical company developing treatments for disorders of the central nervous system, for US$1.1 billion;
- the sale of Israeli game developer Plarium to Australia's Aristocrat for US$500 million;
- the acquisition by auto giant Continental AG of Argus Cyber Security for US$430 million;
- the purchase of Tel Aviv-based customer identity management firm Gigya by German software giant SAP for US$350 million; and
- the acquisition by Gett of Juno Labs for US$200 million, which was the largest deal among Israeli acquirers.
II GENERAL INTRODUCTION TO THE LEGAL FRAMEWORK FOR M&A
The Companies Law 1999 (the Companies Law) is the main body of legislation governing almost every field of corporate activity, save for insolvency and debenture matters, which are governed by the Companies Ordinance 1983 (though a new set of insolvency laws will come into force in 2019, following the enactment of the Insolvency and Rehabilitation Law, 2018). 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 in which 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 (with 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. In addition, 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; in such a 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 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 subsequent 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 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 a tender offer. Pursuant to the tender offer route, for the acquirer to effect a compulsory purchase of dissenting minority shareholders would require 80 per cent acceptances, if the target is an Israeli private company (or, if incorporated before 2000, 90 per cent acceptances), or 95 per cent acceptances if the target is an Israeli public company, 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.
III DEVELOPMENTS IN CORPORATE AND TAKEOVER LAW AND THEIR IMPACT
The Control of Financial Services (Regulated Financial Services) Law, 2016 (FSL) came into force in June 2017 (save for certain provisions which come into force in 2018). It seeks to regulate the provision of non-banking credit services and financial asset services in Israel. It was introduced both to encourage the development and progress of the non-institutional financial services field and to provide an appropriate alternative to the financial services banking system, but also to protect customers and clamp down on illegal activities in an area that was previously barely regulated or supervised.
In general, inter alia, the FSL imposes a licensing requirement on individuals or companies that wish to offer either financial asset services (including currency exchange and certain virtual or pre-paid currencies commonly used in the fintech sector), or provision of credit, defined in a broad manner as 'providing credit by way of occupation'. There are a number of entities that are exempt from this licensing requirement, such as financial institutions that are already regulated under existing legislation. In addition, newly published draft regulations propose to exempt certain types of entities, including banks located in an OECD member country.
On the side of cryptocurrencies, the Committee for the Examination of the Regulation on Cryptocurrencies, within the Israeli Securities Authority (the Committee), published an interim report in March 2018 regarding its main recommendations in respect of the question of whether a cryptocurrency should be deemed a security or a regular coin. The Committee recommended that cryptocurrencies intended solely for payment, clearing or exchange, other than a specific venture, and that do not confer additional rights and are not controlled by a central entity, should not be considered securities. Conversely, it recommended that cryptocurrencies that grant rights to a security similar to that of shares or bonds (voting rights and participation rights) should be deemed as a security (those cryptocurrencies that are usually referred to as security tokens or investment tokens). From another angle, as expected, the Committee said that it would act to ban companies in the cryptocurrency business from being included in the Tel Aviv Stock Exchange's share indices. The robust debate in Israel concerning the regulation and taxing of cryptocurrencies continues but it appears that the Committee has taken a more gentle approach compared with some other jurisdictions.
IV FOREIGN INVOLVEMENT IN M&A TRANSACTIONS
Foreign companies continued to be involved in many major transactions during 2017, with foreign funds, particularly from the United States, leading in terms of the number of deals. Canadian and US corporations acquired 39 Israeli high-tech companies, amounting to 42 per cent of the total number of deals. European corporations (including the United Kingdom and Russia) were purchasers in 13 per cent of all M&A deals and three were led by Chinese acquirers (one fewer than in 2016).
Foreign funds made 233 investments amounting to 52 per cent of first investments, and the remaining 48 per cent comprised 212 investments made by Israeli VC funds. This was the lowest share for foreign funds in five years.
The largest M&A deal in 2017 involved an American multinational corporation and the technology company, Intel, and the second largest was the acquisition by Mitsubishi Tanabe Pharma Corporation, a Japanese public company trading on the Tokyo Stock Exchange, of Israeli pharmaceutical company NeuroDerm. German companies also took part in the biggest deals, with automotive manufacturing company Continental AG acquiring Israel's Argus Cyber Security, whose technology guards connected cars against hacking, and German-based multinational software corporation SAP's purchase of Israel's Gigya, a customer identity management technology company.
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).
V SIGNIFICANT TRANSACTIONS, KEY TRENDS AND HOT INDUSTRIES
Exits and other M&A deals involving Israeli and Israel-related high-tech companies that were acquired or merged in 2017 totalled US$23 billion. Disregarding the two largest deals, the total value was US$6.6 billion. This reflects an increase of 18 per cent from 2016, yet is still lower than 2014 and 2015. There were fewer deals in 2017 compared to 2016, and fewer still compared with the numbers recorded in 2014 and 2015. The Software and Life Sciences exit activity slightly increased in 2017 compared to 2016, yet the number of exits in the communications and internet sector dropped significantly compared with the previous four years. There was also a decrease in the number of exits in the cybersecurity cluster. Nevertheless, the high values of the deals in 2017 are indicative of Israel's superpower status in the cyber sector.
The downward trend from 2016 in the number of capital raising deals continued, with a decrease of 8 per cent during 2017. According to the IVC Research Centre, the decline is due to two main factors. First, compared to 2016, investors, such as incubators and accelerators, were involved in 49 per cent fewer deals than in 2017. Second, VC funds have been avoiding R&D companies, which have continued a noticeable downturn during the past five years. In 2017, they reached their lowest level of involvement, with 40 per cent fewer deals involving VC funds, compared to 2013.
The first quarter of 2018 continued the positive trends in Israeli high-tech industry, with US$1.52 billion being raised in 181 deals. Both the number and the value of deals grew compared to the previous quarter (US$1.46 billion in 161 deals) and compared to the first quarter of 2017 (US$1.06 billion in 155 deals).
There was a lot of hype concerning block chain technology and cryptocurrencies during 2017. While, as noted above, Israeli regulators have published interim reports relating to the possible implementation of laws and regulations dealing with the taxation of cryptocurrencies and initial coin offering (ICO) procedures, this has not stopped Israeli companies from already raising funds through ICO offerings; and the sums are big. A number of start-ups have raised more than US$150 million and, in 2017 alone, 10 Israeli start-ups raised a total of US$480 million through ICOs. For instance, Bancor, a decentralised liquidity network that allows the holding of any Ethereum token (a cryptocurrency) and its conversion into any other tokens in the network, on-chain, with no counter party, raised US$153 million worth of ether in a matter of three hours by selling its digital tokens.
VI FINANCING OF M&A: MAIN SOURCES AND DEVELOPMENTS
The number of Israeli private equity deals grew in the first half of 2017 by 17 per cent compared to the first half of 2016. Israeli and foreign private equity funds were involved in 68 deals in the sum of US$807 million in the first half of 2017. Among the largest deals in 2017 was the buyout of R2Net by Francisco Partners, the buyout 'of Telefire Fire & Gas Detectors by Tene Growth for US$76 million and the buyout of Ace Auto Depot by Kedma for US$50 million.
In the second quarter of 2017, foreign private equity funds invested US$248 million, up from the US$90 million invested in the first quarter (the lowest quarterly amount in the past three years), but substantially below the US$1.1 billion invested in the second quarter in 2016, when foreign funds led with 87 per cent of all private equity investments. In the first half of 2017, only Sky Private Equity III closed its fund, raising capital in the amount of US$200 million.
In terms of sectors, software companies had a productive year raising US$1.9 billion in 208 deals in 2017, similar to 2016 figures. US$1.2 billion was raised by life sciences companies, which is a 41 per cent increase on the US$850 million raised in 2016. Communication companies, though, registered a decline in the number of deals and total capital raised with US$569 million in 72 deals, compared to US$872 million in 106 deals in 2016.
According to the IVC Research Centre, 41 Israeli private equity management companies are currently active, managing a total of US$13 billion, with an estimated US$1 billion available for investments.
VII EMPLOYMENT LAW
Labour protection laws in Israel regulate certain rights of employees regarding a new employer (such as preservation of seniority and the responsibility of the new employer to make payments to the employees and into savings funds with respect to the employment with the previous employer) 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 (subject to their consent to the transfer). 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 only some of the employees to a new employer, with the consequent redundancy of those employees who are not transferred, and there is uncertainty as to the future of those employees who are transferred, it is not unusual to reach an agreement affording those 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
During the past few years, major tax reforms have been implemented and adopted into 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 Israel, or conduct activities there. 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 have been reduced from 36 per cent to 23 per cent in 2018.
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:
- 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 for the holder to receive certain tax benefits);
- 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 if the merger consideration includes securities;
- 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 the withholding until its release from escrow; and
- in the circumstances of certain types of mergers (e.g., one 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 the market share or turnover of the merging companies, are notified to, and reviewed by, the Authority. These decisions can be appealed before the RTP Tribunal, although a fast-track procedure now exists for mergers in respect of which there is no reasonable concern of substantive harm to competition.
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: (1) as a result of the merger, the merged entity would be regarded as a monopoly; (2) 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 (3) one of the merging entities is already a monopoly in any relevant (product and geographical) market.
The parties are globally barred from closing (a carveout 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. This proposal did not progress, however, and in light of the recent Draft Restricted Trade Practices Law (Amendment No. 20) (Strengthening Enforcement and Reducing the Regulatory Burden), 2018 (the Draft Amendment), it is now unlikely to do so. Under the Draft Amendment there are two main issues that concern mergers. One is that it raises the financial threshold of merger notification to 360 million shekels. Second, it extends the duration of the merger examination period to 30 days and gives the Authority the possibility to extend the merger examination period for another 120 days, without the need to obtain the consent of the parties.
The overall average growth rate in Israel during 2017 was 3.1 per cent, which is less than the 4 per cent seen in 2016. Nonetheless, the expected growth rate for 2018 (3.5 per cent) still looks promising. The unemployment rate is at a record low, as job creation has remained robust and according to the Bank of Israel, by the end of 2018, inflation is expected to be 1.5 per cent. Prices of domestic products are expected to continue to rise moderately as certain factors, such as increased competition and government measures to reduce the cost of living, will continue to slow the pace of price increases. On the other hand, the proximity to full employment is expected to continue to support a rise in salary, which may serve to raise domestic inflation.
Despite some concerns in Israel about potential instability regarding the geopolitical situation in the Middle East, it is business as usual.
1 Clifford Davis and Keith Shaw are partners at S Horowitz & Co. The authors would like to thank their colleagues at S Horowitz & Co, Adam Levitan and Gal Nir, for their significant assistance in preparing this chapter.
2 The figures quoted in this chapter are based on reports issued by the IVC Research Centre.