The Marketplace where International Technology Corporations do their Shopping…

by Elinor Sarel-Arbel

What motivates Lucent Venture Partners and Infineon Ventures to invest in Israeli hi-tech companies? What brings delegations from Nokia, AOL, Siemens and Telecom Italia to scout the Israeli landscape for technologies? Is it the Jewish/military mind? Is it the hundreds of new start-ups with a potential to go IPO? Not these days. What counts today, and this is unquestionably the reason for Israel being among the five leading countries in technology innovation, is the creativity and flexibility that characterizes Israeli hi-tech companies. Their ability to adjust business models to the current market demand and to address development efforts to niches which are relatively unoccupied worldwide, draw the international conglomerates to invest and acquire their technologies.

The Israeli hi-tech industry offers an unparalleled diversity of added value technologies. From sophisticated testing and inspection systems for capital equipment manufacturers to innovative chip and semiconductor solutions, advanced components in fiber optic communications for telecom service providers, world-class security hardware and software, and intelligent cellular technologies for next-gen wireless communication. And the list goes on … enterprise storage and data management solutions, smart home solutions for media and cable companies, and cutting-edge medical devices and biotechnology.

All of the above technologies, and more, are much sought after by large international corporations, seeking to enhance their services with easily integrated, revenue-generating solutions. Although Israel hasn't yet produced the next Lucent or Cisco - and this doesn't seem to be in the cards just yet - you can find plenty of technologies here to suit specific needs of corporations and enterprises.

Consequently, the phenomenon of multi-national corporations visiting Israel and scouting technologies is becoming an integral part of the Israeli hi-tech scene, to the point where the corporations' strong presence in Israel is strikingly apparent. Not only do we see minority investments in start-ups, but we also see M&A activity, foreign R&D centers emerging everywhere and multiple strategic investments and cooperation agreements. The level of M&A activity in Israel during FY2000, which totaled $12B in M&A deals, has proven unequivocally that corporations are willing to dedicate unlimited sums from their balance sheets for the acquisition of missing or completing technologies. The principal goal in the venture capital game is to gobble up as many solutions and applications as possible, and to earn a greater market share. This is one of the reasons for Israel being such an attractive shopping mall.

There is also the new corporate trend of creating an off-the-balance-sheet Corporate VC that scatters minority stake investments in various companies, both for easy returns and just to spread their standards around. And how do the local companies benefit from this? Well, it's no secret. They benefit from a valuable investor that not only easily signs checks, but also provides added value itself: assisting with quick penetration into the international market, providing professional technological support and corporate guidance, and strengthening the start-up's image in future private placements and exits, by linking it to the corporate's strong reputation.

Only two years ago, large corporations were passively involved in Israeli hi-tech, investing indirectly through local VCs or other representatives; however, today the corporations and their VCs take an active position in the battle for investment and influence. No longer do they maneuver via local partners, but are actually in Israel meeting with start-ups, hiring local people for business development in Israel, and seeking potential acquisitions and suitable locations for R&D centers. Nokia Venture Partners visited Israel recently to meet start-ups and to find a suitable candidate to locate technologies for them; Corning is seriously considering various options for establishing an R&D center in Israel.

Israel today is home to over 120 R&D centers owned by foreign corporations, with at least 40 of them being branches of multi-national corporations in global terms. These R&D centers are the first manifestations of multi-national corporations in Israel, including Intel, IBM, Microsoft, Cisco, and others. They were established either through the acquisition of a local company or a technological division needed by the corporation, or, as a result of the return to Israel of a senior Israeli engineer, leaving the corporate no choice but to open an R&D center in Israel under his leadership. Lucent, for example, established a full subsidiary in Israel in 2000 by acquiring Chromatis for $4.7B. On the other hand, Dialogic founded an R&D center "around" their returning chief R&D engineer, Nir Nice, and under his management. The operating cost of an R&D center is equally pricey in Israel and in the US, as is the cost of an R&D engineer. So, the reality of multiplying foreign R&D "settlements" has already changed the face of employment in the hi-tech sector, employing approximately 40% of the hi-tech workers in Israel.

In addition to R&D centers, the corporations act in myriad ways to achieve market presence and to secure dollars-and-cents-producing investments. Minority stake investments are the common method where the corporate invests a relatively small amount in a company, and gains up to 15% of the company's ownership. The investments vary from purely synergetic investments, with a strong strategic fit to the core technology, to strategically aligned investments in technologies that can add value and enhance the existing services, or to mainly-for-profit investments in technologies that are not necessarily synergetic to the corporation's agenda.

In most cases, these investments are done through an internal Venture Capital division, a Corporate VC. This hybrid creature invests primarily for the purpose of return, meaning that almost anything goes as long as it has dollar signs on it. A Corporate VC is established on the basis of the corporations' fluid cash for generating profit, as independent entities that are not restricted to a strategic fit. But, on top of this, the Corporate VCs are also used as market sensors, serving as the eyes and ears of the corporate regarding technology hypes and market demands. They encourage their portfolio companies to use the corporation's technology and invest in technologies that are in the company's supply chain. So here synergy is an advantage but not key. And yet each Corporate VC has it's own business structure and target investments, and no two are really alike.

Ilan Rosen, manager of ADC Ventures in Israel, depicts the fund as a corporate tool for investing in strategically important technologies. "Sometimes," he says, "the corporate wants to be close to technologies that are not entirely related to the core business, but it is in the corporation's best interest for future reasons to maintain proximity to this technology. For these types of opportunities the VC was initiated." On the other hand, Michael Hochholzer, Business Development Manager at Infineon Ventures, asserts that the decision-making process at the VC is completely independent and not restricted to synergy. "We invest in good companies where we believe there will be a good return", he says. However, he notes that "we do consult with the corporate on our investments, and we target companies with which the corporate can develop a good cooperation".

In general, we can identify common interests and business models among these Corporate VCs or investment departments. Some Corporations own an internal Venture Capital group, which is a completely separate division. It is dedicated to venture investments and operates off a set amount of capital put forth by the corporation. These include companies such as Sonera Venture, Siemens Venture Capital, Oracle Ventures, Motorola Ventures, Qualcomm Ventures and Corning Innovations Ventures, etc. Since their aim is more synergetic, investments made by these VCs will usually focus on earlier rounds of financing, when the investee is still in the stages of product development or even earlier; therefore the level of influence upon them and their chances for adapting the corporation's standards are higher. Greg Smith, Manager of Corning's VC program explains that his task is to locate purely synergetic optical components start-ups which will enable Corning to make the biggest impact on a start-up and provide the greatest added value - access to the insight, marketing, and commercial experience, as well as technological infrastructure.

Other corporate investment structures include Corporate Business Development groups that invest directly, such as Nortel and Cisco. George Cooney, Manager of Nortel's Business Development and Investment program and in charge of the Israel region, tells us they invest in strategically important companies where good return must be apparent. In their business structure, the decision-making process is as follows: under $50,000,000 will be decided upon by the team together with Nortel's CEO, and over that amount, by the entire Board of Directors.

On the other side of corporate venturing, where strategic fit and synergy are not as important, exist the Limited Partnerships and the externally managed Corporate VCs. Arie Litman, General Partner at Lucent Venture Partners, describes the company as a wholly owned venture capital subsidiary of Lucent Technologies, but not engaged in scouting related technologies or purely strategic investments. Litman says during a conference in Israel, "We invest for return, and for a quick one. Therefore, we are not capable of handling seed funding, only later stages where the model is clearer."

By contrast, Nokia Venture Partners is a Venture Capital firm that includes other limited partners such as financial institutions including Goldman Sachs, CDB WebTech, pension funds and other corporate investors like BMC Software, from the US, Europe and Asia. Although completely independent, with Nokia as a limited partner only, the firm seeks early stage investments in Nokia-related, mobile Internet companies. During his visit to Israel, Martti Malka, Managing Partner, told us that Nokia VP is currently checking out various investments in Israel. One candidate is IXI, an Israeli mobile computing company that develops solutions for optimizing mobile Internet solutions for the upcoming 2.5G and 3G wireless networks. So, an externally managed VC operates in synergy with the corporation's core technology, facilitating the progress towards Nokia's 3G mobile breakthrough.

Minority investments are also a way to achieve good market positioning. In many cases, a corporate makes a strategic decision to invest directly in a technology, not through the Corporate VC. Since, usually, the VC and the corporate business development groups are separate, sometimes the corporate needs to make an investment in order to assimilate its standards, and does it quickly, directly from the balance sheet. Agilent, for instance, invested directly in the Israeli optical communications firm, Trellis Photonics, which requires sophisticated and expensive testing equipment. The maneuver by Agilent assures them that Trellis will buy this equipment from Agilent once it's needed. In this type of minority investment, the company benefits from both an investment return and a profitable sale. Similarly, Compaq, which founded a $100M fund for biotech investments, invests in proteomics and genomics-related companies that will require Compaq's Mega-Computers for their data management and storage.

Unfortunately, (or fortunately?) the M&A activity has nearly come to a complete halt. We expect a dry season in acquisitions, since most of the corporations are too busy licking their wounds. The downturn in technology stocks has caused these giants to focus on internal matters rather than acquisitions of new divisions. Up to now, there have been hundreds of minority investments and mergers between corporations and Israeli hi-tech companies, with Intel at the lead with 32 investments, together with Cisco, Texas Instruments, EMC (that is carefully penetrating the Israeli market these days), Philips, and more. Even today, there hasn't been a plunge in minority investments or in the level of interest in Israeli technologies. On the contrary, we detect a continuous escalation and an ongoing international presence. As long as Israel maintains its rich technological reservoir, the multi-national corporations will continue to visit, invest, cooperate, and shop…

Elinor Sarel-Arbel is the Managing Editor at D&A, (Dolev and Abramovitz)