Israel's Economy: As If the Intifada Weren't Enough...

The global tech crash has taken a tremendous toll on Israeli companies

Last summer, the business sections of Israeli newspapers were crammed with reports of local start-ups luring millions of dollars of venture capital for the next brilliant technology. Israel, not long ago an agricultural and industrial country, had turned itself into a Middle Eastern adjunct of Silicon Valley.

These days, the news is of shuttered young companies and layoffs. The tech boom has gone bust. "Sixty companies have closed down, and around 10,000 workers have been fired since the beginning of the year," says Gilay Dolev, senior analyst at D&A High Tech Information, a Tel Aviv industry analysis firm. Dolev expects 300 companies to close by yearend, a sixfold rise over last year. Victims include software developers Radguard and RealM Technologies, plus ActiveNames, an e-mail tracking service.

HARD TIMES. The global tech downturn knocked the wind out of many countries' sails. But for Israel, the blow is especially harsh. Not only is its economy the most tech-dependent in the world--the sector provides 15% of gross domestic product--but the bust coincided with the revived Palestinian conflict, in its ninth month and getting worse.

High-tech executives insist that the violence isn't the main factor in the Israeli downturn. "It's negligible by comparison to the collapse of the Nasdaq and the hard times facing the global high-tech industry," says Shlomo Kalish, founding partner at Jerusalem Global Ventures, a $200 million fund. But it will make it harder for Israel's tech community to keep its close ties to Silicon Valley's engineers and financiers. After the June 1 disco bombing, Delta Air Lines briefly suspended flights to Israel, and consultancy Gartner Group Inc. canceled a tech conference.

Technology represented two-thirds of last year's 6% growth, which shrank to a paltry 1.7% annual rate in the first quarter. Banks peg 2001 growth at 1%, the worst since 1967.

The cash river is drying up. Investors plowed a record $3.1 billion into local startups in 2000. That figure could drop by at least 60% this year. Funds raised more than $2.5 billion last year. In 2001, they'll get less than $1 billion. "Last year we were investing in at least one startup a month. Now, it has fallen to one every six months," says Zeev Holtzman, chairman of Giza Venture Capital, a Tel Aviv fund.

Stock market doldrums are one reason. Seventeen Israeli companies listed on Nasdaq last year. In 2001, one has. And startup acquirers such as Cisco Systems Inc. and Lucent Technologies Inc., which have their own woes, aren't buying. "With the window of opportunity for going public now shut, and mergers and acquisitions in the doldrums, our money has to last a lot longer," says Chemi Peres, senior partner at Israel's top fund, Polaris Venture Capital, and the son of Foreign Minister Shimon Peres.

Hard times don't deter everyone. On May 7, Benchmark Capital closed a $220 million Israeli startup fund, two months after Sequoia Capital Partners raised $150 million. But those are exceptions, and the government is concerned. It's now tackling problems overlooked in better times. "We've got to take quick action to prevent further damage to the high-tech industry," says Finance Minister Silvan Shalom. He vows to end double taxation on foreigners' capital gains from local venture funds; to halve the 50% capital-gains tax on stock options; and to cut red tape on M&A.

With violence casting its pall, Israel badly needs a global tech rebound. For his part, Jerusalem Global's Kalish says to beware of the Biblical prophecy: that seven fat years will be followed by seven lean ones.

By Neal Sandler in Tel Aviv

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