Tags: Israel | M&A | private | equity

Israel's Wealth Concentration Law Creates Corporate Buyout Opportunities

By    |   Friday, 10 January 2014 09:58 AM

In response to the rising cost of living and concentration of wealth in Israel, in October 2010, the Israeli government established the “Committee on Increasing Competitiveness in the Economy,” also known as the “Concentration Committee,” to examine the existing structure of the economy and to recommend steps to stop the rapid increase in the cost of living in Israel and reduce the concentration of wealth.

Following mass demonstrations by the Israeli public, in February 2012, the Concentration Committee made several recommendations, including prohibiting the simultaneous ownership of certain financial and non-financial entities and breaking up existing pyramidal structures and prohibiting the formation of new ones.

In April 2012, the Israeli government approved the final recommendations of the Concentration Committee and initiated the legislation process. After several months of deliberation by its Finance Committee, the Israeli parliament (Knesset) passed the new “anti-concentration” law based on the Concentration Committee’s recommendations.

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Prohibition on Simultaneous Ownership of “Significant Financial Institutions” and “Significant Non-Financial Entities”

The new law prohibits holding (generally above 10 percent of the outstanding shares) or controlling a “significant financial institution” by a “significant non-financial entity” or a person controlling a “significant non-financial entity.” Among other things, this prohibition is meant to address the risk of a market failure in the event that one of the significant companies or their controlling shareholder is in financial distress and also the potential conflict of interest between financial institutions and competitors of their non-financial affiliates.

Under the new law, a “significant financial institution” is defined as a financial institution (e.g., bank or insurance company) with assets in excess of NIS 40 billion (~$11.2 billion), and a “significant non-financial entity” is defined as an entity, other than a “financial institution, ” with consolidated revenue in Israel in excess of NIS 6 billion (~$1.7 billion) or consolidated debt in Israel in excess of NIS 6 billion. Declared non-financial monopolies with revenue in Israel in excess of NIS 2 billion (~$564 million) are also treated as “significant non-financial entities” for purposes of the new law.

The general rule under the new law is that shareholders who control both types of entities will be forced to sell one or the other within four to six years, thus creating significant LBO opportunities in Israel.

Breaking Up Big Conglomerates

Ownership of Israeli companies is concentrated in the hands of a relatively limited group of Israeli individuals (sometimes referred to as “tycoons”) and families. Using pyramidal structures, those individuals and families have been able to invest relatively small amounts of capital in a public company to buy control of a whole conglomerate consisting of the target public company and many other public companies controlled by it. It is estimated that through such conglomerates, those individuals and families effectively control about 30 percent of Israel’s economy, which puts Israel at the top of the OECD’s chart of countries with most concentrated markets.

In addition to the market concentration problem, pyramidal structures cause a discrepancy between control and economic rights of the ultimate controlling shareholder: by holding a controlling interest in the parent company, the controlling shareholder can exercise control over companies down the corporate chain in which the controlling shareholder has only a minority economic interest. This allows the controlling shareholder to shift a disproportionate share of the risk of transactions involving entities at the lower levels of the structure to the public shareholders. In recent years, controlling shareholders of some conglomerates structured in this fashion raised significant amounts of debt at different levels of the corporate chain, mainly to distribute the proceeds of such debt up the chain for the benefit of the controlling shareholders. In some cases, this practice made some conglomerates insolvent.

Under the new law, controlling a pyramidal structure with more than two layers of publicly traded companies or companies with public debt is prohibited. The new law permits taking a third layer company public, but requires the sale of a controlling interest in the third layer company within six years after its initial public offering. The new law also imposes stringent governance requirements, mainly with respect to board independence, on a second layer company of which a controlling person holds, through another public company or a company with public debt, less than 33 percent of the economic interest. A general transition period of six years is provided for controlling shareholders to unwind existing conglomerates with more than two layers. As a result, additional companies may be offered for sale or become available to be taken private.

Opportunities and Considerations

The corporate buyout opportunities presented by the new law will draw the attention of private equity and strategic investors to the Israeli market. According to news reports, some companies which may be offered for sale as a result of the new law include Paz Oil Company Ltd., First International Bank of Israel, The Phoenix Holdings Ltd., Excellence Investments Ltd. and certain subsidiaries of IDB, among others.

Investors interested in Israeli companies should be mindful of certain unique structuring, funding, corporate and tax considerations that need to be addressed at the early stages of negotiating a buyout of an Israeli company, such as the restriction on using the target company’s cash to finance an LBO (a practice common in U.S. transactions). In light of these considerations, counsel with relevant expertise in Israeli business law should be consulted.

It remains to be seen whether the new law will achieve its goals of increasing competition and reducing the cost of living for Israelis, but in the near term, it will significantly increase M&A activity in Israel, particularly given the limited supply of target companies in the current global M&A market.

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Ariel Yehezkel is a partner in the corporate practice group of Sheppard Mullin Richter & Hampton LLP. Mr. Yehezkel concentrates his practice on private equity and domestic and cross border business transactions, including mergers, leveraged acquisitions, follow on acquisitions, divestitures, debt financing, fund formation, PIPE investments, joint ventures, minority investments and other equity arrangements. He is a leading member of the firm’s Israel practice and has extensive experience with legal and business issues involving Israel.

Amanda Ackerman is an associate in the corporate practice group of Sheppard Mullin Richter & Hampton LLP. Ms. Ackerman has experience in a broad range of transactional matters, with a focus on representation of corporate clients and private equity funds in connection with domestic and cross-border mergers and acquisitions, mezzanine financings, equity investments and venture capital.

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In response to the rising cost of living and concentration of wealth in Israel, in October 2010, the Israeli government established the "Committee on Increasing Competitiveness in the Economy."
Friday, 10 January 2014 09:58 AM
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