The Hi-Tech Bubble Revisited

Going by macroeconomic data, the Israeli economy seems to be doing pretty well with low inflation, low unemployment, a strong shekel (debatable whether that’s good or not) and home grown start-ups continue to be picked up by global companies. An interesting trend is the entry of Asian players seeking opportunities in Israel as is evident with the acquisition of Viber, a video and voice communications application, by Japanese Internet giant Rakuten for 900 million dollars. The sales of household names such as Tnuva to the Chinese, and most recently that of Tambour paints to a Singaporean company would seem to confirm that growing trend.

At the same time, the current state of the hi-tech industry seems reminiscent of the bubble in 2000 in certain ways. As a reminder, early stage start-ups were valued at hundreds of millions of dollars if not more (the ‘eyeballs’ model, if you may) at that time, without having sold a single dollar in revenue. This propelled an exit culture which began in the mid-1990s, culminating in early 2000 and then driving a re-think of the whole business model following the crash. Most companies went back to developing ‘non-sexy’ infrastructure based products and services while adhering to established GAAP accounting principles as the user eyeballs model quickly became a thing of the past. In fact, it was practically impossible for young start-ups to raise funding post 2000 if their offering did not include a substantiated product. This trend would seem to have lasted for five or six years, making a turnabout around 2007 as the phenomenal success of Google, Facebook and Apple’s mobile revolution took center stage.

The industry seems to have reverted to the old model bolstered by Facebook whose revenue structure is primarily focused on users. Indeed, companies like Waze & Viber have been sold for astronomical figures essentially based on the hundreds of millions of users they have registered for their service. No doubt that advances in mobile technology and proliferation of smartphones is the main driver of this trend. Irrespective of their business model, the acquisition of local start-ups can only contribute to national pride. But the worrying trend is notable in the inability of traditional venture capital companies to raise sufficient funds over the past few years. With most early stage start-ups focusing on Internet and Mobile applications where the funds required are significantly lower as compared to firms developing cutting-edge technology (semiconductor or medical devices for instance), VCs seem to be having a difficult time bringing in new investors to support existing portfolios or fund new ones. With most investments being directed to developing applications with a possible Google or Facebook buyout in mind at some point in time, there are serious question marks to how long this trend can last.

Another indicator is a simple job search online – an overwhelming majority of the companies looking for employees seem to be focused on ventures such as “social”, “gaming”, “mobile”, “advertising” and it is rare to come across anything else. Whether this is a genuine paradigm shift, a transformational change of the earlier model for the better or just a blast from the past is anybody’s guess. Nevertheless, it would not make sense to put all the eggs in one basket.

On the bright side of things, there are encouraging signs that a few Israeli companies are making the effort to scale up rather than take the exit path, while focusing on international growth instead of putting themselves up for sale too early in the game. Such companies need to be supported. Government and business leaders responsible for driving the economy need to quickly act to support local venture capital companies and balance their ability to invest in various hi-tech sectors, traditional and otherwise. Israel’s strength has always been in its high quality R&D capabilities, and that needs to be maintained as emerging economies begin to produce a highly educated workforce which is bound to erode what has been Israel’s relative advantage over the years.