After A Chinese Sell-Off, Is Israel Next?

Since 2011, nearly 80 Israeli companies have raised money from Chinese investors, 30 new Chinese investors have entered Israel, and 11 Israeli venture capital funds have raised Chinese capital. In light of Monday’s accelerated selloff in Chinese stocks, what impact will the faltering Chinese economy have on the Israeli tech industry?

Israeli tech to remain resilient

Looking for a strategic location to park their excess liquidity and capital, many Chinese funds have actively scouted Israeli technology and talent, and many rounds, even in the early stages, are being led by corporate VCs like Alibaba, Baidu, RenRen, and Tencent. Additionally, VCs such as Horizons Ventures have been very active in Israel throughout all stages. With 342 Israeli start-ups having raised a record $2.1B in the first half of 2015, the Chinese face fierce competition from other international investors seeking the world’s finest innovation and human capital.

Chinese high-tech entrepreneurs have struggled to raise capital since the steep Chinese stock market fall that started in June because venture capitalists heavily weigh the health of the Chinese economy in their investment thesis. Israeli investments, on the other hand, are built to market and sell their products globally, due to the small size of the domestic Israeli market.  Thus Israeli technology remains as attractive, if not more so, than it did for Chinese investors before the crisis.

Private Investors to remain active, Corporates less certain

In troubling economic times, liquidity and cash flow dry up, and returns can take a nose dive. Many private Chinese investors are learning the hard way that they ought to diversify internationally in order to withstand domestic market volatility.

The effect of the recent crash on private investment in Israel will be slightly negative to net neutral (unless there is a return to a significant recession) as the expected conservatism in light of the down-cycle will be offset by an increased desire to invest outside public and domestic markets.

Furthermore, most private Chinese investment capital is already committed through limited partnerships, and these funds need to invest an annual minimum in order to meet their investors’ return expectations. Expect the $117 million that Chinese investors poured into Israeli technology in the first four months of 2015 to continue at both a similar pace and an aggregate level.

Due to the Chinese downturn, certain industries in which Israeli tech is a major player, like adtech, have already experienced a negative impact in terms of revenues and may experience further headwinds in terms of valuations. Other industries, like defense, are not nearly as sensitive to capital markets, and we expect minimal negative impact on revenues for these types of companies.  As usual, the deployment of funds across industries will reflect the cyclicality of the global economy.

Corporate investors face a slightly different calculus. Benjamin Peng, Business Director of Shanghai-based Yafo Capital says that “Chinese firms still need to innovate in order to compete” and “short-term stock market fluctuations will not prevent them in investing in good technology”. He went on to say that most of the investments in Israeli companies are not large, most are under $100 million which is not a lot by Chinese standards. If there is a change in investment levels, it will be a small one, Peng claims.

Yet until the market stabilizes, Chinese-Israeli tech M&A activity will slow down as CEOs become fearful of adding unprofitable businesses to their balance sheet. Similarly, Asian corporate VCs will decrease their investing in the Israeli ecosystem until there is more clarity as to the direction of the market.

Beware of Contagion

We have seen the U.S. and European capital markets suffer in the past week, as the global integration of capital markets has turned us into the three musketeers, “All for One, and One for All”.  If the slowing growth of the Chinese economy is a function of a deeper systemic failure, where the monitoring and measuring of economic activity has been largely inaccurate and possibly falsified, then the negative impact on the global economy will be increasingly severe.  With contagion risk looming, how will the Chinese government attempt to stimulate and prop up its economy in the coming months?