Israel’s inverted economic pyramid and how to flip it

Israel’s inverted economic pyramid and how to flip it

The opposing examples of IDB Group and Iscar indicate a pressing need to shift the economic narrative from financiers who specialize in gimmicks toward businessmen who build something of real value.

By Sami Peretz | May.03, 2013 | 2:20 PM

Over a hundred years ago, the socialist Zionist leader Dov Ber Borochov defined the structure of Jewish labor in the Diaspora as an inverted pyramid. The narrow base consisted of a few productive workers employed in industry and agriculture and, above them, in a much wider layer, were those dealing in “airy-fairy” jobs (“luftgescheft” in Yiddish), such as middlemen, small merchants and moneylenders.

At that time, the inverted pyramid was the result of Jews being denied access to other jobs and thus pushed into these professions by default. The need, therefore, to transform the Jew from a person dealing with such impractical or insubstantial work into a productive, industrial person was deeply embedded and an integral part of the drive to create a Jewish national home in Israel. A hundred years later, the financial news from this week may confirm this Zionist ideal.

On one hand, we have the Wertheimer family, founders of Iscar, a shining example of a productive industrial business, which just sold another 20 percent stake in the company to Warren Buffett for $2 billion, a deal that reflected a total company worth of $10 billion. On the other hand, a court has nominated an observer to supervise activity at IDB Development, one of the companies in Nochi Dankner’s collapsing pyramid. This company owes its bondholders and the banks NIS 6 billion, and some of its creditors are concerned that the company will default on its commitments. One day after his nomination as observer, attorney Chagai Ulman was instructed by David Hahn, the Official Receiver of Israel, to change the composition of the board of governors at the IDB Group to minimize conflicts of interest. These conflicts of interest played a significant role in the shaky corporate governance which led to the group’s ruin.

A comparison between a productive business such as Iscar and a “froth business” such as the IDB pyramid begs to be drawn. According to any standard, one can see which structure is more useful to the economy, in terms of profits and providing employment, and which damages the economy. It’s easy to demonstrate that the productive industrialist is the successful and profit-earning model, not the failing financier.

Anyone with a modicum of sense can understand the difference between the outrageous way in which IDB was managed and the professional manner in which Stef and Eitan Wertheimer built Iscar. Incidentally, Iscar was jointly owned by IDB and the Wertheimers up to the mid-1990s.

Over the last decade, “froth businesses” have been getting much more attention in the financial press (including this paper) than productive enterprises.  Much of the financial discourse in the media is devoted to public offerings, realizations, exits, fund raising, leveraged takeovers and other financial gimmicks. The reporting is often critical, but that doesn’t change the fact that “boring” topics like the acquisition of new machines, the setting up of new production lines and novel developments or the establishment of small or midsize enterprises are missing from public discourse.

Stef Wertheimer, the man who built Iscar and sold it to Warren Buffett, is the biggest missionary and preacher advocating productive, hands-on work. As far as he’s concerned, we should all go and study metalworking and welding and show up for work every morning at 6 AM. However, this narrative is not taking hold, since it is overwhelmed by the alternative narrative of white collar work and a quest for quick gains.

Technological developments, as well as the Israeli economy’s advantages, will probably not turn this country into a powerhouse of welding and metalwork. However, that doesn’t mean that we can’t turn the pyramid upside down, at least in our discourse.

How does one invert the pyramid? Every decent businessman in Israel today will acknowledge that IDB was badly and disgracefully managed. Even Dankner’s biggest supporters are now willing to admit that he was a failing manager who made some terrible business decisions. He took unwarranted risks, creating a shaky corporate environment while using a faulty rationale for some of the decisions he made.

Many of the missteps that led to IDB’s collapse could have been avoided if the financial system, business norms and regulation were different. Dankner did not build up IDB – he only bought it – but he managed to erect a convoluted, multi-layered legal structure that now owes NIS 9 billion to local and foreign banks, as well as to institutional bondholders, with each borrower seeing and financing a different part of the pyramid. In fact, the only reason Dankner is still in control of IDB is that he built such a complex financial and legal pyramid that its fall would embarrass many people. However, IDB’s survival may only be temporary.

The Israeli system has allowed such pyramids, where the controlling shareholder has a small financial stake while his influence and role in management is huge. In a small market with a limited number of big lenders and borrowers, the risks associated with such pyramids are enormous. The government-appointed committee set up to identify ways to increase competitiveness (the “centralization committee”) gave a partial solution to this problem, recommending a reduction in the number of layers in these pyramids and preventing one person from controlling both real and financial corporations.

But before these recommendations could be implemented, the underlying risks of such pyramids came to light in spectacularly dramatic ways as nearly all the big Israeli tycoons – Nochi Dankner, Lev Leviev, and Yitzhak Tshuva, to Yossi Maiman and Idan Ofer – are now situations in which they have to negotiate debt restructuring. In Africa-Israel and at Delek, the restructuring follows leveraged activity in the real estate market which was badly hit during the global recession. Maiman was hit due to the upheaval in Egypt which stopped the flow of natural gas to Israel. Ofer was hit by the global slump in shipping, which hurt his company Zim.

Dankner was affected by all of these problems. Not only the real estate crisis, which hurt his investment, along with Tshuva, in Las Vegas, but a whole list of business and management mishaps, some of which could have been avoided if his managers, with their cushy salaries, would have stood up to him and said no. Is there a law that can stop a charismatic and rapacious controlling shareholder from running his business into the ground, without any of the multiple directors and managers he employs able to save him from himself?

Apparently not. But a good first step in this direction would be to divert the narrative away from financiers who specialize in gimmicks towards businessmen who focus on productivity and who build something with real value.

Of course, changing the narrative is important, but it is not sufficient. It needs to be accompanied by moving financial support away from leveraged takeovers, “air” businesses and financial gimmicks and directing them towards the building of productive enterprises, small and mid-size. Cash flow to holding companies that support inflated and expensive staff must stop immediately.

Finance Minister Yair Lapid and Bank of Israel Governor Stanley Fischer have announced a committee to examine the whole issue of debt restructuring. Its first recommendation should deal not with defaulting businesses but with how to avoid giving billions of shekels in credit in the first place with insufficient collateral or supervision, based only on a person’s name or charisma.

District court judge Eitan Orenstein, who dealt with appeals by IDB Development’s creditors, expressed his amazement with what transpired in Dankner’s corporation.

“This court, which has dealt with multiple defaults, has never seen such an extreme case in which credit was given by financial institutions on such a large scale with no guarantees or explanations,” he said. “No reports of credit committees at these institutions were presented, explaining their decisions to give this credit without collateral. There are more unclear issues here, which warrant investigation and examination by the authorities.”

The change in business culture, according to the judge, relates not just to Dankner, but to the banks and insurance companies who gave him billions of shekels, as well as to bank and company supervisors, who enabled this flow of cash without interruption.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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