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Out Of The Desert (Int'l Edition)


International -- Cover Story

OUT OF THE DESERT (int'l edition)

A high-tech boom is converting Israel into a mini Silicon Valley Benzion Landa of Indigo is the very image of a Silicon Valley success story. The 49-year-old native of Edmonton, Alberta--"Benny," to employees--has cultivated deep-pocketed partners for Indigo's digital-printing technology, ranging from AT&T to Japan's Toppan Printing Co. Group. When he throws a press conference, it's in the plush Rainbow Room atop New York's Rockefeller Center. When he needs business advice, he calls his friend George Soros, an early backer. And to escape the August heat this year, Landa is taking his family white-water rafting on the Colorado River. He can afford to raft in high style: His family's 70% stake in Indigo, which went public on NASDAQ last year, shot past $2 billion this year before sliding back to a mere $1.8 billion on a recent earnings warning from the company.

Yet Landa has ridden to fame and fortune not in Cupertino or San Jose but in the quiet Israeli town of Rehovot, a bedroom community that's half an hour's drive from Tel Aviv--and 7,400 miles away from Silicon Valley. And he is not alone: Thousands of Israeli entrepreneurs are making themselves felt on technology's cutting edges, from advanced chip design and data-networking systems to medical imaging and encrypted communications. Says Landa: "We have become an atomic reactor of ideas, technology, and entrepreneurship."

The ideas and technology that Landa brags of have thrived in Israel for decades; what's new is the entrepreneurship. No doubt, progress toward peace in the Middle East has helped Israel's high-tech boom. So have 600,000 immigrants from the former Soviet Union, many of them highly trained in technical fields (page 41). Most important, though, has been a revolution in Israel's economic and business culture, from socialistic and inward-looking to entrepreneurial and international. Landa and others like him are fast learning how to combine homegrown Israeli technological strengths--many honed inside secret military labs--with U.S.-style financing and marketing.

MARKET FROTH. There's no doubt that a casino-like atmosphere surrounds some Israeli companies--and that at times, speculation in their stocks outruns reality. With Landa's Indigo, for example, shares ran up from $15 in January to over $60 this month. They retreated to a more realistic $45 after the company announced Aug. 8 that it didn't turn profitable in the second quarter, as was earlier projected.

Still, market froth doesn't obscure the real progress of Israeli companies in penetrating global markets. Using Motorola Inc.'s latest Lingo cellular phone? The core circuitry was developed at Motorola's R&D facilities in Tel Aviv--while the simulation software of an Israeli company, Emultek, enabled Motorola to design the phone in record time. Key parts of Intel Corp.'s 486 and Pentium chips were designed in Israel. And if you start using trifocal contact lenses, it will be thanks to the success of an Israeli startup, Holo-Or.

Israel obviously won't be a world-beater in every sector of high tech. With its population of only 5 million, it can't challenge the combined research and manufacturing strengths of a United States or even a South Korea. What's more, Israel is rapidly losing the cost-of-labor advantage that has helped draw investors. Still, military research has given Israel a clear lead in vital parts of telecommunications and software technology (table). And Israel has carved out other niches that owe nothing at all to the military. For instance, Indigo's Landa claims that his and other digital-imaging companies "can dominate the world printing industry and move it from Germany to Israel."

Like Japan, another nation lacking in natural resources, Israel has developed its human capital to the maximum. It claims the highest proportion of scientists and engineers per worker in the world. Now that the threat of attack is lessening, it's taking to the economic battlefield. Jerusalem is aiding the high-tech transformation with innovative programs for entrepreneurs, from venture-capital matching funds and interest-free loans to speeding up the civilian conversion of the country's vast military-industrial complex. "High tech is clearly where our competitive advantage is," says Jacob Frenkel, a former World Bank chief economist who has been instrumental in shaping the Israeli economy since he became central bank governor in 1990.

The high-tech boom is boosting the Israeli economy, helping cut the jobless rate to under 7%, from 11% two years ago. Israel's 1,800 high-tech outfits, many clustered in industrial parks fanning out from top research institutions such as Haifa's Technion and the Weizmann Institute of Science near Tel Aviv, will ring up exports this year of about $9 billion, nearly double the 1990 level. That's helping to push Israeli economic growth to around 6% a year, rivaling that of Southeast Asia.

"Israel is emerging as a major technological center in the world," says Jonathan Fleming, a partner in one of the largest venture-capital firms in New England, Boston's MVP Ventures. "There's Silicon Valley in California and Route 128 in Boston, and now the third area with the look and feel of those places is Israel." In its first move to invest internationally, MVP raised $10 million early this year for Israeli medical technology and biotech. Fleming says he's attracted by an entrepreneurial spirit he sees lacking in Europe.

Today, Israel is second only to Canada in the number of its companies quoted on U.S. exchanges, with 62. Of those, fully 57 are high-tech, and initial public offerings are running at around one a month. In the first big buyout of an Israeli high-tech group, Netherlands-based Madge Networks agreed in June to pony up $300 million to buy Lannet Data Communications, a leading networking firm. Britain's Cable & Wireless PLC recently bought a strategic 10% stake in Bezeq, Israel's telecommunications monopoly. Such deals are a sign of the new openness of the Israeli economy. "Israeli companies never used to be for sale," says Ron Lubash, managing director of Lehman Brothers Inc.'s Tel Aviv operations. "Now it's happening across the board."

Even the Japanese are buying. "Israel is a treasure house of technology," says Takuro Isoda, chairman of Nippon Investment & Finance Co. With more than $800 million under management, Isoda's NIF has recently taken the plunge with a couple of Israeli high-tech investments, including a stake in Haifa-based DSP Communications, a maker of digital signal-processing chips. Japan's electronics giant Kenwood and CSK, the largest Japanese software house, have also recently taken strategic stakes in Israeli high-tech firms.

For decades, the Israel Defense Forces dominated high- tech development as a means to maintain strategic superiority over Arab neighbors. With security paramount, the IDF discouraged commercialization of technologies such as jam-proof radio communications gear. Foreign investment was scant, too, thanks to Israel's socialist economic policies--and to the Arab embargo on trade with Israel, which was slapped on after the Jewish state declared independence in 1948. Companies such as Sweden's Ericsson, France's Alcatel Alsthom, and major Japanese groups each year solemnly signed Arab Boycott Office papers certifying they didn't trade with Israel.

Israel always had a few homegrown high-tech successes, like Scitex, a world leader in digital color publishing systems. But many other companies faltered. While research was first class, "We suffered from not really knowing how to successfully market what we had," says Yanki Margalit, CEO of Aladdin Knowledge Systems, which makes antipiracy software. Take computed tomography medical imaging, a technology in which Israel's Elscint Ltd. was an early leader. "Once a company like General Electric decided to play, there was no way we could remain the leading force," says Uzia Galil, chairman of Elron Electronic Industries, a major Elscint shareholder.

Haifa-based Fibronics International Inc. also fell short when the going got tough. Founded by engineers who had worked together in military intelligence, Fibronics got off to a fast start in the 1980s with a data-networking technology called Fiber Distributed Data Interface. But it lacked a good U.S. distribution arm and never rode the networking wave. It was taken over last year by Elbit Computers Ltd. Eli Harry, chief executive of LanOptics, has tried to avoid a similar fate by linking his "hub" technology for computer networks with products from its big U.S. partners Cisco Systems Inc. and IBM.

Locking up technology helps, too. Indigo's Landa, a role model for Israeli entrepreneurs, has assembled a whole slew of powerful partners--and built a fence of patents around his technology for short runs of color printing, which allows for customization of printed products like brochures, menus, and labels. Says Landa: "Without technology you can defend, a Hitachi or a Kodak will eat your lunch."

Nir Barkat also knows how to play the game. He and three friends from the Hebrew University of Jerusalem formed BRM Technologies in the late 1980s to develop antivirus software. Their current distributor: none other than Symantec Corp., the $500 million-a-year world leader in desktop software utilities. BRM works closely with Symantec, jointly developing the Cupertino (Calif.) firm's Norton Enterprise Backup, a key networking product.

MILITARY DEFEAT. The success of nimble companies like Indigo and BRM stands in contrast to the experience of Israel's vaunted defense contractors, hit by the downturn in defense spending. Israel Military Industries, which makes the Uzi submachine gun and Merkava tank, is down to 5,000 employees, from over 14,000 five years ago. Rafael, the military's top-secret weapons development authority, could end this year with 3,000 employees, down from 8,000 in the 1980s. Their attempts to convert their technology to civilian purposes have not been roaring successes. Typical was a failed attempt by Israel Aircraft Industries, maker of the Kfir fighter, to upgrade East Bloc passenger planes.

Military technology is reaching the civilian market all right, but it's mainly through people leaving defense manufacturers and elite units of the IDF to form companies, bringing with them top technology and entrepreneurial zeal. For instance, Rafael's pioneering work in spread-spectrum wireless broadcasting technology, allowing Israeli army units to avoid detection while communicating, is being used for cellular phone calls by Geotek Communications, which has offices in Montvale, N.J., but does its R&D in Israel.

The Israeli government, while more market-oriented than in years past, prods along the nation's technology sector to a degree that's hardly imaginable in the U.S. The office of Chief Scientist Yehoshua Gleitman is doling out half a billion dollars this year to high-tech companies, double the amount of just two years ago. The Chief Scientist's Office also targets technologies, such as superconductivity and high-speed gallium arsenide chips. Gleitman is plowing $40 million into a joint project of three Israeli firms--ECI Telecom, Bezeq, and Tadiran--with Haifa's Technion and Tel Aviv University to develop high-speed communications technology.

Gleitman does it all with a minimum of overhead. Operating from a rundown apartment building in Jerusalem, he has a staff of just 30. One of his office's beneficiaries: Enigma, a company founded by veterans of Army Intelligence whose software simplifies the creation of CD-ROM programs. With the Chief Scientist's Office now picking up 30% of Enigma's $1 million a year in R&D expenses, CEO Jonathan Yaron can concentrate on cutting deals. In June, Bankers Trust Co. paid $1.8 million for a 15% stake in Enigma, the institution's first foray into Israeli high tech.

A new wave of aggressive North Americans is injecting life into the high-tech business scene, too. In the last few years, Wall Street whizzes such as hedge-fund king Michael Steinhardt and Morris Smith, who ran Fidelity's Magellan Fund, have started plowing money into Israeli venture capital. Some of the motivation is sentimental, but the profit motive looms large. The $40 million investment Soros made in Landa's Indigo in 1993 is now worth over $500 million. Minneapolis investor Irwin L. Jacobs also struck gold when he paid $6 million late last year for 60% of Accent, a Jerusalem-based maker of a multilingual word processor. A successful NASDAQ flotation in July has given Jacobs a 500% return on his first investment in Israel.

Canada's Marc Belzberg, 40, is one of the most active investors. The scion of one of North America's wealthiest families, Belzberg cut his business teeth on Wall Street in the 1980s, when he parlayed a $750,000 investment in Canada's first cellular telephone franchise into a $150 million profit. He moved to Jerusalem in 1992 and now says the three most important things in his life are religion, business, and Zionism. Says Belzberg: "I asked myself where I could make a difference and where I could make a very high rate of return."

The answer has been high tech. Belzberg's first investment was $500,000 for a stake in Micro Macro Ltd., a software startup that had developed two products: a multilingual word processor and a software protection system using advanced algorithms developed by the Israeli military for encryption. Belzberg split the company and cut a distribution deal with Polaroid Corp. for the word processor. Meanwhile, sales of the company's Microguard software protection will exceed $4 million this year.

Can Israel maintain its momentum in the global technology race? In the 1980s, the pay gap between Israel and Silicon Valley was so great--around 40% for top programmers--that big U.S. investors such as Intel, IBM, and Motorola quickly recouped their investments. Then, the wave of Soviet emigres that began to pour into the tiny country in the late 1980s "meant that we got a huge pool of trained manpower with little if any investment," says Chief Scientist Gleitman. "That also moderated wage growth."

Not anymore. Graduates of Haifa's Technion are now paid $45,000 a year, not much lower than counterparts in the U.S. The average pay differential has narrowed to around 20%--and many Israeli engineers can command Silicon Valley rates. "Japanese companies are interested in coming here to reduce R&D expenses," says Daniel Isenberg, a former professor at Harvard business school who runs a Tel Aviv-based company, Triangle Technologies, advising Japanese companies on investments in Israeli high tech. "So the rising cost of development is a major cloud on the horizon."

Others are more sanguine. Dov Frohman, general manager of Intel's huge Israeli operations, thinks labor costs are less important than the flexibility and speed of Israeli companies. What's more, "for the next 5 or 10 years, Israel still has a tremendous availability of people coming out of the military and wanting to make it in high tech," says Efi Arazi, an Israeli who founded Scitex and went on to start San Mateo (Calif.)-based Electronics For Imaging Inc. With its law firms, banks, and venture capital groups underpinning its entrepreneurs, says Arazi, "Israel now has a critical mass in high technology that is far ahead of anything in Europe."

But the best sign that high tech is here to stay in Israel is that Indigo's Landa and other high-tech successes are inspiring the next generation of Israelis. Enrollment at Israel's business schools is soaring--10 institutes now offer MBAs, double the number of two years ago. And many of the $1 million-plus houses going up in plush suburbs are being put up by entrepreneurs who've made it in fields like chip design, data networking, and wireless communications.

Israel amazed the world when hardworking Jewish settlers made the desert bloom with orange groves. Now, a new generation of Israelis like Benny Landa is making the desert bloom again by building a new Silicon Valley--in a country that has all the silicon you could ever want.

ISRAEL'S HOT CIVILIAN TECHNOLOGIES

High-tech operations in Israel range from state-owned military industries to Silicon Valley-style startups.

TELECOMMUNICATIONS

Israel is a world leader in wireless technology, thanks to systems developed for military aircraft and guided missiles. Startups include Nexus Telecommunications Systems (two-way paging), Geotek Communications (cellular), and Gilat Satellite Networks (small satellite dishes).

SEMICONDUCTORS

Motorola, Intel, National Semiconductor, and other U.S. companies founded Israel's chip industry. Now, Israel has its own chipmakers--led by Tower Semiconductor, a spin-off of National Semi that makes chips for it, Motorola, Hewlett-Packard, and others.

DATA NETWORKING GEAR

Lannet Data Communications is being snapped up by Madge Networks. Others: RAD Group, LanOptics.

SOFTWARE

Israel is a leader in antivirus and antipiracy software. Top names include Checkpoint Software Technologies.

DIGITAL PRINTING

Scitex, which automated pre-press operations, was one of Israel's first civilian-technology success stories. Indigo, a specialist in short-run color printing, has become the latest star in this unlikely Israeli specialty.

OTHERS

Israel has smaller pockets of strength in medical instruments (Elscint), pharmaceuticals and biotech (Teva Pharmaceutical Industries, Interpharm), inspection equipment (Orbotech, Opal), and batteries (Electric Fuel).By John Rossant in Rehovot, with Neal Sandler in Jerusalem


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