Israel economy: Life sciences sector transforming

Economist Intelligence Unit

Despite a decline in several key measures of activity in the Israeli life sciences sector, according to a recent report published by Israel Advanced Technology Industries (IATI; an umbrella organisation representing high-technology and life science firms), the wider
picture and the long-term trends are decidedly positive. Firms are melding Israel’s strong research reputation in the field with its leading information technology and software know-how, but more traditional firms are also important contributors to the economy and changing rapidly. Life-science-rooted firms are now a key component of Israel’s high-tech offering. Nevertheless, the sector is not without challenges.

The new report identifies two sub-sectors in particular within the life science industry-healthcare information technology and digital health-that have seen huge rises both in the number of firms operating in those sectors in Israel and the funding that they have raised, although for other life science sectors, theperformance has been more mixed. From a macroeconomic perspective, the vitality and rapid growth being displayed by the many new companies in the life sciences is positive.

Israel’s behemoths now less dominant on corporate scene

In recent years, the travails of two very large Israeli corporations-Israel Chemicals (IC) and its various subsidiaries, and Teva Pharmaceuticals-have generated growing concern regarding the over-concentration of Israeli industrial exports in a few corporate giants. When these large firms run into trouble-whether owing to industry-specific developments, as in the case of IC, or
because of a wrong or badly-executed corporate strategy, as occurred at Teva-the impact on overall Israeli exports and investments is significant and can be prolonged. A key element in
mitigating this problem is through encouraging the development of many new companies, each of which has the potential for long-term export-led growth based on proprietary technologies or systems.

If, as the report suggests, the life sciences industry “is demonstrating encouraging signs of maturity, with more companies reaching the revenue stages”, this will have broader long-term
implications for the country’s corporate scene and the economy as a whole.

Furthermore, within the life science industry, the report finds the degree of diversification is growing. Thus, although the sector “is still heavily biased towards medical devices”, an industry in which Israel has several firms that are global leaders in their niche, this sub-sector’s share of the overall life sciences industry shrank from 53% to 42% between 2014 and
2016. The continued dominance of the medical devices sub-sector is reflected in the fact that the next largest sectors, therapeutics and healthcare information technology, each comprise
only some 16% of the total, and the share of the fourth-largest sub-sector-diagnostics-is below 10%.

New firms still emerging, even in established areas, but pace
slowing

According to the IATI’s calculations, there were some 1,350
Israeli life sciences companies active in 2016. It also
determines that in the decade ending in 2016, 1,234 life science
companies were established, of which 612-almost half-were still
active in 2016. The remaining 622 had ceased activity, most often
because of failure, but also owing to merger, acquisition (often
by large overseas firms) and other developments. Against this
background, the finding that 2016 itself saw a relatively low
number of new companies established (90, versus an average of 123
a year over the decade 2007-16), and an exceptionally low number
ceased operations (23, against an average of 62), possibly
suggests that the sector is beginning to mature beyond the
start-up highest-risk stage.

According to the IATI, the percentage of active companies
generating revenue in 2016 reached 38%, of which 33% were
classified as “initial revenues stage”, and 5% had graduated to
the “revenue growth” stage. Nevertheless, half the companies were
still in the research and development stage and some 125 were in
the “seed” stage. This again support’s The Economist Intelligence
Unit’s view that the sector is dynamic and firms are young on
average, but it is maturing.

Firms are finding financing domestically and from more varied
sources

Data from the IVC-ZAG (a local industry research firm) High-Tech
Capital Raising Survey show the wider Israeli high-tech sector
raising a record US$4.8bn in 2017, bucking a global weakening
trend. Of this, US$823m went to life sciences companies-a 17%
drop from the record-breaking US$957m raised in 2015, but still
the second-highest annual total ever and well above the average
for the decade of 2007-16. However, at 20%, the share of life
sciences in overall high-tech capital raising was at the low end
of its 19-35% range over the last decade and well below its 26%
average share.

Drilling down into the sources of this flow of capital reveals
some significant developments, with long-term implications for
the life sciences sector. First, a rising share of the total is
from domestic sources-US$312m in 2016, comprising 38% of the
total-compared with US$265m (28%) and US$193m (24%) in 2015 and
2014 respectively. The flip side of this, however, was that the
absolute level of foreign investment in Israeli life sciences
companies fell for the first time in five years, increasing
dependency on local financing.

Second, the level of “non-venture-capital (VC)-backed
investments” rose in both absolute and relative terms-from
US$299m (31%) in 2015 to US$354m (43%) in 2016. Here, too, the
rise in the share of non-VC-backed investments implies a fall in
those of VCs-but in this case, from a record level in 2015, to a
level still some 50% higher than the average for VC-backed
investments over the last decade. Interestingly, the share of
Israeli VC funds remained stable, with the drop concentrated in
foreign VC investments.

“Non-VC-backed investments” include many sources, among them
wealthy individuals (“angels”), but their growth trend suggests
that Israeli institutional investors are responding to calls-from
both government and the private sector-to increase their exposure
to high-tech in general and to life sciences start-ups in
particular. These investors are often making long-term strategic
commitments to the firms. The long-term nature of investments in
this sector before profits can be made is well-suited to
institutions engaged in pension and long-term savings rather than
VCs looking for faster returns, but they must also feel
comfortable with the unusually high risk-reward ratio that
characterises life sciences companies. More local financing and
from longer-term institutional investors could help to keep more
of the economic benefits of the success of these firms in Israel
and also spread the benefits more broadly across the population.
It seems likely that these shared interests will push
policymakers, fund managers and the industry to create a
structure that will enable greater involvement of institutional
investors that could spur further long-term investment in the
life sciences sector.