Why Tech Transfer Is Key to Stronger China-Israel Ties

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On the surface, the $2 billion acquisition of Tnuva, Israel’s biggest foodmaker, by Shanghai-based Bright Food this spring looks like just another foreign conquest by a Chinese company with global aspirations. Bright Food has been snapping up companies like Britain’s Weetabix and Australia’s Manassen Foods, and says it is on the hunt for businesses in the dairy, sugar and wine sectors.

But Bright Food isn’t interested in Tnuva as a way of entering the small Israeli market. With its 8.3 million people, Israel is no bigger than a single medium-sized Chinese city. Rather, Bright Food wants access to Israeli technology.

That might seem odd because Tnuva doesn’t deal in semiconductors or biotechnology, but instead focuses on very “old economy”-based businesses like cottage cheese and milk. Yet even in the dairy industry there is high and low tech, and Israel’s dairy sector is decidedly high-tech. The country is very hot and very dry — farming conditions that are similar to those in China. But Israeli cows produce three or four times more milk than their Chinese brethren. If China is going to build its dairy industry, it has to make it more productive, and Tnuva can help Bright Food to close the productivity and technology gap in agriculture.

Tnuva illustrates the critical role that technology and innovation are playing in the emerging Israel-China relationship. A tiny economy geographically distant from China, Israel is counting on its innovative prowess to make itself strategically important to the Asian powerhouse and to build more durable ties than ordinary trade, investment and tourism relations would normally produce.

‘A Real Challenge’

There are good business reasons for Israel’s strategy. For one, Israel’s biggest trade partner, Europe, has been weighed down by recession and debt. Meanwhile, China and the rest of Asia are playing a growing role in the world economy that Israel can’t afford to miss out on.

That was a major reason why Edouard Cukierman, whose Tel Aviv-based Cukierman & Co. investment house focused on Europe for its first two decades, decided to change strategy. Last year, the firm formed a technology-oriented private equity fund, Catalyst CEL, with China Everbright, a Chinese state-owned financial services company. The fund has raised $100 million and is targeting up to $300 million that it will put into companies in emerging markets, particularly China. “This is the fastest-growing market and one where Israeli companies can do much more than they are currently doing,” says Cukierman. “Successful Israeli companies typically have a strong presence in the U.S. and Europe. But to tackle the Chinese market is a real challenge.”

Developing economic ties, however, isn’t just about business. Israel’s traditional orientation toward Europe and North America has come under strain in recent years. Disagreements over how to advance the peace process with the Palestinians and criticism of Israel’s human rights record have complicated Jerusalem’s official relations, especially with European governments.

“You have to understand [Chinese] culture…. Until you achieve a true appreciation and trust, you’ll never make it there.”–Aron Shai

Polls show that Israel has lost the support of public opinion in Europe, too. Although calls to boycott Israel have so far had little effect, Israeli policymakers are concerned about the long-term implications, especially if the Palestinian issue remains unresolved. In addition to China, Israel also is pursuing closer relations with India, Japan, South Korea, and a host of smaller powers like Vietnam.

Technology Questions

The shift has been evident in the political sphere. Israeli officials said in April that the country would join China’s new Asian Infrastructure Investment Bank even though the U.S. has been discouraging allies from doing so. Israel’s foreign ministry has increased China-related staffing 30% over the past two years despite budget cuts elsewhere and the two countries have been engaged in a strategic dialogue for the past three years.

Israel’s infatuation with China is relatively new. Jerusalem only formed diplomatic relations with Beijing in 1992, and economic and political ties grew gradually, although there was considerable arms trade in the early years. By 2006, however, two-way trade had reached $3.8 billion and then grew steadily, interrupted only during the global recession in 2008-2009. By last year, two-way trade had reached $10.9 billion, 200 times 1992 levels.

Even these figures understate the extent of the trade, much of which is routed through Hong Kong and counted separately. China is now Israel’s third-biggest export market and last year Israel for the first time imported more goods and services from China ($8.1 billion) than the U.S. ($7.4 billion). Israel and China are now negotiating a free-trade area agreement, which should help spur trade further.

Nevertheless, the trade figures are the weakest element of the bilateral relationship. For one thing, Israel runs a big trade deficit with China: Last year, it reached $3.2 billion. Another problem is that bilateral trade growth has lagged overall growth in Chinese trade and, in recent years, growth has slowed further, edging up only 0.5% in 2014. In any case, in simple trade terms, Israel is little more than a blip on China’s screen: In 2013, Israel accounted for only 0.2% of China’s imports.

Worse still, only two companies account for a quarter of Israel’s exports to China. One is Israel Chemicals, a decidedly medium-tech maker of fertilizers, and the other is Intel, an American company that exports semiconductors from its Israel plant to China.

For smaller and medium-sized Israeli companies, China has been a hard nut to crack. Notes Aron Shai, head of Tel Aviv University: “You have to understand [Chinese] culture…. Until you achieve a true appreciation and trust, you’ll never make it there. This takes time, and only big companies can actually do it.”

It also takes money. Shai, also is a professor of East Asia studies who has specialized in the obstacles to Israel doing business in China, notes “a round trip to China can cost $10,000. You come and they greet you and show you respect, but you’ve done nothing. They say come again and you spend another $10,000 and you still haven’t done anything.”

“What we’re seeing [in Israel] is the tip of the iceberg of Chinese capital.”–David Fuchs

Technology-based partnerships, on the other hand, offer an opportunity for Israel to punch above its weight in China. Chinese companies have developed on the basis of low costs and huge economies of scale, but if they are to move up the value chain they have to put themselves at the forefront of global technology, note many observers. This is the case not only for state-of-the-art products, but also for manufacturing processes and services as China’s costs rise and its unskilled labor supply contracts.

Moreover, China faces immense challenges feeding its billion-plus population, ensuring adequate water supplies, meeting growing energy needs, providing health services and schooling, and coping with the pressures of rapid urbanization and environmental hazards.

In many of these these areas, Israeli technology — Tnuva’s state-of-the-art dairy operations being one small example — could offer solutions, say Chinese officials. Unlike America and Europe, Israel has no pretentions of competing with China industrially, nor does it have quite the same security concerns as the U.S. does about about technology sharing. “China and Israel complement each other in technology,” Wu Bin, Beijing’s commercial and economic counselor in Israel, said at a January conference. “Israel leads the world in high-tech and its high-tech products are needed in China. China has a huge market and strong industrial capacities. Israeli technology could easily be industrialized in China.”

That budding technology relationship shows up in a rush for Chinese technology investment in Israel, in buying startups, setting up R&D centers, and forming and financing joint ventures between Israeli and Chinese universities.

Deep Pockets

China offers deep pockets for the Israeli technology. Eighty Israeli start-ups have raised capital from Chinese investors, nearly all of it in the past four years, according to IVC Research Center, which tracks Israel’s venture capital industry. What’s more, the value of financing rounds by Israeli start-ups involving one or more Chinese investors nearly tripled since 2012 to $302 million last year. IVC predicts that the figure will reach $467 million this year, a 54% increase over 2014.

Among the recent investors is China’s biggest search engine provider, Baidu, which put $3 million into the video-capture startup Pixellot last December. In January, China’s online retailing giant Alibaba put an undisclosed sum into QR code generator Visualead, its first investment in an Israeli start-up. In addition, 11 Israeli venture capital funds have raised money from Chinese investors, IVC estimates, including a commitment by Alibaba to back a new fund by Jerusalem Venture Partners.

Israeli technology companies are heading to China, too. IVC estimates 138 have a presence in China. That’s a tiny fraction of the approximately 1,300 Israeli companies in the U.S. and 750 in Europe, but the number is growing.

David Fuchs, managing partner of the newly formed $20 million Synergy China Funds, aims to encourage such moves by providing financing and access to the China market through its Chinese backers. “Today’s Chinese VC market is growing by leaps and bounds,” Fuchs says. “In 2014 it was $15.5 billion, and in the first quarter this year it was $7 billion. What we’re seeing [in Israel] is the tip of the iceberg of Chinese capital Twitter .” Unless they have a presence in China, he adds, “start-ups don’t have access to the iceberg below the surface.”

Beyond raw technology or start-ups, many Chinese companies are looking for innovation mature enough to be incorporated into products and industrial processes. That is the logic behind the Catalyst CEL fund, which is, tellingly, the first overseas private equity fund for Everbright, a Chinese financial services company. “There’s high synergy between the two markets,” says Shengyan Fan, head of strategic investment and development at Everbright. “China has huge wealth in the public and private sector. A lot of Chinese companies have huge acquisition powers and investment powers to deploy. At the same time, Israel has a lot of interesting tech companies of a global nature and is eagerly searching for new markets.”

But China is also looking for something bigger than a technology-based product upgrade. It also aims to tap into Israel’s basic research capabilities and innovative culture. That became more clear in May 2014 when Tel Aviv University and Tsinghua University of Beijing launched a $300 million joint center for innovative research and education, with Chinese Vice Premier Liu Yandong coming to Israel to mark the event.

“A lot of Chinese companies have huge acquisition powers and investment powers to deploy. At the same time, Israel has a lot of interesting tech companies of a global nature and is eagerly searching for new markets.”–Shengyan Fan

And a year earlier, Chinese billionaire Li Ka-shing — whose Horizons Ventures is one of the biggest technology investors in Israel today — donated $130 million to the Technion, Israel’s leading engineering school, to build a joint academic and teaching center in China’s Guangdong province dedicated to research and innovation in science, engineering and life sciences. “What the Technion has done to advance the Israeli economy through student and staff research and innovation is an example for Chinese universities to follow,” Shantou Provost Gu Peihua said at the dedication ceremony.

The Political Price

Many Israelis, most prominently Efraim Halevy, a former Mossad spy agency chief, worry that Israel will pay a steep political price for drawing so close to China. Critics, for instance, contend that the Chinese don’t differentiate between politics and business. Tnuva is a case in point: Before it was acquired by Bright Food, the company had been controlled by the British buyout fund Apax Partners, but critics say that didn’t create any national security concerns.

“Anyone who says there’s no difference between British and Chinese ownership is making a big mistake,” an Israeli treasury official told the Yediot Ahronot daily, as Israelis were debating the Tnuva sale. “Apax is a British fund, but it is motivated exclusively by business considerations while in the case of Bright Food we’re talking about China itself, which has consideration far beyond economics.” Now every time a regulator of the treasury wants to take action against Tnuva, it will become a diplomatic issue between the Israeli and Chinese governments.”

The Tnuva acquisition has raised concerns mainly about food safety (given China’s poor record at home) and about food security (that government-owned Bright Food will export Tnuva products back home rather than feed Israelis). Others have expressed concern about lax Chinese attitudes toward patents and copyright, which is a particularly sensitive factor if Israel is going to base its China relations on technology and intellectual property.

Other questions have been raised about China’s growing role in building and operating major infrastructure projects like ports and railways, or about letting Chinese companies manage Israeli financial assets, an issue that came up when in two separate deals, Chinese investors sought to buy control of two leading Israeli insurers.

On the level of politics and diplomacy, many worry that if Israel tilts too strongly toward China, it risks chilling relations with the U.S., which remains its most important ally and economic partner by far. The critics have so far been on the losing side in the debate over Israel’s China embrace: Unlike in the U.S., no deal involving China has been scuttled over national security concerns.

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