Coffee with Gidi – 2024 Overview and Insights for 2025

“AI companies currently enjoy a massive premium that won’t last long”

So says the CEO and founder of S Cube, part of IBI Capital, Israel’s largest technology valuation firm, who reflects on the past year and outlines goals for the next. While the Nasdaq reaches record highs, the ongoing war in Israel weighs heavily on the performance of the local tech sector, which, despite a significant increase in M&A activity, lags behind.

S Cube conducts approximately 650-700 valuations annually, with the vast majority of its clients operating in the tech sector, particularly startups at various stages. In fact, the company handles most tech valuations in Israel, granting it a comprehensive perspective on the microcosm known as Israeli high-tech. Looking back at 2024, the effects of the ongoing war and geopolitical instability in Israel have begun to impact the local tech sector, which, unlike in previous years, has diverged from the trends seen in the U.S. tech sector, showing a negative trend[1]. Although there was a notable increase in local M&A deals last year, I believe this is no reason for optimism. These deals were driven by investors opting for exits rather than injecting more capital, indicating a lack of financing alternatives rather than strategic preference. Looking ahead, geopolitical uncertainty will likely continue to burden the performance of Israel’s tech sector.

As you predicted last year, the Nasdaq climbed to record highs ahead of the U.S. elections and is now significantly above its 2021 levels, which many considered a bubble. How do you see the state of the global tech sector now?

The Nasdaq is indeed the leading index for global tech stocks, but I believe treating it as a benchmark for the entire sector is somewhat misleading. Over the past year, and consistent with recent trends in the sector, “Magnificent Seven” tech giants like Apple, Microsoft, NVIDIA, Alphabet (Google), Amazon, Tesla, and Meta (Facebook) have leveraged their enormous size advantages to strengthen their positions relative to the rest of the sector. As we examine smaller companies among the micro-caps, including most private companies in the U.S. market, the signs of a bubble disappear. For example, the average weighted market cap of the 25 largest Nasdaq 100 companies rose by about 60% over the past year. However, excluding the top 10 companies in the index, the remaining 15 saw an average increase of only 25%. In contrast, the average weighted market cap of the 25 smallest companies in the index dropped by about 2% over the past year.

Nevertheless, I think AI companies currently enjoy a massive premium that likely won’t last long. Stocks like NVIDIA, which delivered over 160% returns in the past year, along with other software giants such as Apple, Microsoft, NVIDIA, Alphabet, Amazon, and Meta, saw market cap increases ranging from 20% to 80%, propelling the Nasdaq 100 to new heights.

The tech sector, and particularly AI, led the stock markets over the past year. Is this a continuation of previous trends, or is there a specific reason behind it?

We are in the midst of a prolonged process where AI is penetrating a growing number of industries and activities. While this technology is being developed for genuine economic reasons and to enhance productivity, I believe part of this phenomenon is hype, which influences valuations. This hype is unlikely to persist. For instance, companies seeking to raise funds may find it easier if they market the AI components of their solutions, especially if these include a cybersecurity element. Similar to the hype surrounding the automotive sector a few years ago, the AI sector will likely return to more reasonable valuations over time. It’s important to remember that AI is not a standalone field but typically serves to streamline processes in specific areas. AI has already made significant strides in fields like law and accounting, which involve repetitive, non-physical tasks. However, its contribution to more advanced sectors will likely be smaller.

Despite a recent sense of relative relief in Israel, the effects of the Swords of Iron war and uncertainty surrounding its resolution cast a shadow over the Israeli economy throughout the past year. How much has this impacted business activity?

For the first time in years, I genuinely think there’s cause for concern about the state of Israel’s tech sector. When comparing capital raising in Israel’s tech sector to that in the U.S. from 2021 to 2023, the local sector performed similarly to its American counterpart. There were differences in the scale of funding rounds and company valuations, which were naturally higher in the U.S., but the trends were consistent. However, examining fundraising in the first three quarters of 2024 reveals a negative trend in both the number of companies successfully raising capital and the valuations granted in Israel[2].

Valuation declines were sometimes accompanied by improved conditions for investors, such as granting warrants or providing multipliers greater than one on guaranteed returns. While these terms don’t appear in reported valuations, they economically signify lower valuations. In contrast, the U.S. experienced a positive trend last year, including valuation increases during fundraising rounds. The economic explanation lies in the rising risk premium associated with Israeli-linked companies. I attribute the gap relative to the U.S. market to the ongoing war and the uncertainty it generates, which includes credit rating downgrades for Israel, foreign investors’ refusal to visit physically, low national morale, and capital flight out of the country. These trends were especially dominant in the past year.

How did companies cope with the year’s challenges in terms of capital raising within the Israeli tech sector?

Alongside the increased specific risk associated with Israel’s tech sector and its impact on fundraising, companies unable to move toward financial balance face significant challenges, as investors are reluctant to inject substantial funds. Consequently, last year saw a significant rise in M&A activity within the sector. Investors seem to prefer exiting their investments rather than injecting capital with the hope of long-term value creation.

After two years of a near halt in secondary transactions, which persisted until late 2023, did the pace of deals pick up last year?

In secondary transactions, two main changes emerged compared to the previous year. First, the number of deals grew in 2024, a welcome development for tech employees. Second, there was a change in the guidelines of the American Institute of CPAs regarding these transactions, which now grant them greater weight in valuations than before[2]. This is less favorable news, especially for American employees or workers in companies that grant options at FMV (Fair Market Value). Historically, secondary transactions raise exercise prices for employees. Therefore, I recommend seeking advice to understand the potential impact on ordinary share valuation before finalizing deals.

What lies ahead for the global and local tech sectors in 2025?

Globally, the positive trend in the tech sector is expected to continue into 2025. Following a pause in IPOs last year, I anticipate an increase in tech company IPOs. Massive amounts of capital are still seeking investments, and expectations of interest rate cuts in the U.S. will likely boost demand for venture capital and startup investments.

The relatively calm geopolitical situation in Israel should be approached cautiously. While the battles with Hezbollah in Lebanon were better managed than expected, we suffered tragic losses, and the duration of the ceasefire on that front is uncertain. Regarding the Syrian front, it’s too early to determine the implications, but the fall of the Assad regime by jihadi militias, while positive for much of the Syrian population, may not be good news for Israel. Most critically, the issue of hostages in Gaza remains unresolved, and Hamas has not been subdued. The geopolitical uncertainty still exists and significantly affects Israel’s economy. This uncertainty will likely persist into 2025, potentially driving continued capital outflows and significantly impacting the local economy.

[1] Israeli data – according to S Cube’s research, US data – according to WSGR.

[2] According to S Cube data.

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