Africa Israel's predicament should be a warning

One of the nation's most prominent businessmen,once considered to be the richest person in Israel, has become the mostprominent victim of the violent crisis that hit the global economy.Leviev is a classic self-made man from a small town who went from beinga modest diamond cutter to a mogul running a multibillion-dollar empireof diamonds and real estate. But he is now one step away from completebankruptcy and losing control of his Africa Israel global real-estatebusiness - together with lost credibility and a stain on his good name.

In short, what destroyed Africa Israel is the same thing behindthe current severe recession: over-leveraging. Over the past fiveyears, Africa Israel took part in dozens of ambitious real-estateprojects in the United States and Russia. They were also veryexpansive, and the company made some serious investments in "hot"markets just when the global real-estate bubble was reaching its peak.But it seemed Leviev didn't care: financing was so easy to get and, inIsrael, institutional investors (the guys who manage your pensionmoney) had loads of spare cash to spend.

So all he had to do after reaching the limits of his bank'scredit lines was to address these investors - backed with glowingreports and "independent evaluations" of his company's assets - andrecruit many more billions of shekels, without even needing properguarantees, except for his word of honor.

Indeed, Africa Israel's grim case is a good exampleof the terrible damage caused by adopting the shameful accountingpractice known as IFRS (international financial reporting standards).Under this new practice, the "good old" accounting principle ofconservatism has been abandoned, and companies are allowed to rewritevalues of assets using up-to-date evaluations.

For a global real-estate giant like Africa Israel, thispractice was used to upgrade the value of its books' assets by billionsof dollars and use it for raising more billions in debt and in IPOs,such as the one by its subsidiary AFI Development in London last year.

In 2004, Africa Israel's total debt, includingsubsidiaries, was about NIS 6 billion. By late 2008, it was NIS 22.5b.Moreover, most of the company's assets by the time markets started tofall were only in the developing stage, especially in Russia. The ratiobetween these kind of assets to mature ones that yield steady cashinflows was getting risky. When real-estate prices started to fall,Africa Israel found itself caught between the worse market in decadesin the US and a devastated market in Russia, where the economy hadalmost ground to a halt.

When the seriousness of this collapse became clear lastSeptember, anyone looking at Africa Israel's balance sheet should haveseen a default coming. The company tried to calm things down, declaringit was "financially stable" and had been able to sell assets to injectmuch-needed money.

But even these actions, which provided some false support toits stock, were seen by many as a sign of weakness. One of AfricaIsrael's biggest problems was the shortage of income-producingproperties; the sale of its Israeli crown jewel, the mall in RamatAviv, together with some other cash-bearing assets left it morecash-flow naked than ever.

So now the banks, institutional creditors and private investorsare all trying to save something from the mess Leviev left them with.It has been said that all these lenders share a common interest ofwanting to keep the company alive so that it can recover some of themoney it owes.

But Africa Israel's ability to do that even if it is kept aliveis very low. It doesn't have many more "live assets" left in itspipeline; most of the ones it still had were already given to the banksas collateral. That means its bondholders, to whom Africa Israel owessome NIS 9b., have little chance of getting their money back.

This is what makes the whole affair more significant than justanother story about a business failure. It is clear that Africa Israelis not alone. Many other companies, especially in the globalreal-estate business, are facing the same problems Leviev has.

Fischman Group, Arazim, Azorim and lately even Zim, one of theOfer family's leading companies, are struggling to survive in anenvironment of deteriorating business and huge debts. Many of them owesubstantial amounts to unsecured bondholders.

Those "bondholders" are none other than you and me, whose moneywas involuntarily handed over to incompetent money managers of theprovident, pension and insurance funds. Now these same people whoinvested our money so poorly are trying to make amends by fighting likelions over each shekel they can squeeze out of Africa Israel andLeviev.

One of the most curious questions is what's happening withLeviev's privately held businesses, especially the diamond business.When Leviev approached the capital market to raise money, he used hisreputation and personal financial status to promote his new businessventures. So his creditors should now be very adamant and target someof his personal money - just in case Africa Israel's assets don'tsuffice.

The institutional investors should make Africa Israel's case anexample for other companies with impending default announcements. Ifthey let the beleaguered players - including Leviev and his foreign andlocal bank creditors - leave them in the lurch, we might soon witness awave of such defaults.

But insisting on getting what they deserve at almost any cost -including confiscating Leviev's shares in Africa Israel, appointing adifferent management team and going after his private assets - wouldsend a strong message to the business community and the public. And itwould set a new standard for a more reasonable and moral world for thegood days that will come when this painful crisis ends.