Preferred Shares in Israel: Potential, Complexities, and Market Maturity

Preferred shares (preferred stock) are a unique financial instrument offering a hybrid arrangement between a public company and investors: purchasers may receive an attractive dividend and priority over common shareholders in receiving dividends and distributing company assets upon liquidation. From the company's perspective, this raises capital without granting voting rights or diluting control, while maintaining significant financial flexibility compared to standard debt issuance.

However, this arrangement comes with a price. Preferred shares are not bonds: the company does not commit to fixed interest and principal repayment dates, the instrument does not necessarily have a maturity date, and the investor does not enjoy creditor status. Therefore, the dividend yield alone is not enough to determine whether the investment is worthwhile.

The planned preferred share issuance by renewable energy company Nofar Energy, which was scheduled on the Tel Aviv Stock Exchange but ultimately postponed for now, vividly illustrates the potential and complexity of this instrument. It also raises a broader question: Is the Israeli capital market ready to absorb financial instruments positioned on the boundary between debt and equity?

A Stock with Preference, But Without Control

Preferred shares grant holders preferential rights over common shares. Section 46B of the Securities Law defines preferred shares as those granting preferential rights to dividends, but without voting rights. In other words, the distinction is not only economic but also legal: the holder enjoys priority in dividend distribution but waives the ability to influence company operations.

Nevertheless, dividend priority does not guarantee that a dividend will actually be distributed. The company is still required to pass a distribution resolution and meet legal conditions. The investor is thus in an intermediate status: senior to common shareholders, but junior to debt holders. From legal and accounting viewpoints, the instrument leans toward equity, but economically it strongly resembles debt.

The Yield Does Not Tell the Whole Story

In preferred shares, the auction price directly impacts the effective yield: the lower the price, the higher the effective yield, and vice versa. The auction price reflects how the market prices unique risks—the lack of commitment to ongoing payments, the absence of a binding maturity date, and inferior status relative to bonds.

The natural comparison is to the company's bonds. With bonds, the company commits to paying interest and principal on specified dates, and non-payment constitutes a legal default. With preferred shares, even when dividends accumulate, there is not necessarily a regular cash payment, and the economic right depends on company decisions and distribution capacity.

What Is the Risk Premium Worth?

This highlights the central question: what yield gap is required to justify shifting from a company's bonds to its preferred shares? Nofar Energy's case demonstrates this clearly: if a company's bond trades at a yield of 6% to 6.5%, while the preferred stock offers a base dividend of 8.5%, the investor must decide whether an annual gap of about 2% compensates for the differences between the instruments.

Another key characteristic is that preferred shares are often perpetual (without a fixed maturity date). Redemption rights are typically at the company's sole discretion, meaning they do not constitute a safety net for the investor.

What Does the Issuing Company Gain?

For issuing companies, preferred shares serve multiple needs simultaneously:

Retaining control: Raising capital without diluting voting rights.
Strengthening the balance sheet: Increasing the equity base and managing leverage ratios.
Cash flow flexibility: Adapting to project-based activities where cash flows do not fit rigid bond amortization schedules.

However, the very flexibility that serves the company constitutes the source of risk for the investor.

The Unattainable Model Abroad

In developed markets, particularly the US, preferred shares are a standard and significant investment category. Leading indices, such as the S&P U.S. Preferred Stock Index, alongside ETFs and tracking products, allow the public liquid and orderly exposure to the sector.

The Bottom Line: What Is Missing in Israel?

Postponing a single issuance does not mean there is no demand for preferred shares in Israel. It primarily indicates that the local capital market is not yet mature: it lacks depth, diverse issuances, dedicated indices, tracking products, and clear, comparable information systems.

For preferred shares to transform from a niche gimmick into a genuine investment category in Israel, attractive terms for a single issuance are insufficient. Gradual construction of the entire infrastructure is required—ranging from transparent pricing to establishing a liquid secondary market and appropriate benchmark indices.