Israel information technology report q1 2015

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ISRAEL

INFORMATION TECHNOLOGY REPORT

INCLUDES 5-YEAR FORECASTS TO 2018

Report Q1 2015

INCLUDES 5-YEAR FORECASTS TO 2018

Part of BMI’s Industry Report & Forecasts Series

Published by: Business Monitor International

Copy deadline: October 2014

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BMI Industry View 7

SWOT 9

IT SWOT 9

Wireline SWOT 11

Political 12

Economic 13

Business Environment 14

Industry Forecast 15

IT Market 15

Table: IT Industry - Historical Data And Forecasts (Israel 2011-2018) 15

Broadband 20

Internet 20

Table: Telecoms Sector - Wireline - Historical Data & Forecasts (Israel 2011-2018) 20

Macroeconomic Forecasts 22

Economic Analysis 22

Table: Economic Activity (Israel 2009-2018) 27

Industry Risk Reward Ratings 28

Industry Risk/Reward Index 28

Table: MEA IT Risk/Reward Index, Q115 32

Market Overview 34

Hardware 34

Software 40

Services 44

Industry Trends And Developments 48

Regulatory Development 52

Table: IT Regulatory Authorities 52

Table: Government Initiatives 54

Competitive Landscape 56

International Companies 56

Table: Intel 56

Local Companies 57

Table: Amdocs 57

Table: Check Point 58

Table: Imperva 59

Table: Retalix 60

Company Profile 61

Ness 61

Matrix 67

Regional Overview 71

Industry Risk/Reward Index 71

Table: MEA IT Risk/Reward Index, Q115 75

Demographic Forecast 77

Table: Israel's Population By Age Group, 1990-2020 ('000) 78

Table: Israel's Population By Age Group, 1990-2020 (% of total) 79

Table: Israel's Key Population Ratios, 1990-2020 80

Table: Israel's Rural/Urban Population Split, 1990-2020 80

Methodology 81

Industry Forecast Methodology 81

Sources 82

Risk/Reward Index Methodology 83

Table: It Risk/Reward Index Indicators 84

Table: Weighting Of Components 85

BMI Industry View

BMI View: Israel has the most mature IT market in the Middle East and Africa region, and its skilled

workforce, vibrant start-up culture and strong government and university engagement in developing cutting edge research has attracted investment from nearly all major global IT firms However, because of the comparatively high penetration of IT products and services, as well as its small population, Israel's IT market is expected to grow more slowly than most others in the region Between 2010 and 2014, the IT market was also impacted by sluggish GDP growth, but we expect an improving macroeconomic outlook to support accelerating demand for IT software and services in the latter years of our forecast period to 2018 Given Israel's geopolitical location and the uptick in violence in the region, we expect spending on cyber security to be a key driver of growth in Israel's IT market, chiming with our view that software and services will increase as a proportion of IT spend to account for 65% of the market by 2018.

Headline Expenditure Projections

Computer Hardware Sales: Forecast to reach ILS9.225bn in 2014, up from ILS9.143bn in 2013 We

expect a return to growth in 2014 to be driven by the launch of 4G mobile networks and ongoing migration

to the Windows 8 OS

Software Sales: ILS5.867bn in 2014, up 4.5% year-on-year (y-o-y) from ILS5.524bn in 2013 Enterprise

software spending will be the main growth driver as device and data proliferation will result in increasedspending on customer relationship management (CRM), databases and business intelligence

IT Services Sales: We expect IT services sales will continue to outperform the rest of the IT market,

reaching ILS8.26bn in 2014, up from ILS7.91bn in 2013 Cyber security services will outperform in terms

of growth, but it will be stable sectors such as government and defence that continue to account for themajority of spending

Key Trends And Developments

In September 2014 the Israeli government confirmed that Intel will invest around USD6bn to upgrade itschip plant in Kiryat Gat This is the largest single investment from a foreign company in Israel and

highlights the attractiveness of the Israeli tech market to global IT hardware and software firms The trend

that the country's high-tech start-ups raised nearly as much during 9M14 as during the whole of 2013, withQ214 recording the strongest quarter of fundraising since 2000.

Israel's defence, public and private installations are prime targets for cyber attacks, partly due high

geopolitical tensions The recent uptick in regional conflicts and Israel's military activities in Gaza haveamplified the threat level in 2014, and is expected to result in growing demand for cutting-edge solutionsfrom public and private institutions Local and international companies are already positioning themselves

to take advantage of this opportunity by investing in various efforts to develop new solutions for the market

In July 2014, Microsoft and cloud services provider Akamai partnered to launch a cyber security-focused start-up accelerator program in Israel, in partnership with venture capital firm Jerusalem Venture

Partners In June, Israeli security analytics company Fortscale announced that it raised USD10mn in funding from Intel Capital and Blumberg Capital to expand its R&D program Also in June, cyber security start-up Hexadite announced a USD2.5mn in seed funding for its operations.

IT SWOT

SWOT

Strengths ■ Home to the most well developed economy and IT market in the region with major

local IT companies based in the country, a highly educated, linguistically skilledworkforce, and relatively low labour costs compared with developed markets

■ Strong defence and government spending provides base for IT demand

■ Strong political support, with the government having implemented many policies toaid in the expansion of the IT sector

■ Investment in FTTH and wireless data networks provide basis for cloud computinggrowth and internet of things expansion

Weaknesses ■ The recession at the beginning of the 2000s focussed customers on the bottom line,

with enhanced services and customer market power adding to pressure on pricingand margins

■ Digital divide, with just 30% of the bottom-income group having home internetaccess

Opportunities ■ Cyber security threats should attract increased spending on safeguards as the

concerns of government and enterprises escalate

■ Growing demand for tablets and other mobile computing devices such as hybrids andultrabooks

■ Defence and government projects should be less sensitive to fiscal retrenchment,with a major data centre project under way for the Israel Defense Forces

■ Outsourcing, Software-as-a-Service (SaaS) and applications management likely togrow fastest out of IT services, with particular opportunities in the financial sector.Opportunities for partnership/investment in Israel's lively local IT company sector

SWOT - Continued

Threats ■ Government austerity measures will dampen consumer and business spending

■ Other factors may affect business confidence, notably the security situation

■ The weaker local currency, and aggressive pricing, may continue to constrain growthand put pressure on margins

Wireline SWOT

SWOT

Strengths ■ Well developed internet/broadband sector compared with regional peers

■ Fixed-line liberalisation has led to increased competition and the erosion ofincumbent market share

■ Incumbent operator Bezeq faces strong competition from HOT Telecom, which hasrecently entered the mobile market

Weaknesses ■ Internet infrastructure is currently controlled by Bezeq and HOT Telecom

■ Regulator was slow to license new services eg WiMAX licences

■ Slow development of triple-play for Bezeq could hinder value growth prospects

Opportunities ■ Introduction of LLU will give alternative operators access to Bezeq's network and

should stimulate much greater competition

■ The ViaEurpoa-led consortium building a fibre network over the Israel ElectricCorporation (IEC) infrastructure would provide competition for Bezeq and HOT, andultimately boost growth in the market

Threats ■ Continued reduction of internet tariffs could have a devastating effect on revenues

■ Fixed broadband growth is slowing as mobile broadband services becomeincreasingly popular

■ Operators, Bezeq in particular, have resisted the introduction of number portability,which could lead to a price war and thus drive down mobile revenues

SWOT Analysis

Strengths ■ Despite corruption allegations against some officials and members of parliament,

government members are still some of the most accountable in the region

■ Elections are for the most part free and transparent, ensuring that a broad spectrum

of political views is represented within government

Weaknesses ■ The protracted conflict with the Palestinians means there are persistent security risks

Strategies to minimise or end the conflict are domestically divisive, with tensionsbetween Israel and Hamas set to remain elevated

■ Frequent change to the composition of the coalition government often leads topolicies becoming fragmented or significantly diluted

■ With the civil war in Syria continuing, risks of a spill over into Israel are ever-present

Opportunities ■ A warming of relations with Greece has given Israel the ability to engage in military

exercises over a larger geographic area

Threats ■ Finding a lasting solution with the Palestinians continues to pose a dilemma for Israel,

and we think a final agreement will remain elusive

■ Continued home-building in some West Bank settlements antagonises thePalestinians and stands in the way of the peace process

SWOT Analysis

Strengths ■ The policy framework has stabilised in recent years, and austerity measures will help

to keep the fiscal deficit under control

■ The workforce is highly educated and skilled

■ The country's close ties with the US provide it with substantial financial assistance foreconomic and military ends

Weaknesses ■ A sharp deterioration in the security situation can have an immediate impact on

domestic confidence, tourism receipts, the exchange rate and foreign investment

■ The economy is highly exposed to that of the US and Europe in terms of exports andinvestment

Opportunities ■ In the long term, relatively elevated levels of employment will underpin private

Threats ■ Appreciatory pressures on the Israeli shekel risk damaging the country's exports That

said, risks will remain contained by the Bank of Israel's commitment to intervene inthe forex market to stem excessive appreciation of the unit

■ Competition from emerging Chinese and Indian producers of high-tech goods andpolished diamonds could undermine demand for Israeli exports

Business Environment

SWOT Analysis

Strengths ■ The business environment is supported by sound infrastructure and communication

networks, as well as transparent legislation

■ The banking system is one of the most sophisticated in the region, and offers a widerange of both consumer and commercial credit products

Weaknesses ■ Historic political instability increases the risk premium of investment in Israel

■ Some limits on repatriation of capital exist and there are constraints on foreigninvestment in the high-tech sector

Opportunities ■ The beginning of offshore exploration will increase foreign direct investment in the

country

Threats ■ Strike action has proved extremely disruptive to the business environment in 2011,

and could regain strength over the next years

■ The parliament approved a plan to increase the country's oil and gas royalties, whichcould reduce energy profits in the future

e/f = BMI estimate/forecast Source: BMI

We continue to hold the view that the Israeli IT market will experience only limited growth over themedium term and will gradually decline as a percentage of GDP This is a product of saturation of thehardware and software/services market and price competition between vendors, which will hold down theoverall value of the market Nevertheless, Israel remains at the forefront of development of security servicesand continues to attract investment in research and development centres from global IT firms

We forecast the IT market to reach a value of ILS23.355bn in 2014, equal to USD6.635bn and up fromILS22.6bn in 2013 Despite our expectations of relatively weak growth in 2013 and 2014, we maintain amore positive outlook for Israel's IT market over the long term Israel remains a robust IT market withplenty of opportunities across industrial, government, defence and financial services spending

Our five-year CAGR sees growth around 4.8% in Israeli new shekel terms for the period from 2014-2018

We expect IT services will be the fastest growing segment of the IT market, narrowly ahead of software,with both growing fast relative to hardware In terms of key verticals, the financial services and defencesectors drive growth, with rising geopolitical tensions likely to result in even stronger demand for ITsecurity solutions The nature of sales will change, however, as business management becomes increasinglyimportant and the hardware segment contributes comparatively less to the market's overall growth GivenIsrael's relatively rich tech skills resource base, many organisations prefer to conduct software development

2014 Outlook

We project real GDP growth of 2.5% in Israel in 2014, then expect slow but steady acceleration in GDP

growth throughout our forecast period, reaching 3.9% in 2018 BMI's Country Risk team downgraded

Israel's growth forecast slightly in the wake of the violence between Israel and Gaza, but does not expect theevents to have a lasting negative impact on the economy

BMI also forecasts relatively weak expansion of private consumption growth at 3.0% in 2014, mainly as a

result of the implementation of austerity measures by the government Private consumption growth has alsobeen fairly insulated from the eruption of violence between Israel and Gaza in Q213 and Q314

While government austerity and political instability have weighed on Israel's economic outlook, we believethere will nonetheless be opportunities for vendors in the IT market, most notably in demand for cyber andinformation security products and services This is a growth area in IT markets globally, but there is aparticularly large opportunity in Israel where regional political tensions and the uptick in cyber attacks in

2012 and 2013 affecting Israel, UAE and Saudi Arabia, have concentrated the minds of government andenterprise decision-makers on investments to protect their IT systems

Other areas where we expect to see growth include business intelligence and cloud computing, with thelatter likely to gain traction among SMEs as a lower cost alternative to bespoke systems Meanwhile sales

of hardware and software will receive a boost from Windows-8 driven upgrades and computer purchasespreviously delayed as a result of the economic situation The move to mobility and new form factors such astablets, hybrids and ultrabooks will help to drive demand in the consumer segment, while to some extentundermining demand for traditional notebooks

Meanwhile, despite the challenging trading conditions, vendors have reported a continued flow of IT

projects, with large tenders from the Israeli ministries of finance and defence and the Bank of Israel In

December 2013 VMware won a data centre contract from the Israel Defence Forces valued at USD27mn inthe local media

Industry Trends - IT Market

2011-2018

IT market value, ILSmn (LHS) IT market value, % of GDP (RHS)

2011 2012 2013 2014e 2015f 2016f 2017f 2018f 0

10,000 20,000 30,000 40,000

2 2.1 2.2 2.3 2.4 2.5

e/f = BMI estimate/forecast Source: BMI

Market Drivers

The Israeli IT market has several supportive fundamentals that should keep it in positive territory during

BMI's five-year forecast period to 2018 Although household computer penetration of more than 75% offers

only limited potential for growth derived from first time buyers, there are several factors pushing multipledevice ownership Innovation in form factors, including tablets and hybrids will push sales of personaldevices Meanwhile, investments by telecoms operators to expand the reach of high capacity wireless andwireline broadband services will catalyse demand for personal devices Spending will continue to moveaway from desktops as more consumers acquire personal devices such as tablets - which may also cut intospending on notebooks

Per capita IT spending is expected to rise from ILS2,986 in 2014 to ILS3,496 by 2018 However, spendingwill fail to keep pace with GDP growth in Israel as the economy becomes less heavily weighted towards thehigh-tech sector following gas exploration and growth in other sectors Some key IT spending verticals will

vicissitudes Vendors will target projects across a range of sectors; from government to financial services,telecoms and utilities.

While the defence sector is expected to remain the single most important vertical, investments by financialsector organisations should mean more large outsourcing deals Other sectors of opportunity will includehealthcare and telecoms, as well as infrastructure, transport and the small office and home office sector

Income Per Capita Breakdown

2011-2018

Poorest 20%, net income per capita, ILS Richest 20%, net income per capita, ILS Middle 60% of population, net income per capita, ILS

2011 2012 2013e 2014e 2015f 2016f 2017f 2018f 0

25,000 50,000 75,000

e/f = BMI estimate/forecast Source: National sources, BMI

BMI expects IT services will display the highest growth over the forecast period to 2018, due to growth in

key verticals and the opportunities presented by cloud computing, big data analytics and real-time enterpriseservices based on the internet of things

As noted, cloud computing is expected to be a source of revenue growth over the medium term as

organisations looking for efficiencies turn to Software-as-a-Service and Infrastructure-as-a-Service

Particular areas of opportunity for cloud computing include banking and retail, as organisations in thosefields look to save money on hardware and improve customer services

While large organisations still dominate, SMEs have been investing more and represent a growth

opportunity Many SMEs are waking up to the need to compete through more direct investment in supportand service infrastructures Cloud computing is a field which could gain traction with SMEs as the on-demand model fits well with their smaller budgets and lack of demand for bespoke in-house solutions andsoftware

Summary

BMI believes IT spending has sufficient strength in key demand verticals to maintain a positive trajectory

over the medium term However, we do not expect growth to keep pace with GDP as market saturation andprice competition between vendors limit increases in the total value of the market The hardware market isforecast to grow from ILS9.1bn in 2013 to ILS10.1bn in 2018, with PC sales projected to rise from anestimated ILS7.8bn to ILS8.9bn While growth will remain strong, the market will be increasingly

dominated by IT service sales and software sales, indicating the maturity of the market BMI forecasts

software sales to account for 28.2% of Israel's IT market by 2018, up from 24.5% in 2013, while servicesare forecast to rise from 35.0% of the IT market to 36.8% over the same timeframe

Inhabitants 23.9 25.5 26.2 27.2 27.8 28.2 28.5 28.5

e/f = BMI estimate/forecast Source: BMI, operators

We have revised our forecast for the development of Israel's internet user and broadband subscriber marketsbased on new data from the country's service providers We revised our YE13 estimate for the number ofinternet users down to 5.33mn, giving Israel a penetration rate of 68.9% We expect steady, but slowing,growth in the number of internet users to continue for the duration of our forecast, resulting in 6.295mninternet users in 2018, equivalent to a penetration rate of 76.1%

Meanwhile, owing to a lack of reliable data on the number of mobile broadband subscribers (specificallythose subscribers who use USB dongles and data cards to access the internet via laptops, PCs and

smartphones), our forecast for the Israeli broadband sector is currently based on fixed broadband

connections only Data published by incumbent telecoms operator Bezeq and alternative operators HOT and Partner Communications suggests that the number of fixed broadband subscribers had increased to around 2.131mn at the end of 2013, up by 9.3% year-on-year (y-o-y) BMI estimates that, by the end of

2014, Israel's broadband subscriber base will have risen to 2.24mn; this is equivalent to a penetration rate of28.6% and reflects full year growth of 5.1%

Industry Trends - Wireline Sector

2011-2018

Main telephone lines in service, '000 Broadband internet subscribers, '000

2011 2012 2013e 2014e 2015f 2016f 2017f 2018f 0

1,000 2,000 3,000 4,000

e/f = BMI estimate/forecast Source: Operators, BMI

Up until 2018, we envisage average annual growth of around 3.1% for the Israeli broadband sector Thiswill see the subscriber base reach 2.48mn, equivalent to a penetration rate of 30.0% We expect the growingpopularity of mobile broadband services to result in slowing demand growth in the fixed broadband sector.Nevertheless, we identify several developments which will sustain fixed broadband growth for the duration

of our forecast and beyond These include the launch of wholesale broadband services by the ViaEuropa-led

consortium building a fibre network over the Israel Electric Company (IEC) infrastructure and Bezeq's

ongoing deployment of its fibre-to-the-cabinet (FTTC), a development which is helping to drive capacityfor its residential and corporate customers' broadband access Meanwhile, recent months have seen

considerable reductions in the price of broadband tariffs being offered by the major operators Anotherdevelopment likely to stimulate growth is the introduction of LLU, which will give alternative operatorsaccess to Bezeq's network and stimulate much greater competition

Macroeconomic Forecasts

Economic Analysis

BMI View: We have revised down our forecast for Israel's 2014 real GDP growth due to the recent conflict

with Hamas and now project the economy to expand by 2.5% this year and 3.6% the next A moderation of austerity policies and increasing exports underpin our positive medium-term outlook for the economy.

We have revised down our 2014 real GDP growth forecast for Israel to 2.5%, from 3.2% previously, andproject the economy expanding by 3.6% in 2015 - the result of low base effects and accelerating exportgrowth Economic growth slowed to 1.7% year-on-year (y-o-y) in Q214 - before the beginning of theconflict with Islamist group Hamas in the Gaza strip in July - from 2.8% y-o-y in Q114 The hostilitieslikely resulted in an even sharper, if temporary, economic contraction in Q314

A moderation of austerity policies over the coming years, coupled with increasing exports and a subsequentacceleration in fixed investment growth, underpin our positive view for the Israeli economy over the nextfive years, and we forecast real GDP growth to average 3.6% over this period

Conflict Hitting Economy Hard This Year

Israel - GDP

Nominal GDP, USDbn (LHS) Real GDP growth, % y-o-y (RHS)

2009 2010 2011 2012 2013e 2014f 2015f 2016f 2017f 2018f 0

100 200 300 400

0 1 2 3 4 5 6

e/f = BMI estimate/forecast Source: Central Bureau of Statistics Israel, UN, BMI.

Private Consumption Outlook: Private consumption will accelerate in 2015, and we forecast growth of

3.5% following 3.0% growth in 2014 Consumer spending slowed to 1.8% y-o-y in H114, from 4.0% inH213 We expect private consumption to remain subdued in Q314 amid declining consumer sentimentresulting from the conflict in the Gaza Strip

Modest Increase In Spending In 2015

Israel - Government Revenues & Expenditure

Fiscal revenue, ILSbn (LHS) Fiscal expenditure, ILSbn (LHS) Budget balance, % of GDP (RHS)

2009 2010 2011 2012 2013 2014f 2015f 2016f 2017f 2018f 0

100 200 300 400

-5 -4 -3

-6 -2

e/f = BMI estimate/forecast Source: Israeli Ministry of Finance, BMI

The ongoing conflict in the Gaza Strip will result in a persistently elevated fiscal deficit in Israel, which weforecast to come in at 3.6% and 3.5% of GDP in 2014 and 2015 respectively This will result in tight fiscalpolicies in Q414 and 2015, as the government will have to make up for higher-than-expected spending byincreasing taxes That said, hikes will not be dramatic; higher-than-expected revenues and lower expensesbrought the 12-month rolling deficit to only 2.5% of GDP in H114, allowing the government some room formanoeuvre

Government Spending Outlook: Public spending averaged 3.6% in H114, and we expect growth in this

component to slow over the coming quarters as the government attempts to absorb the costs of the war withHamas The conflict resulted in a significant drop in consumer spending, business activity and tourism,which hit government revenues We project government consumption to expand by 2.8% and 3.2% in 2014and 2015 respectively

Fixed Investment Outlook: We expect growth in gross fixed capital formation to accelerate in 2015, a

result of low base effects and accelerating export growth Investment in the Israeli technology and

pharmaceutical segments will contribute to the expansion of the component in 2015 Indeed, on August 21,

Swiss drugmaker Novartis announced it will acquire a 15% stake in Jerusalem-based healthcare services company Gamida Cell in a USD600mn deal.

The five-year outlook for gross fixed capital formation is encouraging, particularly given prospects forincreasing investment in the energy sector In the middle of August, it was announced that estimated naturalgas reserves at Israel's Leviathan gas field have risen by 16% to 620bn cubic metres (bcm), from

535.4bcm previously We project fixed investment to expand by 1.0% in 2014 and 4.0% in 2015, and togrow by 3.9% on average over the next five years

Investment Opportunities Lie Ahead

Israel - Gas Production (bcm)

2012e 2013e 2014f 2015f 2016f 2017f 2018f 2019f 2020f 2021f 2022f 2023f 0

5 10 15 20 25 30

e/f = BMI estimate/forecast Source: EIA, BMI

Net Exports: We see Israel recording net export surpluses of ILS12.2bn (USD3.4bn) and ILS13.3bn in

2014 and 2015 respectively, from ILS12.4bn in 2013 Goods and services exports have likely declinedsignificantly in Q314, a result of the conflict with Hamas Tourism - which accounts for approximately 7%

of Israel's economy - has been among the hardest-hit industries, with the number of visitors declining by

We expect total exports to contract by 1.5% in 2014 and expand by 3.5% in 2015, largely a result ofaccelerating economic expansion in key export markets Europe - particularly the UK, Belgium, the

Netherlands and Germany - accounted for 45.2% of total Israeli exports in 2013, and we expect an

improvement in macroeconomic conditions in those markets to benefit Israeli exporters next year Exportswill also be supported by the beginning of gas production in 2015, albeit on a small scale Large-scale gasexports will begin only in 2018, in our view, which will result in an uptick in total export growth in thelatter part of the decade

Encouraging Medium-Term Outlook

Israel - Components Of GDP (ILSbn) & Real GDP Growth, % chg y-o-y

e/f = BMI estimate/forecast Source: Central Bureau of Statistics Israel, UN, BMI.

We project imports to decline by 1.5% this year and expand by 3.3% in the next on the back of low baseeffects and an uptick in domestic consumption and fixed investment Import growth will remain robust overthe medium term, offsetting the projected acceleration in export growth

Table: Economic Activity (Israel 2009-2018)

2009 2010 2011 2012e 2013e 2014f 2015f 2016f 2017f 2018f

Nominal GDP, USDbn 195.0 218.0 243.7 241.2 270.1 293.3 312.1 332.6 355.4 378.7 Real GDP growth, % y-o-y 1.1 5.0 4.6 3.4 3.3 2.5 3.6 3.7 3.8 4.2 GDP per capita, USD 26,806 29,384 32,305 31,552 34,929 37,497 39,413 41,432 43,633 45,808 Population, mn 7.3 7.4 7.5 7.6 7.7 7.8 7.9 8.0 8.1 8.3 Industrial production, % y-o-y,

ave -5.9 8.1 16.5 6.8 -2.0 0.2 3.6 4.9 5.7 6.0Unemployment, % of labour

force, eop 7.2 6.6 5.4 6.7 5.9 6.7 6.5 6.5 6.4 6.4

e/f = BMI estimate/forecast Source: National Sources, UN, BMI

Industry Risk Reward Ratings

Industry Risk/Reward Index

BMI View: We retain our positive growth outlook for the IT sector in most countries in the Middle East and

Africa (MEA) Growth will be driven mainly by government and enterprise spending, with rising demand for software and services in the more mature IT markets of the Gulf Cooperation Council (GCC) countries and Israel High growth levels in Nigeria, Ghana, Kenya and Egypt are primarily the result of low base effects, with long-term opportunities for vendors as government agencies and enterprises adopt IT solutions for the first time

There have been only minor changes in the rankings on our Risk/Reward Index (RRI) table and in theaverage segment and aggregate IT scores in Q115 Israel pulled ahead of Qatar into first place, while at thebottom Lebanon slipped below Ghana into 12th place owing to a big drop in its industry rewards score This,

as well as a decline in Kenya's industry rewards score, pulled the average score for the category down by 2points to 46.7 out of 100 The average country rewards score increased by 0.4 points to 65.0, while theindustry risks score remained flat and the country risks score was down just 0.1 point to 56.4 This resulted

in an overall 0.8 point decline in the aggregate MEA IT score to 53.2

Industry Rewards

Nigeria and South Africa remain the top performers in the industry rewards category, with respective scores

of 65.0 and 61.7 We have a bullish outlook for both countries' IT markets in view of Nigeria's strongeconomic growth and high government spending in South Africa

The high sector growth rates in Nigeria, Ghana, and Kenya are largely due to low base effects As a result,

we believe these countries, along with Egypt, offer long term growth opportunities for investors consideringthe low level of development of their IT markets relative to the more developed GCC states

Wealthy Markets Score Highly

MEA IT Risk/Reward Outlook, 2014

contracts to global vendors, including Cisco Systems, Microsoft, Amadeus and EMC.

Lebanon and Kenya both saw sharp declines in their industry rewards scores in Q115 In Lebanon weakeconomic growth, forecast to reach 1.8% in 2014, has weighed on the government and the private sectors'ability to spend on IT products and services, dragging on our growth forecast and resulting in a 10-pointdrop in Lebanon's industry rewards score, to 25 In Kenya, the government's school children laptop

programme was postponed yet again when the High Court cancelled the USD285mn tender in September

2014 This resulted in a sharp decline in our growth forecast and a contraction of Kenya's industry rewardsscore, to 41.7 Although below the regional average of 46.7, Kenya's score is still buoyed by its large

Country Rewards

The country rewards category evaluates consumers and businesses' potential spending power on IT productsand services, based on macroeconomic indicators such as GDP per capita and the rate of urbanisation Ahigher urbanisation rate means that a greater proportion of the population is likely to have access to highquality broadband networks, translating into higher demand and use of IT services Meanwhile, high incomelevels mean a larger segment of the population can afford expensive IT hardware products, as well asgenerally higher private consumption levels, which in turn create increased demand for IT solutions frombusinesses in consumer facing industries

Qatar, Kuwait, the UAE and Israel had the highest GDP per capita at the end of 2013, at approximately

USD93,000, USD53,000, USD43,000 and USD35,000 respectively, according to BMI data However, the

UAE misses out on a higher score in this category as around 16% of the population live in rural areas,compared to 8% in Israel and less than 2% in Kuwait and Qatar

The African countries, including Egypt, all score below 50.0 in this category, but there are growth

opportunities for investors with a long-term outlook Nigeria, Egypt, South Africa and Kenya all havepopulations of more than 40mn, and this vast potential will attract significant interest from businesses with

consumer-centric solutions Among the leading global IT software and services firms, SAP, Microsoft and IBM have made the most concerted efforts to establish a presence in the region, while local firms such as AfricaOnline, iWayAfrica and SevenC Computing are gradually building their capabilities Kenya's

particularly low score of just 10 is due to its urbanisation rate of just 25% and GDP per capita of aroundUSD1,250 in 2013

Industry Risks

There were no changes in the industry risks category

in Q115 Intellectual property (IP) theft remains the

key risk in the category, with levels of software

piracy remaining generally high in MEA According

to a survey by BSA | The Software Alliance,

published in June 2014, the average rate of

unlicensed software use in MEA in 2013 was around

59%, compared to 29% in Western Europe and 19%

in North America

BMI believes the level of IP risk throughout the

region is the result of consumer spending power,

with high demand for low-cost, often pirated,

products in low income countries, contrasting with

government commitments to limiting access to

counterfeit and pirated products This is reflected in BMI's newly developed Operational Risk Index, which

evaluates trade and investment risks for the ICT sector on a country-by-country basis, based on the level of

IP protection and legal framework in the sector, among other indicators Both BMI and BSA data show that

the African countries in our MEA IT Index and Lebanon have high levels of software piracy, while

enterprises and consumers in wealthier GCC countries and Israel are much less prone to using counterfeit orpirated software

Country Risks

Our country risks scores for the IT sector assess key external factors that could affect a country's overallinvestment outlook and consequently the growth prospects for the IT sector These factors include short-term external and financial risk, trade bureaucracy, legal frameworks and corruption perception The GCCcountries and Israel all score higher than 60 (apart from Oman, on 59.2), mainly due to the favourable short-term external risk factor scores and stronger corruption perception indices Countries with lower scores allstruggle with high levels of corruption and lack of transparency in trade bureaucracy and legal frameworks

The potential for oil prices to slide down to USD80 a barrel or lower over coming quarters is the biggest

IP Protection A Key Risk

Operational Risk ICT Index, 2014

Scores out of 100, with 100 the best Source: BMI

remains the biggest spender on IT products and services, and a sharp decline in oil prices could result inreduced government spending on non-essential services For Saudi Arabia, Kuwait, the UAE and Qatar,

BMI believes depressed oil prices would have limited impact on the IT market, as all they have enormous

reserves and lower break even points for oil prices Among those included in our IT RRI, Bahrain andOman's governments are most likely to curb IT spending if lower oil prices are sustained, as they are both

already expected to run fiscal account deficits in 2014, according to BMI forecasts Outside the GCC,

falling oil prices could also have an important impact on Nigeria's ability to implement IT projects;

regardless of oil prices, the government will likely postpone some IT investments in favour of socialdevelopment projects in the run-up to general elections in H115

The deterioration of the security situation in the Middle East, first with the eruption of violence betweenIsrael and Gaza and then Islamic State's occupation of key cities in Iraq and Syria is a doubled edged swordfor the IT sector The elevated security risk has already affected investment inflows into various sectors inIraq's economy, a trend that has also contributed to Lebanon's weakened industry rewards score However,the heightened security risk will likely also encourage government and private institutions to bolster their ITsecurity capabilities in order to insulate themselves from the increased security threats Many global firmsare already positioning themselves to take advantage of this opportunity by investing in various efforts to

develop new solutions for the market In July 2014 Microsoft and cloud services provider Akamai

partnered to launch a cyber security-focused start-up accelerator programme in Israel, while several othercompanies have acquired local cyber security firms to bolster their capabilities

Table: MEA IT Risk/Reward Index, Q115

Country Industry rewards Country rewards Industry risks Country risks Overall IT score Rank Previous rank

Israel 55.0 100.0 65.0 69.7 69.9 1 2 Qatar 57.5 100.0 55.0 67.7 69.4 2 1 UAE 52.5 90.0 60.0 68.3 65.4 3 3 Kuwait 45.8 100.0 40.0 66.7 62.2 4 4 Saudi Arabia 50.8 80.0 55.0 67.7 61.5 5 5 South Africa 61.7 45.0 45.0 59.1 55.1 6 6 Bahrain 28.3 85.0 57.5 61.8 51.7 7 7 Nigeria 65.0 35.0 45.0 44.0 51.5 8 8 Oman 33.3 70.0 52.5 59.2 49.3 9 9 Egypt 51.7 30.0 45.0 46.1 44.6 10 10 Ghana 38.3 35.0 40.0 48.8 39.6 11 12 Lebanon 25.0 65.0 20.0 41.5 37.2 12 11

MEA IT Risk/Reward Index, Q115 - Continued

Country Industry rewards Country rewards Industry risks Country risks Overall IT score Rank Previous rank

Kenya 41.7 10.0 55.0 32.9 33.9 13 13

Scores out of 100, with 100 the best Scores are weighted as follows: 'Rewards' at 70%, of which Industry Rewards 65% and Country Rewards 35%; 'Risks' at 30%, of which Industry Risks 40% and Country Risks, 60% The 'Rewards' score evaluates the size and growth potential of the IT market in any given state, and broader economic/socio-demographic characteristics in a country that affect the industry's development; the 'Risks' score evaluates industry-specific dangers and those emanating from the state's political/economic profile, based on BMI's proprietary Country Risk Indices, that could affect the realisation of anticipated returns Source: BMI

Market Overview

Hardware

BMI estimates Israel's IT hardware market declined by 2.6% in 2013 to ILS9.143bn However, we expect it

to return to growth in 2014 and forecast a CAGR of 3.0% over our five-year forecast from 2014 to 2018 In

2013 the value of hardware sales was squeezed by a weaker currency, price competition and the lower unitprice of mid-range tablets hitting the market Despite a slightly weaker private consumption outlook for

2014, BMI believes that increased take-up of tablets and the end of support to older Windows operating

systems will boost sales throughout the year

As well as economic and IT market trends, the escalation of hostilities between Israel and Gaza in Julyposes a potential downside risk to the country's GDP growth for 2014 At the time of writing, BMI's countryrisk team had not yet altered its growth forecast of 3.2% for 2014, as bombing between Israel and Gaza hadextended for less than a month, a period of time which historically has not affected Israel's GDP growth.Nevertheless, wider economic uncertainty means businesses are now investing more to increase flexibilityand realise cost efficiencies rather than expand IT hardware capabilities There should be growth areas, yetlower average prices have meant that revenue growth in most segments has lagged shipments

BMI expects Israel's real GDP growth to continue on its gradual downward trend, falling from 3.3% in

2013 to 3.2% in 2014 However, we forecast a return to growth beginning in 2015 Real private

consumption growth and real government spending are expected to slow slightly in 2014, falling from 3.4%and 3.1% in 2013 to 3.1% and 2.6% in 2014, respectively The decline in private consumption is owing to

government austerity measures, such as the 1% rise in VAT implemented in June 2013 BMI expect that

austerity measures will continue to have an impact on discretionary spending on items such as PCs andnotebooks in 2014 This has an obvious impact on the growth potential of the IT market, as consumersconsider reigning in their spending and government faces fiscal constraints on new investments

Despite the weak consumer outlook in Israel there are several factors which present an optimistic mediumterm outlook for continued hardware sales The Israeli government has launched various initiatives toincrease computer and internet penetration, such as Computer for Every Child, now morphing into 'Tabletfor Every Child' according to Israeli Prime Minister Binyamin Netanyahu, and 'Digital Israel', a proposedinitiative to streamline the digitisation of public sector services, such as education, healthcare and socialservices The level of support, however, has been criticised by some industry insiders as too low Betweenits launch in 1995 and June 2013, the Computer for Every Child initiative reportedly distributed 55,000computers in around 2,000 localities, representing a tiny fraction of total hardware sales in Israel Industry

stakeholders see Digital Israel essentially as a duplication of its Government Computing Center The centrewas established in February 2012 and operates under the auspices of the Ministry of Finance, with many ofthe same goals as Digital Israel However, Carmela Avner, Israel's first chief information officer whoheaded the centre, announced her resignation in December 2013 owing to the body's lack of power toimplement digital initiatives.

Therefore, BMI expects upgrades to new systems, Israel's vibrant local start-up and IT research &

development markets, and purchases of personal computing devices to remain the bulk of market sales.Mobile computing devices including tablets, slimline notebooks, ultrabooks and hybrids present a keygrowth opportunity for vendors as consumers increasingly complement household desktop and laptops withmore easily transportable devices Although tablet computers took longer to reach mass popularity in Israelthan other mature ICT markets, we expect demand to strengthen from 2014, further supported by an

improving private consumption outlook

Meanwhile, the end of all support for Windows XP in April 2014 and of mainstream support for Windows 7

in January 2015 is expected to result in higher sales of the Windows 8 OS in the retail and enterprisemarkets In the retail market Windows 8 will deepen the tablet and hybrid PC markets, while in the

enterprise sector the new OS should trigger computer hardware tenders previously delayed because ofweakened economic growth The launch of Windows 8 in Israel coincided with the launch of the Surfacetablet and a new suite of mobile handsets using Windows Mobile Former Microsoft CEO, Steve Ballmer,began an international promotional tour for the new operating system in Israel in November 2012

Hardware Market

2011-2018

Personal computer sales, ILSmn Servers sales, ILSmn

2011 2012 2013 2014e 2015f 2016f 2017f 2018f 0

2,500 5,000 7,500 10,000

e/f = BMI estimate/forecast Source: BMI

Evolving Form Factors

The Israeli IT market is relatively mature, but BMI estimates that hardware will still account for 39.5% of

the total market in 2014 (excluding communications hardware) Prior to 2012, notebooks were the growing segment of the market, although as recently as 2008 desktops still took around two-thirds of unitsales In 2010-2011, however the share of desktops declined precipitously, and then in 2012 there was a

fastest-shift from notebooks to tablets as the fastest growing segment of the market BMI forecasts notebooks and

tablets will account for 78% of total PC sales in Israel in 2014, up from 60% in 2009

This trend of preference for mobility is expected to continue over the 2014-2018 forecast period Despite itsdeclining share of sales, however, the desktop sector is still significant, largely due to business and

government end-users Although take-up of tablets has been relatively slow in Israel, the country's

consumers have embraced the smartphone According to a Google survey from June 2013, around 57% of Israelis had a smartphone This chimes with BMI's estimate that 3G subscriptions accounted for around

65% of Israel's total mobile subscriber base at the end of 2013, forecast to rise to 71.7% in 2014, with

mobile penetration reaching around 127% The competition from mobile devices is driving innovation innotebook and tablet design, as slim-line and hybrid devices are increasingly the centre-piece of Windowsvendors product ranges

The tablet market in Israel has been dominated by Apple Although Apple has faced tough competition

from a broadening pool of tablet vendors, it managed to maintain its dominance of Israel's tablet market in2013; a position we expect it to hold on to, at least for the duration of 2014 Data from Statcounter showthat iOS, run on Apple's tablets, accounted for 71.7% of all tablet browsing traffic in Israel in September

2014, down by 7.6pps y-o-y By contrast, Google's Android OS, which is used on Samsung, Asus andGoogle's own Nexus range, accounted for 27.9% of tablet browsing traffic, up by 8.0pps y-o-y AlthoughStatcounter data suggest that Apple devices remain by far the most popular among Israeli consumers, IDCestimated that Apple's share of tablet sales dropped considerably in 2013 to 31.4%, down from 49.1% a yearearlier Both data support the trend of a widening range of Android devices - including the Kindle Fire from

Amazon, the Nexus 7 and 10 and Samsung's Galaxy Tab range (all launched in 2013) beginning to make a

dent in Apple's market share Statcounter data suggest that Samsung has been the driving force behind thegradual erosion of Apple's dominant market share, with its share of browsing traffic reaching 12.7% inSeptember 2014, up from 8.7% a year earlier All other vendors, including Asus, Acer, Google and Sonyhave browsing market shares below 5%, although Asus' rose from 2.3% in September 2013 to 4.7% a yearlater

One key threat posed to Apple by Android vendors came with the release of lower-cost tablets, which werepredominantly the smaller 7" form factor This contrasted with Apple's larger and more expensive iPad -and the popularity of these smaller, cheaper devices, catalysed the development of Apple's own iPad Mini.Apple is set to face competition throughout 2014 from rival Android vendors that will continue to offerconsumers a wider choice in terms of price and size, as well as specifications and features

The gap between the strategies of some of the leading players is also worth noting On the one hand Appleand Samsung are hardware vendors and look to profit from the sale of devices, while on the other sideGoogle and Amazon are services firms and offer tablets almost at cost The strategies of services firms(combined with low cost OEM tablets from China) will likely put pressure on the margins of hardwarecentric vendors in the medium term

However, the tablet market remains relatively undeveloped in Israel's hardware sector, which is heavilydominated by Windows machines When looking at the combined tablet and desktop/laptop computer

September 2014 (This is nevertheless up from 2.6% and 0.9% of browsing traffic a year earlier.) The eventwith the largest impact on Israel's PC market was the launch of Windows 8 in October 2012, which enabledWindows vendors to introduce touch devices; a number of tablets were released throughout 2013 and 2014.The addition of more vendors and another touch OS has added to competition in the market and put furtherdownward pressure on prices.

Another significant development is the medium term impact on innovation and form factors Windows has atraditional strength in productivity use cases and software, with the OS being central to the enterprisemarket and Microsoft's ubiquitous Office Suite There is therefore an opportunity for vendors to leveragethis strength over rival iOS and Android devices by designing tablets with strong productivity functionalityalongside the passive media consumption features Early examples have been hybrid devices such as

Microsoft's own Surface (RT & Pro), Hewlett-Packard's Envy and Lenovo's Yoga and Helix Although

design innovation has some way to go, and prices of hybrids will need to decline, the multi-use device hasscope to capture a share of the tablet market by offering a stronger value proposition to consumers while notcompromising on user experience

Another device category that should receive a boost from the launch of Windows 8 is the ultrabook, ahigher-performance notebook designed to compete with Apple's MacBook High prices limited initialpopularity of these devices, and vendors subsequently focused on releasing low-end ultrabooks The success

of lower cost Windows 8 powered PCs is reflected in the latest Statcounter data, which show that Window 8and Window 8.1 accounted for almost 13% of browsing traffic in Israel in September 2014, up 6.5ppts from6.4% a year earlier By comparison, Mac OSX's share of browsing traffic increased by 1.2ppts, to 3.9%over the same period

Israel PC Browsing Traffic By OS (%) And Y-o-Y Change (pps)

September 2014

Source: Statcounter

Vendor Performance

The Israeli PC market has undergone significant changes in terms of market shares In the PC market, the

top three vendors, HP, Lenovo and Dell, had enjoyed a combined market share approaching 50%, but while Lenovo has gone from strength to strength, HP and Dell have been hit by competition from Asus and

Samsung - as well as the shift to tablets Most PC market growth in 2012 was driven by the mobile PCsegment, and in fact notebook sales declined and growth was solely driven by tablets according to researchfrom IDC IDC's data for 2012 show that laptop sales declined 16.4% from 2011 to 2012, falling to around427,000, in contrast to a 20.2% increase in tablet sales to around 226,000 In the laptop market Lenovo leapt

to top spot with a market share of 21.2%, overtaking HP and Dell In second position was Asus with 16%market share, up from 12.2% in 2011, also overtaking HP and Dell which both had 15.2% market share in

2012 Based on these figures BMI estimates Lenovo and Asus achieved 8.8% and 9.7% growth in laptop

unit sales respectively, standing in stark contrast to the 25.6% and 40.3% respective declines in laptop unit

Chinese giant Lenovo has built its strong position in the Israeli market following its purchase of IBM's PC

unit in 2005, and in 2012 the company continued to increase its investment into the country In 2012,Lenovo claimed that it had top spot in the commercial laptop market in the country, and that it was thesecond largest PC vendor overall Acquisitions and strategic investments are part of Lenovo's strategy toconsolidate its position in the Israeli market, and in February 2012 the vendor announced that it would

invest in Vertex Venture Capital's new venture capital fund The investment is aimed at helping Lenovo to

build a solid R&D base in the country, with priority areas including enterprise IT, infrastructure and

greentech, and digital media technology and applications

Lenovo is far from the only multinational PC vendor to be increasing its R&D investment in Israel In 2012Apple opened a research centre in Haifa and in December 2013 it opened its third Israeli research centre inRa'anana In September 2014 Lenovo's Senior Vice President met with hundreds of Israeli start-ups andsuggested that the company was considering establishing an R&D centre in the country

Software

BMI forecasts Israeli software spending to increase to ILS5.87bn in 2014, up 6.2% y-o-y We expect

growth in the software segment to accelerate, with a CAGR forecast of around 3.8% over the five years to

2018 In the past few years, there has been a pick-up in demand for systems and upgrades in public andprivate sectors, with investments by government organisations such as the Israeli Ministry of Defense andIsraeli Police, and from utilities leader Israel Electric Company Much of this growth is related to increasinguse of cloud services and related rising demand for security services

In 2013, leading software vendors in the Israeli market reported steady, single-figure growth, much in line

with our forecast Leading Israeli software and services group Formula Systems announced that its

revenues were up by 7% y-o-y in 2013 However group company Matrix, which derives most of its

revenues from the Israeli market, experienced a decline in its revenues and profits in 2013, due largely toseasonal factors With seasonal factors no longer an issue, Matrix reported improved performance in thefirst two quarters of 2014 (See Matrix Company Profile for further details.)

Opportunities for software vendors in Israel exist across a range of sectors; from government to energy,financial services, telecoms and utilities Major customers for software solutions in Israel include large andmedium enterprises such as commercial banks, loan and mortgage banks, credit card companies, insurancecompanies, telecoms service providers, hi-tech companies, and the Israeli Defense Forces, government

ministries and public agencies Large organisations investing in SAP-based systems included the Meitav Regional Water and Sewage Corporation and Israel Direct Insurance (IDI).