Israel information technology report q2 2009

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Including 5-year industry forecasts

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Israel Information Technology

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Technology Report Q2 2009

Including 5-year industry forecasts by BMI

Part of BMI's Industry Report & Forecasts Series

Published by: Business Monitor International

Publication date: April 2009

CONTENTS

Executive Summary 5

SWOT Analysis 8

Israeli IT Sector SWOT 8

Israel Telecommunications Sector SWOT 9

Israel Political SWOT 10

Israel Economics SWOT 11

Israel Business Environment SWOT 11

Middle East Regional IT Markets Overview 12

Market Growth And Drivers 13

Sectors And Verticals 15

IT Business Environment Ratings 17

Regional IT Business Environment Ratings 19

Market Overview 20

Government Authority 20

History and Market Structure 20

Hardware 22

Software 22

Services 23

Industry Developments 25

Industry Forecast 28

Table: Israeli IT Industry (US$mn, unless otherwise stated) – Historical Data & Forecasts 29

Internet Forecast 30

Table: Internet Data & Forecasts 30

Macroeconomic Forecast 32

Outlook Darkening As Consumer Takes Fright 32

Table: Israel – Economic Activity 34

Country Context 35

Table: Consumer Expenditure, 2000-2012 (US$) 35

Table: Rural/Urban Breakdown, 2005-2030 35

Competitive Landscape 36

Internet Competitive Landscape 38

Company Profiles 39

Ness 39

IBM 41

HP 42

Matrix 44

Microsoft 45

Country Snapshot: Israel Demographic Data 47

Section 1: Population 47

Table: Demographic Indicators, 2005-2030 47

Section 2: Education and Healthcare 48

Table: Education, 2002-2005 48

Table: Vital Statistics, 2005-2030 48

Section 3: Labour Market and Spending Power 49

Table: Employment Indicators, 2001-2006 49

Table: Average Annual Wages, 2000-2012 49

BMI Forecast Modelling 50

How We Generate Our Industry Forecasts 50

IT Industry 50

IT Ratings – Methodology 51

Table: IT Business Environment Indicators 53

Weighting 54

Table: Weighting Of Components 54

Sources 54

Executive Summary

Market Overview

Despite an anticipated slowdown in 2009, the Israeli IT market should have enough momentum from key

sectors to continue to expand over BMI’s 2008-2013 forecast period BMI estimates that the local IT

market reached an estimated value of US$4.83bn in 2008 The market is forecast to grow at a CAGR of 6% over the forecast period, to reach a projected US$6.5bn in 2013

IT spending still grew in H108 with stronger-than-expected demand from both enterprise and household

sectors However, following a deterioration in H208, BMI believes that growth will ease further in 2009

thanks to the economic slowdown Rising unemployment, and job insecurity for those in work, will have

a negative impact on consumer sentiment, while many companies facing tight credit conditions will likely cut back on IT budgets

The Israel IT market has a number of positive fundamentals, which should keep it in positive territory Low computer penetration, of around 30%, offers potential for continued growth High internet

penetration and growing broadband penetration are drivers for the retail segment, along with interest in multimedia and mobile computing applications, and the new popularity of netbooks

Industry Developments

Israel’s high-tech merger activity fell in 2008, as a result of the downturn in the global economy

According to figures from Israel’s Venture Capital Research Centre (JVC), the value of Israel high-tech mergers were down 19% year-on-year (y-o-y) to US$2.64bn The average deal size was also down, to around US$31mn The whole year passed without a single high-tech IPO, a first since 2003

IT is viewed as an important policy tool for the Israeli government’s 2008-2010 socio-economic policy framework The National Economic Council recently submitted a policy agenda to the government, which specified two main policy tracks of reducing poverty and achieving balanced growth The first track is expected to emerge as the main priority

As part of its modernisation agenda, the government is pressing ahead with various other strands of its government project Among other initiatives, there has also been spending on computers in healthcare and the nationwide paperless court initiative The e-government programme is leading to increased demand

e-for computers, with the Israeli government reaching a supply agreement in 2007 with Dell and HP

Competitive Landscape

Israel’s leading IT services vendors reported continued growth in 2008, despite the economic crisis Ness

Israel reported revenues, with18.7% top-line growth, year-on-year, to a record US$664.8mn Ness’s

defence and homeland security business performed particularly well Meanwhile, Matrix also chalked up

a number of successes in 2008, including winning a ILS20mn project to implement a CRM system at

long-time customer Bezeq, and a number of public-sector CRM projects

In 2008, SAP reached an agreement with Ness to purchase the latter’s SAP sales and distribution division

in Israel The move paralleled the acquisition by SAP, at the end of 2007, of partner SAP Arabia’s

software licences and customer maintenance products SAP implementations are a major IT services category in Israel, and SAP aims to be closer to its customers and partners

As a result of the economic slowdown, HP announced in March 2009 that it was shutting down several

wide digital printer production lines at its HP Indigo plant in Kiryat Gat However, IBM Global Services

announced in 2008 that it was establishing a new systems and technology group lab in Israel Meanwhile, computer vendor Dell reportedly accepted an invitation to establish a new R&D and business centre in Jerusalem

Computer Sales

Computer sales in Israel including servers and accessories were valued at an estimated US$1.85bn in

2008, up from US$1.68bn in 2007 The market is forecast to grow at a CAGR of 6% over the 2008-2013 forecast period to reach close to US$2.5bn in 2013 Despite the economic slowdown, PC sales continued

to grow in H108 with stronger-than-expected spending in both enterprise and household sectors The PC market is expected to slow in 2009 as a result of declining consumer and business sentiment, but one area

of growth will be lower-priced netbooks which are establishing a position in the market

Software

Israel software spending was estimated at US$309mn in 2008, up from US$255mn in 2007 The

packaged software segment is expected to grow at a CAGR of around 7% over the forecast period Spending on software is shifting towards the small- and medium-sized enterprise (SME) segment, which forms the mainstay of the Israeli business sector Spending on enterprise solutions has grown since 2007, with reviving or emerging areas of opportunity including security, CRM solutions and business

intelligence In terms of verticals, the financial sector has been a mainstay of demand, with other key areas including defence and healthcare

IT Services

The IT Services sector had an estimated value of US$1.54bn in 2008, and this is expected to grow at a CAGR of 8.6% over the forecast period to reach US$2.34bn in 2013 The number of new projects is expected to be reduced in 2009 thanks to the anticipated economic slowdown Government and Defence are two key sectors likely to be a continued source of opportunities, because the factors driving spending

in each case are not particularly sensitive to economic downturn Israel seemingly possesses many

advantages as an outsourcing destination – in particular a technologically literate, linguistically skilled

workforce, and low labour costs relative to most developed countries Despite failing to capitalise in the past, the country is starting to emerge as a desirable location for packaged applications and localisation services

E-Readiness

At the end of 2008, Israel had an estimated 4.5mn internet users, representing a penetration rate of 61.9%

of the population Broadband penetration was estimated at 22.6%, or 1.6mn accounts The government has announced that it intends to make a big effort to narrow the digital gaps that manifest themselves across various demographic lines

SWOT Analysis

Israeli IT Sector SWOT

Strengths ƒ One of the most modern economies in the region, with a highly educated,

linguistically skilled workforce, and relatively low labour costs (compared with most developed countries)

ƒ Strong defence and government spending provides base of IT demand

ƒ Relatively mature IT market, with services accounting for an estimated 32% of spending in 2008 Despite this, the market for basic IT hardware and software is far from saturated

ƒ Strong political support, with government having implemented a number of policies to aid in the development, success and expansion of the IT sector

Weaknesses ƒ The recession at the beginning of the decade created a client mentality of

focusing on the bottom line, with enhanced services customer market power adding to pressure on pricing and margins

ƒ Digital divide, with 3% of bottom income group having home internet access

Opportunities ƒ Despite financial crisis, the financial services sector, which accounts for around

15% of spending, will have to spend on compliance with Basel II and other international standards, driving growth

ƒ Defence and government projects should be relatively less sensitive to the economic downturn

ƒ Outsourcing, Software as a Service (SaaS) and applications management likely

to grow fastest out of IT services, with particular opportunities in financial sector

ƒ Opportunities for partnership/investment in Israel’s lively local IT company sector

Threats ƒ Economic downturn and unemployment will lead to weaker consumer and

business sentiment

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

ƒ Aggressive pricing may continue to constrain growth and put pressure on margins

Israel Telecommunications Sector SWOT

Strengths ƒ Well-developed internet/broadband sector compared with regional peers

ƒ Liberal mobile market, consisting of four operators

ƒ Mature market, with strong take-up of value-added and 3G services

Weaknesses ƒ Mobile penetration rate of over 120% means that growth in the mobile

market has slowed considerably and operators must look for alternative revenue sources

ƒ Lack of competition in all telecom sectors

ƒ Regulator has been slow to license new services, such as Worldwide Interoperability for Microwave Access (WiMAX) wireless broadband

ƒ Voice over Internet Protocol (VoIP) licensing and triple-play for Bezeq placed on hold, which could hinder prospects

Opportunities ƒ Emergence of rival operator HOT Telecom, made up of main three cable

operators – Golden Channels, Matav and Tevel – to compete against Bezeq could provide cheaper services

ƒ Introduction of number portability and the entry of mobile virtual network operators (MVNOs) to the mobile sector could shake up competition and drive down retail prices for consumers

Threats ƒ Continued interconnection tariff reduction could have a devastating effect

Israel Political SWOT

Strengths ƒ Despite corruption allegations against some officials and members of

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

ƒ Elections are for the most part free and transparent, ensuring that a broad spectrum of political views are represented within government

Weaknesses ƒ The protracted conflict with the Palestinians means there are persistent

security risks, although violence in the West bank has been reduced significantly Strategies to minimise or end the conflict are domestically divisive

ƒ Frequent change to the composition of the coalition government often leads

to policies becoming fragmented or significantly diluted

Opportunities ƒ The Annapolis conference in November 2007 laid the foundations for an

eventual peace agreement with the Palestinians, and improved relations with traditionally hostile Arab states, particularly Saudi Arabia

Threats ƒ The victory of Hamas in the 2006 Palestinian elections, its subsequent

takeover of the Gaza Strip, and Israel's military incursion into the territory in December 2008/January 2009 has added to uncertainty Finding a lasting solution poses a dilemma for Israel, which has previously said it will not talk

to the militant organisation

ƒ The construction of the West Bank barrier and the continued home-building

in some West Bank settlements antagonises the Palestinians and stands in the way of the peace process

ƒ Iranian president Mahmoud Ahmadinejad has intensified his anti-Israel rhetoric, adding to Israeli concerns about a possible Iranian nuclear weapons programme

Israel Economics SWOT

Strengths ƒ The policy framework has stabilised in recent years with fiscal deficits

brought well under control (although the deficit is set to expand again in 2009)

ƒ The workforce is highly educated and skilled

ƒ The country's close ties with the US provide it with substantial financial assistance for economic and military ends

Weaknesses ƒ The main downside risk to the economy is the security situation A sharp

deterioration can have an immediate impact on domestic confidence, tourism receipts, the exchange rate and foreign investment

ƒ The economy is highly exposed to that of the US, in terms of exports, investment and remittances

Opportunities ƒ In the long-term, rising levels of employment will underpin private

consumption growth

ƒ FDI stocks amounted to 37% of GDP in 2007, according to UNCTAD, and this should continue to propel growth for some years to come

Threats ƒ As a net fuel importer, Israel is vulnerable to large price fluctuations; the

surge in oil prices in 2008 contributed to rising inflation

ƒ Competition from emerging Chinese and Indian producers of high-tech goods and polished diamonds, as well as sluggish growth in eurozone, could undermine demand for Israeli exports

Israel Business Environment SWOT

Strengths ƒ The business environment is supported by the sound infrastructure and

communication networks, as well as transparent legislation

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

Weaknesses ƒ Historic political instability and, more recently, suicide bomb attacks,

increase the risk premium of investment in Israel

ƒ Some limits on repatriation of capital exist and there are constraints on foreign investment in the high-tech sector

Opportunities ƒ Ongoing cuts will bring the top level of corporate tax down from 29% in

2007 to 25% by 2010

ƒ The Qualified Industrial Zone agreements with Jordan and Egypt boost the potential for trade

Threats ƒ Strike action has proved extremely disruptive to the business environment

over the past two years With economic conditions deteriorating, more strikes are likely to take place in 2009

Middle East Regional IT Markets Overview

BMI projects continued improvement in

regional ICT indicators over the next few

years, driven by investment in broadband

and government ICT initiatives The

Middle East divides into two groups in

terms of information society

development In the first group are richer

and more technologically advanced

countries, such as Israel and the UAE,

where internet penetration is relatively

high and many households have access to

broadband services In the more

emerging markets such as Egypt, on the

other hand, computers remain a luxury

for many

The number of internet users is expected

to grow significantly across the region

Qatar is projected to advance the most in

percentage terms, with penetration rising

from about 50% in 2008 to 78% by 2013

Egypt will have nearly 23mn subscribers

in that same year, up from 11mn in early

2009 The UAE is one of the most

advanced states in the region in this

respect, with internet penetration seen as

reaching 78% within the forecast period

By contrast, Saudi Arabia is forecast to

achieve a 7% rise in subscribers, but at

this rate would still reach only 30%

Similar contrasts are apparent in relation to broadband penetration, which currently ranges from 0.8% in Egypt to 22.6% in Israel Again, Qatar is forecast to achieve the most dramatic advance, with broadband penetration in the small state exceeding 30% by 2013 Government initiatives are afoot in most places, ranging from wireless broadband in Dubai to plans to deploy optical fibre extensively in countries such as

Internet Penetration

(per 100 population)

0102030405060708090

Egypt Israel Kuwait Qatar Saudi UAE

Egypt Israel Kuwait Qatar Saudi UAE

2007e 2012f

e/f = estimate/forecast Source: BMI

Kuwait Broadband penetration is seen as being at about 25% or above in the UAE, Saudi Arabia and Israel by the end of the forecast period, but at only around 3% in Egypt and Kuwait

Internet and broadband penetration growth will receive boosts from continued efforts to liberalise

regional telecoms markets In 2008 the Qatari government announced that eight operators had submitted bids for new fixed-line licences Egypt also continued liberalisation of its telecoms market last year, and similar moves have been seen in the Kingdom of Saudi Arabia Broadband penetration has become a driver of PC ownership in some segments, due to the growing variety of multimedia and communication services available There is plenty of room for PC growth, given the current low levels of

computerisation, which are estimated at less than 50% in every country in the region

Governments in the region are allocating significant budgets for e-government development The UAE launched several new projects in 2008, including an ID card initiative that will be a key element

underpinning future information society development Meanwhile, in June 2008 Saudi Arabia’s

governing Shoura Council approved a draft national strategy for the IT industry that aimed to raise the contribution of the industry to GDP to 20% by 2020 Israel has announced that it intends to make a big effort to narrow the digital divide, and there has also been spending on computers in healthcare and a nationwide paperless court initiative

Market Growth And Drivers

Despite the global economic slowdown,

the Middle East appears better placed

than most other regions to withstand the

current global economic headwinds In

GCC states, the precipitous fall in oil

prices in H208 had a negative effect on

spending in previously fast-growing IT

spending verticals such as oil and gas,

construction and real estate Companies,

hit by slowdowns in key export markets

and credit tightening, were looking to cut

costs

IT Market Sizes (US$mn)

2007e

0 1,000 2,000 3,000 4,000 5,000 6,000 Egypt

Israel Kuw ait Qatar Saudi UAE

e = estimate Source: BMI

However, the region has a number of

positive factors to help it avoid

stagnation There is increasing economic

diversification and strong spending from

non-oil sectors such as government,

financial and enterprise sectors By 2012

this should be more evident, with IT’s

share of GDP rising in these countries

Other drivers include fairly resilient

consumer demand and ongoing

infrastructure projects in major verticals

such as oil and gas, telecoms and power

As a result, IT market growth is expected

to remain in positive territory in most places in 2009 Youthful population demographics, retail sector development and rising PC penetration will drive growth Growing regional competition and

opportunities, with the development of the Arab Free Trade Zone will encourage spending

Several sectors will offer opportunities

despite the economic headwinds

Telecoms liberalisation and a big push

towards broadband penetration are

expected to drive demand Banks are

implementing solutions to increase

business flexibility and introduce new

services, including Islamic banking In

Israel, spending in two of the largest IT

verticals, defence and government,

should be relatively immune to the

economic situation Another key area for

IT spending in many countries will be

healthcare, with several major projects

launched

The highest growth MEA IT market over the forecast period is expected to be Egypt, with compound growth of 65% for 2008-2013 There is room for considerable growth in the country in the next few years, given the current low level of computerisation, which is much higher in the business sector than in the population at large Other high growth markets are expected to include Kuwait (64%) and Qatar

2007

e/f = estimate/forecast Source: BMI

IT Markets Compound Growth, (%)

2008e-2013f

0 20 40 60 80 Egypt

Israel Kuw ait Qatar Saudi UAE

e/f = estimate/forecast Source: BMI

Sectors And Verticals

Hardware will continued to dominate regional IT spending as the number of personal computer users rises

steadily over the forecast period This will be driven by growing affordability, government initiatives and

the popularity of notebooks and netbooks Notebook shipments grew about 50% in the Gulf last year,

with the notebooks the main product category driving retail segment growth, as consumer sales feel the

benefits of aggressive channel promotions

The economic slowdown and credit tightening may have an impact on hardware spending in the

enterprise sector, as companies look to cut costs However, PC prices are continuing to fall, and this –

along with more credit availability – is bringing computers within the reach of many more people

Meanwhile, the advance of ‘big box’ retailing, with larger outlets offering lower prices and more choice,

will also stimulate sales

Government programmes in Egypt and Saudi Arabia have made low-price computers available in easy

instalment payment schemes Strong demand for notebooks is another key factor driving growth, although

desktops remain important for small and medium-sized enterprises (SMEs) and other groups Government

investment in education and e-services will mean desktop purchases for schools, colleges and government

offices

Spending on software as a share of total IT spending is as low as 14% in Egypt and below 20% in a

majority of MEA markets Despite the difficult economic environment, which will encourage companies

to focus on the bottom line, Demand from the oil and gas segment was hit in H208, but BMI predicts

plenty of room for growth over the forecast period as numerous untapped sectors still exist Key verticals

will include telecoms, finance, retail, healthcare and the public sector

Market Structure (% of Total IT Market)

0 10 20 30 40 50 60 70

Egypt Israel Kuw ait Qatar Saudi UAE Hardw are

Softw are (Russia = softw are + services) Services

SMEs are likely to lead spending growth, with manufacturing and trading firms seeking efficiencies by making the transition from manual environments to full automation of back-office systems Customer relationship management (CRM) will be a growth area, as fewer than 2% of SMEs in the Middle East region having a specialised CRM application in place Other high-growth categories are set to include business intelligence, storage and security products Security software is a growing opportunity, with the UAE currently the largest market

There are some challenges for the regional software market One key issue is that of illegal software: across the region up to 80% of software is counterfeit Another important factor is of course low income, and the high costs of operating systems such as Windows, which has led to activity to promote open

source in countries such as Egypt, championed by IBM and other vendors

BMI predicts that IT Services will remain in positive territory during the 2008-2013 period However,

the economic situation is likely to have an effect in some key verticals, particularly real estate and oil and gas In H208 there were reports of IT managers in various sectors looking to cut costs, although in some cases the emphasis was more on scaling back projects rather than cancellation In the government sector, budgets have often already been commissioned, and so the effects are more likely to be felt in the second half of 2009 and in 2010

Currently, IT Services’ share of IT spending ranges from around 24% to 32% in the MEA countries

covered by BMI Support and maintenance account for around one-third of spending on IT Services, but ,

demand for more complex services has increased, with large outsourcing deals in the UAE, Israel and elsewhere There is also demand for services such as hosting, facilities management and disaster

recovery Even in less mature markets such as Egypt, larger customers are becoming more demanding in terms of their IT expectations

IT Business Environment Ratings

BMI’s Middle East and Africa (MEA) IT Business Environment Ratings compare the potential of the key

regional markets over our forecast period, through to 2013 The ratings reflect our consideration of political and economic risks, as well as risks associated specifically with IT intellectual property (IP) rights protection and government projects Q209 once again includes Turkey in the MEA ratings, in addition to Europe, reflecting its strategic importance for vendors in both regions

In our updated Q209 rankings, the wealthy, high-tech Gulf Co-operation Council (GCC) markets continue

to occupy the higher positions, with factors such as comparatively resilient consumer demand, and

ongoing infrastructure projects, meaning that this region is better placed than most to withstand that global economic slowdown The top four countries remain the same, with only a small change in the order For the second quarter running, the UAE has the top spot, while Kuwait reclaims second place, swapping positions with Qatar, which moves down in third Still in fourth place is Israel, where spending

in government and defence verticals and growing PC and broadband penetration should be enough to prevent stagnation, despite an expected further easing in 2009

Saudi Arabia, Bahrain, Turkey and Oman occupy the next four places and – like Qatar and Saudi Arabia – are expected to remain in positive territory A key factor will be continued opportunities in sectors such

as government, education and telecommunications, even as spending declines in other sectors more affected by the economic headwinds such as construction and real estate PC sales slowed in Turkey in the middle of 2008, as the global credit crunch hit consumer spending, but the fundamentals of low computer penetration and rising incomes should keep the market on an upwards path South Africa’s relatively lowly ninth spot reflects business environment risks, rather than the potential of the country’s

IT market, which will receive stimulus from infrastructure initiatives Bringing up the field, Egypt’s high growth potential is constrained by income and business environment considerations, while Lebanon is still recovering from the events of 2006

A key variable for IT spending in this region is economic diversification Some economies in the Middle East, such as Kuwait’s, remain highly dependent on oil In the UAE, however, some 80% of GDP is accounted for by the non-oil sector, and in Qatar around 38% In many countries, liberalisation in

telecommunications and financial services are factors driving demand for IT products and services The share of the non-oil sector in IT spending is expected to fall slightly in the UAE but to rise in Saudi Arabia, which accounts for 40% of regional IT spending However, there will continue to be significant spending on new technology-driven solutions in the hydrocarbons sector

Another factor that will keep IT spending growing despite the economic downturn, is the waves of government initiatives being implemented in states like Kuwait, the UAE and South Africa, among

e-others First-placed UAE has continued to roll out e-services in 2008, following the recently announced UAE Strategic Plan, which called for a strengthening of e-government programmes The UAE’s federal government is attempting to emulate the best practices of the local governments In Saudi Arabia, too, substantial budgets have been allocated for e-government infrastructure development

Government accounts for up to 40% of the IT market in some states, which is a ratings risk given frequent bureaucratic inertia and resistance to reform Over time, this risk should be reduced by economic

diversification as technology-using sectors such as financial services, communications and real estate invest in new solutions Qatar is a good example, with the government recently outlining new ICT

investment plans and the foundation of a new technology park

Saudi Arabia, Bahrain and Oman rank slightly behind their equally fast growing GCC peers on grounds

of general business environment, but the IT market metrics remain attractive Saudi Arabia will continue

to be a lucrative market for technology products and services, with the country’s youthful population

supporting a continued rapid rise in internet, PC and notebooks penetration BMI also takes a positive

view of market performance in Bahrain over the 2008-2013 forecast period, in line with our GDP and oil price projections A particularly important factor is Bahrain’s growing status as a financial hub Oman, although like Bahrain one of the smaller markets in the region, should also benefit from an emphasis on diversification, which is encouraging infrastructure projects in sectors ranging from tourism to ports

Of the non-GCC countries, Israel – in fourth place – should maintain its IT market momentum despite exposure to adverse global economic conditions Nearly 50% of IT spending is accounted for by

government and military projects, which are less likely to be affected by a short-term slowdown Israel’s

IT market is also benefiting from record-breaking foreign investment, as well as growing demand for major IT outsourcing solutions Investments by financial sector organisations are on the rise

South Africa is one of the Middle East and Africa’s most significant IT markets in terms of size and growth potential However, the country loses points for country structure and market risk, where we took account of factors such as high unemployment and an uncertain environment surrounding government tenders The energy crisis and weakening external demand may precipitate a more cautious spending approach by some organisations, but the market will be supported by factors such as the 2010 Football World Cup, government digital divide projects and sectors such as telecoms

Lebanon has strong intrinsic advantages, including a cosmopolitan and multi-lingual labour force, and a strategic position for the Levant markets However, fulfilment of the market’s undoubted potential will depend on a functioning government being able to take the steps necessary to enable this Meanwhile, Egypt is expected to be one of the fastest growing IT markets in the region over the next few years, but has a number of constraints, including low disposable incomes and economic disparities The country has the potential to rise up the regional rankings over time as computer penetration rises

Regional IT Business Environment Ratings

Limits of Potential Returns Risks to realisation of returns

Country Structure Limits

Market Risks

Country Risk Risks

IT BE Rating

Regional Ranking

Country Risk which have a 40% and 60% weighting respectively and are based on a subjective evaluation of industry regulatory and IP regulations (Market) and the industry's broader Country Risk exposure (Country), which is based on BMI's proprietary Country Risk Ratings The ratings structure is aligned across the 14 Industries for which BMI

provides Business Environment Ratings methodology, and is designed to enable clients to consider each rating

individually or as a composite, which the choice depending on their exposure to the industry in each particular state For a list of the data/indicators used, please consult the appendix at the back of the report

Market Overview

Government Authority

The Ministry of Science, Culture and Sport was established in 1982 as the Ministry of Science and Development; it has undergone numerous name changes, receiving its current name in 2006 The

responsibilities of the ministry are the formation of a national policy towards science and technology, technological analysis and organisation, and the co-ordination of research areas

The main priorities for the Ministry of Science, Culture and Sport are as follows:

ƒ Setting up a national policy and priorities for research and development (R&D);

ƒ Development of scientific and technological infrastructure;

ƒ Establishment and strengthening of foreign scientific relations;

ƒ Participation in the establishment of research centres, including regional R&D centres;

ƒ Participation in the development of scientific and technological human resources;

ƒ Increasing awareness of science within the public, especially the youth of Israel;

ƒ Developing digital infrastructure (facilitating access to information); and

ƒ Consulting the government and its offices in the area of science and technology

History and Market Structure

All the major vendors have a direct presence in Israel, employing substantial numbers of staff For

example, IBM has its only IBM Global Services (IGS) regional subsidiary in Petach Tikva, and employs around 2,000 staff at its Haifa Labs and various IBM facilities in Rehovot and Jerusalem HP has as many

as 4,000 employees and has long offered services and support through its subsidiary HP-OMS Other vendors such as Oracle and EDS also have a sizeable presence

FDI first started to play a key role in Israel's economy in the mid-1990s, as the country's high-tech sector underwent a rapid expansion Together with the opening up of the financial and telecom sectors, the high-tech sector succeeded in attracting large FDI flows The government’s policy made foreign high-tech companies eligible for government grants covering 38% of the cost of new R&D facilities Indeed, today, Israel has more offshore R&D centres of US high-tech companies than any other country

Local companies also have a significant presence in the Israeli IT market, with seven of the top 10 IT

services firms being Israeli Major players include Matrix, Ness Technologies and Malam Group, with

Israel typically accounting for between 40% and 50% of their revenues

Table: Government Initiatives

Gov@Net – Government intranet

ƒ A cross-government intranet planned to connect over 80 governmental networks and hundreds of institutes The implementation will create the largest Israeli IP-VPN The project will allow efficient internal communication and resource sharing

Mercava – Government ERP

ƒ Mercava is the largest-ever IT project implemented in Israel It will gradually replace the assortment of unique legacy systems currently operating in governmental bodies with a central, unified ERP system, running on SAP software

ƒ This project will create a unified language for cross-government activities

Government EIP

ƒ This project is intended to promote enterprise portals within the government Since a cross-government portal will be based on information received from the different bodies, the first step involves the construction of a ministry-level

portal This portal will draw information from ‘Merkava’ (see Industry Developments), from ministry-specific

operational systems, and from intra-government shared resources

Tehila – Government ISP

ƒ The GISP project has been operational since 1998, providing essential infrastructure for public-government

communication

ƒ To date, 60% of the governmental bodies have voluntarily joined the project

Shoham – e-commerce infrastructure and service

ƒ A central e-commerce service allowing citizens and companies to access a uniform interface to carry out a variety of payments and purchases, which includes the payment of taxes, fees, fines (VAT, vehicle and driving licence fees and traffic fines) and the purchase of tangible goods (government publications) The service processed over

ILS250mn in its first year

Lehava project

ƒ Group of initiatives to help close digital divide

Hardware

Computer sales in Israel including servers and accessories were valued at an estimated US$1.85bn in

2008, up from US$1.68bn in 2007 The market is expected to grow at a CAGR of 6% over the 2008-2013 forecast period to reach close to US$2.5bn in 2013 Despite the economic slowdown, PC sales continued

to grow in H108 with stronger-than-expected spending in both enterprise and household sectors

However, BMI believes that growth will be slower in 2009 with an economic slowdown and

unemployment hitting consumer demand for high-tech goods

Retail spending has been buoyant in the past two years, with drivers including the strong shekel, higher broadband penetration, and demand for multimedia applications Despite strong growth in demand for notebooks, the desktop sector is still unsaturated and accounted for as much as 75% of PC sales in 2007, largely to business and government end-users Going forward, the PC market is expected to slow, through

a combination of reduced consumer and business confidence

These factors were apparent in H208, but because of the upwards trend in the first half of the year, total

PC sales were still up overall in 2008, at around 439,000 One area of growth will be lower-priced computers, or netbooks, which are establishing a position in the market The current low rate of PC penetration represents potential for organic growth PC penetration was only 26.4% in 2005, while digital divide issues mean that Israel currently has 600,000 children living below the poverty line, only 3% of whom have internet or home PC access, compared with 90% in the top income group

mini-The Israeli government is taking various measures aimed at increasing computer and internet penetration – Computer for Every Child, Window to Tomorrow’s World, Tapuah (The Israeli Society for the

Advancement of the Information Age) and others The level of support, however, has been criticised by some industry insiders as too low

The Israeli IT market is relatively mature, but hardware still accounts for around half of the total market (excluding communications hardware) Notebooks are the fastest growing segment of the market, but desktops still dominate with around two-thirds of unit sales Government and defence tenders are a significant constituent of demand Government IT project investments started to rise in 2007, with IT budgets being restored after many years of cuts

Software

Israel software spending was estimated at US$309mn in 2008, up from US$255mn in 2007 The

packaged software segment is expected to grow at a CAGR of around 7% over the forecast period In recent years the SME segment, mainstay of the Israeli business sector, has emerged as an important growth area Spending on enterprise solutions has grown since 2007, with reviving or emerging areas of

opportunity including security, CRM solutions and business intelligence In the current economic climate, vendors will look to pitch the efficiency gains potentially offered by these applications

A recent survey of IT managers suggested that current areas of high demand include management of

Microsoft systems and servers, as well as systems management, basic data management, firewalls, ERP

implementation and CRM CRM is a particularly buoyant area, with local IT company Matrix reporting a number of public- and private-sector successes in 2008, while customers for Microsoft’s Dynamics CRM

platform include Israeli health maintenance organisation (HMO) Maccabi Healthcare Services

The security software segment is also an important opportunity, projected to be worth tens of millions of dollars in 2009 Israel has become more aware about the growing threat and sophistication of cyber attacks, and has been encouraging government and private-sector organisations to take action Spending is likely across all sectors, with security content and threat management the current priorities

In terms of verticals, the financial sector has been a mainstay of demand, with other key areas including defence and healthcare These three sectors are likely to be somewhat immunised against the

consequences of the global slowdown Despite the current financial crisis, regulatory compliance and demand for new services, requirements will continue to drive IT spending by banks Similarly, defence spending on new systems is likely to be maintained given the current security situation

Software comprises an important part of Israel’s industrial production and exports, with software exports

of around US$3bn being comparable to about two-thirds of the entire value of the domestic IT sector Almost all global vendors are active in the domestic market, selling licences, along with integration and

applications services Global vendors control more than three-quarters of the market, with SAP in first

place In the past, the Israeli SME segment was dominated by local software companies Now,

international players, including market leaders like SAP and Oracle, are entering with appropriate

software packages Microsoft is also designing a software package for this market segment

Services

The IT Services sector had an estimated value of US$1.54bn in 2008, and this is expected to grow at a CAGR of 8.6% over the forecast period to reach US$2.34bn in 2013 The relatively robust economy and increased investment by a number of key sectors have driven recent growth, although the number of new projects is expected to be reduced in 2009 owing to the economic slowdown

Spending has been particularly strong in the financial sector, where international regulatory compliance and structural and market reforms have driven substantial IT investment The sector accounts for around 25% of total IT services spending, while the government accounts for another quarter Along with

defence, these two key sectors are likely to be a continued source of opportunities because the factors driving spending in each case are not particularly sensitive to economic downturn

In H208 there were reports of IT managers scaling back projects by 10%-20% but in the near-term

budgets have often already been commissioned, and so the effects are more likely to be felt in the second half of 2009 and in 2010 Much will depend on the speed of global economic recovery, particularly in key Israel export markets

While large organisations still dominate, SMEs have also been investing more Many SMEs are waking

up to the need to compete through more direct investment in support and service infrastructures Similar factors are driving an increase in demand for managed services, with businesses reluctant to invest in internal IT capabilities, or deterred from doing so by a lack of available skills

Outsourcing has become a bigger factor and is estimated to account for up to 20% of IT services

spending, or about US$300mn in 2008 Some key sectors include:

ƒ The military, with outsourcing deals such as that awarded to HP by the Israeli Navy for management of its IT infrastructure highlighting the opportunities there While the value of the

HP deal was not made public, it is estimated to be worth several million shekels

ƒ The financial sector is another lead vertical for outsourcing In 2006, an outsourcing deal

between First International Bank of Israel and EDS Israel was the largest outsourcing contract

in the Israeli banking industry and a milestone at the time Indian consultancy giant Tata’s

recent decision to open a local branch also underlines the potential attraction of the financial sector, now benefiting from economic recovery and greater security

ƒ The retail sector offers further opportunities, with IBM Israel having a 10 year outsourcing

contract with Clubmarket Marketing Chains, with the contract including computer systems for

the supermarket chain’s branches and point-of-sale terminals

Although Israel seemingly possesses many advantages as an outsourcing destination – in particular a technologically literate, linguistically skilled workforce, and low labour costs relative to most developed countries – the country has failed to capitalise on these strengths in the past Aside from Israel’s small size, another issue is security However, the government is now actively promoting Israel to

multinationals, and there has been a spate of call-centre construction The work seems to be paying off, with Israel starting to emerge as a desirable location for packaged applications and localisation services

Industry Developments

IT is an important element of the Israeli government’s socio-economic policy framework for 2008-2010 The National Economic Council recently submitted a policy agenda to the Government, which specified two main policy tracks of reducing poverty and achieving balanced growth The first track is expected to emerge as the main priority for the government The digital divide is both a symptom and an aggravator

of relative poverty

Economy Impact on Israel Tech Sector

Israel’s high-tech merger activity fell in 2008, as a result of the downturn in the global economy

According to figures from Israel’s Venture Capital Research Centre (JVC), the value of Israel high-tech mergers were down 19% y-o-y to US$2.64bn The average deal size was also down, to around US$31mn

An even more striking development was that the whole year passed without a single high-tech IPO, a first

since 2003

However, the number of Israel tech companies involved in mergers was just one down on the 2007 figure,

at 84 companies, indicating that the supply of promising companies has not dried up Indeed current low valuations represent an opportunity for investors, although JVC forecasts that Israel high-tech companies will raise only US$300mn this year, down 62% from last year

Israel’s Digital Divide

It has been estimated that Israel currently has around 600,000 children living below the poverty line The gini coefficient has been estimated as among the highest of any OECD country A 2007 survey found that only 30% of children living in poverty have internet or home PC access, compared with 90% in the top income group Alarm at such statistics has helped to make tackling the digital divide central to the

government’s key policy goal of reducing poverty There is also an ethnic dimension to digital

inequalities Recent research by the University of Haifa showed a consistent gap in internet access

between Jews and Arabs, with 72.5% of Jews in Israeli using the internet, compared with 52.5% of Arabs

In order to deal with the digital divide problem, the following measures have been proposed:

ƒ A senior minister for the high-tech sector should be appointed to co-ordinate activities currently carried out by various ministries The minister should prepare a master plan for government policy in the information industry;

ƒ Regulations should be amended to facilitate rapid investments in communications, technological infrastructure, bandwidth and fast internet backbone;

ƒ Massive investment should be made in the educational system for training information workers;

ƒ Aid to be given to the less wealthy to make them part of Israel’s information industry

Leveraging IT For Growth

IT will also be harnessed to the second goal of achieving balanced, long-term growth Israel’s software sector has long been one of the country’s economic pillars and a magnet for inward investment Recently

released figures underlined that IT represents a crucial part of Israel's economy The Israeli Association

of Electronics and Software Industries (IAESI) projected that the software sector will generate

US$3.2bn annually by the end of the decade According to recent figures, electronics and software

exports had already reached US$1.87bn in 2006 The government is hoping that the high-tech sector will generate US$3.0bn for the nation’s economy by 2010

to around 61,000 in 2006, according to the government’s Central Bureau of Statistics Engineering

salaries in Israel are about half those in the US, but double those in India

beginning of 2007, about 40 government units and more than 3,000 users were estimated to have been covered

Among other initiatives, there has also been spending on computers in healthcare and the nationwide paperless court initiative The e-government programme is leading to increased demand for computers,

with the Israeli government reaching a supply agreement last year with Dell and HP The government

chose Microsoft search technology to power its government services portal, gov.il

Meanwhile, the Israeli government was progressing with its plans to roll out Smart ID-card systems intended to cover the entire population With an urgent need for the government to update technology and strengthen authentication systems, the original target was to introduce 2.5mn Smart ID cards In

December 2008 HP was awarded the contract to produce five million ID-cards, however it is yet to receive the go ahead from the Knesset who are deliberating over the passing of the biometric database bill The ID-cards – set to cost Israel US$67.49mn – would use ‘smart’ identification methods which involve fingerprints and digital photography