Israel information technology report q3 2013

... 14 Israel Information Technology Report Q3 2013 2013 Outlook Despite a slight improvement in the rate of real GDP growth from 2012 to 2013, BMI forecasts a slowdown in spending growth in 2013. .. annually over the 2013/ 17 period © Business Monitor International Page 25 Israel Information Technology Report Q3 2013 Table: Israel Economic Activity 2009 2010 2011 2012e 2013f Nominal GDP,... recent acquisitions of Israeli NAND flash technology manufacturer Anobit for a reported US$390mn © Business Monitor International Page 35 Israel Information Technology Report Q3 2013 In 2011, US PC

Q3 2013 www.businessmonitor.com

ISRAEL

INFORMATION TECHNOLOGY REPORT

INCLUDES 5-YEAR FORECASTS TO 2017

Report Q3 2013

INCLUDES 5-YEAR FORECASTS TO 2017

Part of BMI’s Industry Report & Forecasts Series

Published by: Business Monitor International

Copy deadline: May 2013

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BMI Industry View 7

SWOT 9

IT SWOT 9

Political 11

Economic 12

Business Environment 13

Industry Forecast 14

IT Market 14

Table: Israel IT Industry - Historical Data And Forecasts (ILSmn) 14

Internet 19

Table: Table: Internet Data And Forecasts, 2010-2017 19

Macroeconomic Forecasts 21

Macroeconomic Forecast 21

Private Consumption Outlook 22

Fixed Investment Outlook 22

Government Spending Outlook 23

Net Exports 24

Medium-Term Outlook 25

Table: Israel Economic Activity 26

Industry Risk Reward Ratings 27

Table: Middle East And Africa Risk/Reward Ratings, Q313 29

Market Overview 31

Hardware 31

Software 36

Services 40

Industry Trends And Developments 44

Regulatory Development 48

Table: IT Regulatory Authorities 48

Table: Government Initiatives 50

Company Profile 51

Ness 51

Matrix 56

Regional Overview 60

Demographic Forecast 64

Table: Israel's Population By Age Group, 1990-2020 ('000) 65

Table: Israel's Population By Age Group, 1990-2020 (% of total) 66

Table: Israel's Key Population Ratios, 1990-2020 67

Table: Israel's Rural/Urban Population Split, 1990-2020 67

Methodology 68

Methodology 68

IT Industry 68

IT Ratings - Methodology 69

Table: IT Business Environment Indicators 70

Weighting 71

Table: Weighting Of Components 71

Sources 71

BMI Industry View

BMI View: IT spending is expected to reach ILS23.18bn in 2013, with relatively stronger growth in

software and services, compared to hardware as the market matures Although hardware sales are in

relative decline, the release of Microsoft Windows 8 in October 2012, and associated innovation from

vendors that has deepened the tablet market and seen hybrids appear on the market, offers scope for growth Nonetheless the market will increasingly be driven by software and services in key sectors such as government, defence and financial services - resulting in IT services accounting for 36.4% of the overall market spending by 2017

Headline Expenditure Projections

Computer Hardware Sales: ILS9.83bn in 2012 to ILS9.81bn in 2013, down 0.2% in local currency terms.

The slowdown is primarily the result of macroeconomic factors, but Israeli businesses are investing more tofacilitate expansion and development and sales growth should strengthen from 2014

Software Sales: ILS5.14bn in 2012 to ILS5.25bn in 2013, an increase of 2.1% y-o-y Device and data

proliferation will drive spending on customer relationship management (CRM), databases and businessintelligence

IT Services Sales: We expect IT services sales will outperform the rest of the IT market, increasing from

ILS7.95bn in 2012 to ILS8.12bn in 2013 Stable sectors such as government and defence offer continuedrevenue opportunities, while growth will be derived from cyber and data security, cloud computing andoutsourcing

Key Trends & Developments

■ The IT market in Israel continues to be held back by the wider economic environment, underpinning ourview of weak IT market sales growth in 2013 Despite a domestic slowdown and global economicheadwinds, a significant number of opportunities remain The launch of Windows 8 operating system and

an expected increase in tablet sales will offset some of the economic slowdown in the retail hardwaremarket, as will the development of multi-use hybrid notebooks by Windows vendors in 2013 and 2014

■ The IT services market will also fare better than either software or hardware, with sales driven by cloudcomputing, outsourcing and security As a wider range of cloud computing products are released, andincreased competition between vendors lowers prices, uptake will increase among enterprises andgovernment Particular areas of opportunity for cloud computing include banking and retailing asorganisations in those fields looking to save money on hardware investments Businesses will not onlyseek to make cost savings, but will look to boost efficiency and increase flexibility of response tocustomer needs

■ BMI also highlights the potential for cyber and data security companies in Israel IT security firms are

expected to benefit from rising awareness of threats globally, but Israel should be an outperformingmarket due to the prevalence of high-tech firms and the risks of political tensions spilling over into cyberattacks In 2012 Israel was subject to several cyber attacks that have catalysed government to announce

the creation of the 'digital Iron Dome' and the National Cyber Bureau Local companies such as Check Point and Imperva are well positioned in the local market, but there is also scope for international

vendors to enter the market

IT SWOT

SWOT Analysis

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

linguistically skilled workforce, and relatively low labour costs compared with mostdeveloped countries

■ Strong defence and government spending provides base for IT demand

■ Relatively mature IT market, with services accounting for an estimated 34.7% ofspending in 2012 Despite this, the market for basic IT hardware and software is farfrom saturated

■ Strong political support, with the government having implemented many policies toaid in the development, success and 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 created a client mentality of focusing on

the bottom line, with enhanced services and customer market power adding topressure on pricing and margins

■ Digital divide, with just 3% of bottom-income group having home internet access

Opportunities ■ Cyber security is a growing concern for government and enterprises, with potential for

sales growth in data security as well

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

■ Despite the financial crisis, the financial services sector, which accounts for around15% of spending, will have to spend on compliance with Basel II and other

international standards, driving growth

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

SWOT Analysis - Continued

■ Outsourcing, Software-as-a-Service (SaaS) and applications management likely togrow fastest out of IT services, with particular opportunities in financial sector

■ Opportunities for partnership/investment in Israel's lively local IT company sector

■ Healthcare IT will be a growing source of opportunity

Threats ■ Economic downturn and unemployment will lead to weaker consumer and business

sentiment

■ 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

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

■ The fallout between Turkey and Israel, caused by the Gaza flotilla incident of May

2010, has meant that Israel has lost a key Middle East ally

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

exercises over a larger geographic area

Threats ■ 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 have added to uncertainty Despite the ongoing truce between Jerusalem andGaza city, finding a lasting solution continues to pose a dilemma for Israel

■ The construction of the West Bank barrier and the continued home-building in someWest Bank settlements antagonises the Palestinians and stands in the way of thepeace process

■ Iranian President Mahmoud Ahmadinejad's refusal to give up his country's nuclearprogramme raises concerns that an open military conflict between Israel and theIslamic republic could erupt in 2013

SWOT Analysis

Strengths ■ The policy framework has stabilised in recent years, and recent 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 ■ The main downside risk to the economy is the security situation A sharp deterioration

can have an immediate impact on domestic confidence, tourism receipts, theexchange 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, high levels of employment will underpin private consumption growth

■ Israel produces more technology start-up companies than any other country in theworld except the US

■ The discovery of large offshore gas deposit will bring an influx in foreign investmentand is expected to serve the country's energy needs for decades

Threats ■ Israel's energy supplies are not stable at the moment - the Egypt-Israel gas pipeline

has been targeted frequently in 2011, forcing the country to buy more expensive fuelsfrom alternative sources That said, risks will abate as production in the recentlydiscovered Tamar gas field is expected to begin in 2013

■ Competition from emerging Chinese and Indian producers of high-tech goods andpolished diamonds, as well as sluggish growth in the eurozone, could underminedemand 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 ■ Corporate tax rates, at 25%, have not increased markedly despite social protests in

2011

■ The Qualified Industrial Zone agreements with Jordan and Egypt boost the potentialfor trade

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

and could regain strength in 2013

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

- PC 6,844 7,208 8,058 8,119 8,325 8,649 9,226 9,647

o/w Software 4,225 4,541 5,144 5,254 5,516 5,870 6,416 6,606 o/w Services 6,529 7,018 7,950 8,120 8,525 9,072 9,916 10,471

IT Market, % of GDP 2.3 2.3 2.5 2.4 2.4 2.3 2.3 2.2

e/f = estimate/forecast Source: BMI

We have made a minor adjustment to our forecast in the Q313 update on the basis of the macroeconomicenvironment, but our assessment of the underlying trends in the market is unchanged We continue to holdthe view that the Israeli IT market will experience only limited growth over the medium term and decline as

a percentage of GDP This is a product of uncertainty in the domestic and global economy, saturation of thehardware and software/services market and price competition between vendors, which will hold down theoverall value of the market

We believe the IT market reached a value of ILS22.9bn in 2012, equal to around US$5.9bn Our lowerexpectations of growth in 2012 and 2013 have caused the decrease in our forecasts, although the latter yearssee little change to overall growth expectations Israel remains a robust IT market with plenty of

development across industrial, government, defence and financial services spending

Our five-year CAGR sees growth around 4.5% in Israeli new shekel terms for the period from 2013-2017

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, defence and government will remainkey in the market's sustained importance to the overall economy, with security an important source ofgrowth The nature of sales will change however as business becomes increasingly important and thehardware segment contributes comparatively less to the market's overall growth

2013 Outlook

Despite a slight improvement in the rate of real GDP growth from 2012 to 2013, BMI forecasts a slowdown

in spending growth in 2013 to 1.1% The downward revision to the Israeli market forecast is in part due tothe risk of a further escalation of hostilities between Israel and Gaza Meanwhile, the Israeli economycontinues to cool and sluggish external demand and weaker consumer spending are likely to weigh onheadline growth throughout the year The government is set to rein in spending, while leading indicator datapaint a relatively negative picture for private consumption and fixed investment

Although we expect the overall growth rate for the Israeli market to slow in 2013 there will nonetheless be

opportunities for vendors One such opportunity is in the provision of cyber and information

security products and services This is a growth area in IT markets globally, but there is a particularly largeopportunity in Israel where regional political tensions and the uptick in cyber attacks in 2012, affectingIsrael, UAE and Saudi Arabia, have concentrated the minds of government and enterprise decision makers

on investments to protect their IT systems

Other areas we expect to see growth include business intelligence and cloud computing, with the latterlikely to gain traction among SMEs as a lower cost alternative to bespoke systems Meanwhile sales ofhardware 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 ITprojects, with large tenders from the Israeli Ministry of Defense and the Israel Electric Company Followingthe global financial crisis, vendors reported demand had revived in the key financial services vertical, withnew projects including an US$11mn IT outsourcing tender by the First International Bank of Israel

Healthcare, the public sector and utilities were also generating new projects or significant contract

extensions

Migrations to Microsoft's Windows 8 operating system could trigger a new cycle of hardware upgrades in

2013, although much will depend on business and consumer confidence A substantial share of Israelicomputer users are estimated to still be using the Windows XP operating system Windows 8 could also fuelthe Ultrabook market as tablet makers leverage its capabilities to offer devices with touch screens andconvertible designs

Market Drivers

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

BMI's five-year forecast period to 2017 Although household computer penetration of around 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 ILS2,965 in 2013 to ILS3,459 by 2017 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 willhowever keep pace, for instance defence and financial services, which are somewhat insulated from

economic vicissitudes Vendors will target projects across a range of sectors from government to financialservices, telecoms and utilities Regulatory compliance will continue to necessitate IT spending by banksand the financial services sector, which accounts for about 15% of Israeli IT spending

Another 50% of IT spending is accounted for by government and military projects, which will have arelatively low sensitivity to economic downturn compared with the commercial sector Government IT anddigital-divide initiatives are important sources of opportunity for vendors, with recent projects ranging fromgovernment e-services portals to healthcare The government remains determined to preserve the country'sstatus as a high-tech powerhouse and drive development of the knowledge economy

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

BMI expects IT services will display the highest

growth over the forecast period to 2017, due to

growth in key verticals and the opportunities

presented by cloud computing, big data analytics and

real-time enterprise services based on the internet of

things In addition, growing enthusiasm for

outsourcing is putting Israel on the map, with some

recent large tenders such as HP's contract for

outsourced management of the Israeli navy's IT

infrastructure The economic slowdown may

reinforce this trend

Israel is also emerging as a location for some

business process outsourcing (BPO) functions

helped by government incentives However, much

depends on there being a sustained improvement in the economy, as well as the overall political

environment

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 retailing, as organisations in thosefields look to save money on hardware

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

The Israeli economy remains vulnerable to global economic headwinds, with an escalation of risk

particularly around events in the eurozone Despite these storm clouds BMI believes IT spending has

Industry Trends - IT Market

2010-2017

e/f = BMI estimate/forecast Source: BMI

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 and price competitionbetween vendors limit increases in the total value of the market The hardware market is forecast to growfrom ILS9.81bn in 2013 to ILS11.65bn in 2017, with PC sales projected to rise from an estimated

ILS8.11bn to ILS9.65bn While growth will remain strong, the market will be increasingly dominated by ITservice sales and software sales, indicating the maturity of the market

No of internet users/100 inhabitants 67.2 67.6 70.2 72.3 74.2 75.5 76.3 77.7

No of broadband internet subscribers, '000 1,762 1,800 1,860 1,917 1,971 2,023 2,071 2,119

No of broadband internet subscribers/100 inhabitants 23.8 23.8 24.2 24.5 24.8 25.1 25.3 25.9

e/f = BMI estimate/forecast Source: BMI

As with our fixed-line and mobile telephony

forecasts, we have revised and extended our forecast

for the development of Israel's internet user and

broadband subscriber markets Our new set of

forecast figures runs to the end of 2017 There were

approximately 5.115mn users as of 2011, giving

Israel a penetration rate of 67.6% We expect steady,

but slowing, growth in the number of internet users

to continue for the duration of our forecast, resulting

in 6.356mn internet users in 2017, equivalent to a

penetration rate of 77.7%

Meanwhile, owing to a lack of reliable data on the

number of mobile broadband subscribers

(specifically those 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

telco Bezeq suggests that the number of fixed broadband subscribers had increased to around 1.800mn at the end of 2011, up by 2.2% y-o-y BMI believes that, by the end of 2012, Israel's broadband subscriber

base will have risen to 1.860mn; this is equivalent to a penetration rate of 24.2% and reflects full yeargrowth of 3.3%

Industry Trends - Internet Sector

2010-2017

e/f = forecast Source: BMI

Over the next five years ending 2017 we envisage average annual growth of 3.9% for the Israeli broadbandsector This will see the subscriber base reach 2.112mn subscribers, equivalent to a penetration rate of25.9% We expect the growing popularity of mobile broadband services to result in slowing demand growth

in the fixed broadband sector Nevertheless, we identify several developments which will sustain fixedbroadband growth for the duration of our forecast and beyond These include Bezeq's ongoing deployment

of its fibre-to-the-cabinet (FTTC), a development which is helping to drive capacity for its residential andcorporate customers' broadband access Meanwhile, recent months have seen considerable reductions in theprice of broadband tariffs being offered by the major operators Another development likely to stimulategrowth is the introduction of LLU, which will give alternative operators access to Bezeq's network and willstimulate much greater competition

Macroeconomic Forecasts

Macroeconomic Forecast

BMI View: We project real GDP growth in Israel to come in at 3.5% and 3.9% in 2013 and 2014,

respectively, compared to our estimate of 2.8% growth in 2012 Growth will be driven primarily by fixed

investment as well as declining imports, while private consumption patterns will slow

We forecast real GDP in Israel expanding by 3.5% and 3.9% in 2012 and 2013, respectively, compared toour estimate of 2.8% growth in 2012 Fixed investment will remain the major driver of economic growth,while the commencement of natural gas production in the recently discovered Tamar field will reduce thecountry's import bill However, the domestic economy will remain in a soft patch, with private and

government consumption growth slowing significantly

Fixed Investment Growth Slowing

Israel - Components Of Real GDP, % chg y-o-y

Source: BMI, Central Bureau of Statistics Israel

Private Consumption Outlook

Private consumption growth averaged only 2.5% over the first three quarters of 2012, having declinedsteadily since Q111, and we see the downtrend continuing over the coming quarters Indeed, leadingindicators continue to paint a relatively negative picture Israel's Bank Hapoalim consumer confidence indexdeclined in January to 123.5 points, from 126.7 in December, and, with the economy remaining in a softpatch and the government set to implement austerity policies this year, consumer confidence will continue

to decline (see our online service, February 14, 'Chart Of Day: Consumer Confidence To Fall Further').

We also believe that the unemployment rate, which came in at 6.7% in December 2012, will remain

relatively elevated as a result of slow growth in the economy We forecast private consumption increasing2.5% and 3.0% in 2013 and 2014, respectively

Still Elevated

Israel - Unemployment Rate, %

Source: BMI, Central Bureau of Statistics

Fixed Investment Outlook

Although gross fixed capital formation (GFCF) growth slowed steadily in 2012, the component increasedfaster than any other in the economy last year While we do not expect GFCF growth to return to levels seen

in 2011, this component of GDP will contribute more strongly to growth than any other in 2013, with base

effects also contributing to an acceleration Indeed, BMI sees Israel as the country with the most attractive

business environment in the Middle East and North Africa region, with a score of 64.9 out of 100, meaning

that foreign direct investment should remain elevated Moreover, BMI's Infrastructure research team sees

significant prospects in the energy sector, as the discovery of the Leviathan and Tamar gas fields, whichcomprise some of the Mediterranean's largest gas finds, has attracted interest from oil majors such as

Russian outfit Gazprom We forecast real growth in the energy and utilities infrastructure industry

increasing 7.0% in 2013, from 2.9% in 2012 Finally, we project real growth in the residential industryincreasing 6.1% this year, from 2.7% last year, with the government set to undertake significant investment

in the housing sector For instance, the Israel Land Administration said at end-2012 that around 35,000homes are to be developed on land formerly leased to the Defence Forces, while the government approved

in February the construction of 500 new homes in the West Bank We forecast fixed investment increasing8.5% and 6.0% in 2013 and 2014, respectively

Attracting Investors

MENA - BMI Business Environment Rating, Selected Economies, max= 100.

Source: BMI

Government Spending Outlook

Government consumption growth averaged 3.5% over the first three quarters of 2012 Given our view thatthe administration will cut total expenditure, albeit moderately, in 2013, government spending will be

slightly lower this year That said, the centrist party Yesh Atid, which is likely to become a key member inthe next government, campaigned on a platform focused on investing in education, housing, health, policeand welfare As a result, investment in such areas is unlikely to decline at a rapid clip We forecast

government consumption increasing 2.5% in 2013 and 1.5% in 2014

Net Exports

We see Israel's net exports in negative territory to the tune of 1.1% and 0.3% of GDP in 2013 and 2014,respectively, from a deficit of 1.9% in 2012 Total export growth averaged only 0.2% over the first threequarters of 2012, compared to 6.8% over the same period in 2011 The decline was mainly triggered byslow growth in the US economy and in the eurozone - which together account for approximately 60% ofIsraeli exports We see growth in the EU flatlining in real terms in 2013, from a projected contraction of0.7% in 2012, while real GDP in the US will expand 2.3% in 2013 from 2.2% in 2012 While an

improvement, it will mean Israeli exports increase only modestly Israel's exports will increase only

moderately Moreover, nearly 70% of the Tamar field's production will be reserved for domestic

consumption, and we do not expect LNG exports from the field to begin before end-2013 As such, weforecast total exports increasing 1.2% and 2.5% in 2013 and 2014, respectively

Imports have been declining steadily over the past quarters The downtrend was mainly triggered byslowing expansion in private consumption and exports, and, as we see growth in those components unlikely

to pick up significantly, imports will continue to grow at a modest pace Moreover, with the Tamar fieldexpected to begin commercial production in H213, energy imports will decline significantly Indeed, thecountry has been importing LNG to overcome gaps in its natural gas supply, particularly since exports fromEgypt were cancelled following the Egyptian revolution The majority of LNG imports have been supplied

by British Petroleum, and the contract with the oil major will end in May 2013, at which time the Israeli

government anticipates replacing supplies with reserves from the Tamar field (see, 'LNG Imports To Provide Security And Flexibility' July 26 2012, and 'Gazprom Moves Tamar Closer To LNG Exports, February 28) We forecast total imports increasing 2.0% in both 2013 and 2014, from 3.3% in 2012.

Optimistic Medium-Term

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

Source: BMI, Central Bureau of Statistics Israel

Table: Israel Economic Activity

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

Nominal GDP, ILSbn 3 770.7 818.1 869.9 911.4 963.2 1023.1 1094.9 1183.4 1277.8 Nominal GDP, US$bn 3 196.2 219.2 243.1 236.5 267.5 289 311.1 338.1 365.1 Real GDP growth, % change y-o-y 3 0.8 4.5 4.8 2.8 3.5 3.9 4.2 4.4 4 GDP per capita, US$ 3 27,021 29,544 32,151 30,734 34,218 36,399 38,588 41,318 43,957

Industrial production index, % y-o-y, ave 1,3 -5.9 8.1 7 7.2 8.8 6.4 7 5.8 6 Unemployment, % of labour force, eop 2,3 7.2 6.6 5.4 6.7 6.6 6.2 6 6 5.8

Notes: e BMI estimates f BMI forecasts 1 Seasonally adjusted; 2 Seasonally adjusted, methodology was adjusted in

2012 Sources: 3 Central Bureau of Statistics/BMI; 4 World Bank/UN/BMI.

Industry Risk Reward Ratings

We have added three new countries to our Africa coverage and to our Middle East and Africa Risk/RewardRatings for the first time With smaller markets than most in the Middle East, newcomers Ghana, Kenyaand Nigeria enter the ratings in the bottom half of the table However, each offers good potential for growthand is already setting up to be a regional hub for IT development While Kenya starts at the bottom of ourtable, it has one of the strongest scores for industry risks, suggesting it has the potential to move up ourratings Turkey has been removed from the MEA regional ratings and is now being compared with

developments in European markets

The addition of three new African markets has had little impact on the overall table Changes to the scores

of Qatar and South Africa, however, saw both markets jump several places Qatar moved to the top of ourratings in Q313 as a strong increase in its industry rewards rating allowed it to leapfrog its closest peers.Meanwhile, South Africa's position has improved from ninth to fifth this quarter

With IT market development so closely linked to the performance of a country's economy, the fact thatwealthy countries top our ratings is unsurprising The more developed business environment and consumerpicture combine to drive up demand for IT products and services These more mature markets see the ITservices segment gradually increasing to become the largest share of overall IT spending Hardware

spending remains strong as customers are used to buying the latest devices but consume an increasingnumber of services

Qatar's improved position is predominantly the result of its continued improved outlook for total marketgrowth An expected 21% increase in IT services in local currency terms is based on the demand for cloudcomputing and smart systems Qatar, as well as fourth-ranked Kuwait stand out for their top countryrewards scores, with low rural populations and high GDP per capita While both markets are small, thesefactors underpin their strong ranking among countries in the Middle East and Africa

Although Israel and the UAE both saw improvements to their scores, on the back of better industry rewardsscores, these were not as strong as Qatar's Economic headwinds play into our forecasts for the market butthere are still indications of strong growth in new hardware such as tablets providing a lift to the marketwhile faster growth will be seen in new areas such as cyber and data security Consumers in the UAEmarket, on the other hand, are driving growth in hardware through looking for premium devices, such ashybrid laptops and ultrabooks More connected devices will help drive the demand for cloud services, which

BMI believes is underdeveloped in the UAE's market.

Fourth-ranked Kuwait held its place although scores did increase The country is held back by weakerindustry rewards and risks scores, which prevent it from emulating Qatar, with which it shares a number ofcharacteristics Kuwait attracts major vendors looking to cater to the high end of the market with premiumdevices, but its 3mn population restricts the reach of its market Although there has been considerablegovernment investment in IT services, the country is not as large a business hub as some of its counterparts

in the region, limiting the scope of expansion

With two of the largest populations in the MEA ratings, South Africa and Saudi Arabia stand out SouthAfrica's improved position in the list is the result of a strong increase in its industry rewards rating In localcurrency, the market's growth prospects are very strong, making it an attractive market for investors Inaddition, South Africa is setting itself up as a regional hub for IT development Much like the three newmarkets added to our ratings this quarter, South Africa is attracting plenty of interest from major IT vendorsbut benefits from a more established IT market and an existing strong presence in Sub-Saharan Africa

Oman and Bahrain's smaller markets offer more limited potential for growth with smaller populations andeconomies While there are still growth opportunities and growing interest in new technologies such ascloud computing, the smaller market size prevents these markets from moving up our ratings

Of our three new markets, Nigeria ranks highest reflecting a strong industry rewards rating owing to itslarger market size Nigeria has the largest population in Sub-Saharan Africa as well as a larger economy andGDP per capita than either Ghana or Kenya These factors have helped bring Nigeria into ninth place in ourMEA ratings Despite having a potentially larger market than some of the markets in the Middle East,Nigeria's IT market growth is restricted by a number of factors There is a sizeable portion of the populationliving in rural areas, the majority of which will have limited demand for IT products and services, at least inthe short term Our industry risks scores highlight a strong government backing for IT development, but arelimited by a low score for IP protection with the counterfeit software segment still quite high

This latter score has a negative impact on the remaining four markets in our ratings This higher level ofcounterfeiting is off-putting to many investors and can limit the level of input from international players.Lebanon holds the weakest score in the region for industry risks, reflecting high levels of counterfeiting and

no discernible ICT policy from the government The new African markets in contrast have stronger ratingsfor industry risks based on a strong government focus on developing their markets in the IT industry

Egypt, previously the lowest ranked market, remains near the bottom of the table, falling one place, withGhana entering above and Kenya taking last place Although Egypt has a potentially larger market thanGhana, its weaker country rewards and risks scores hold it back Political turmoil has certainly improved

since the height of the country's revolution, but BMI believes the country will 'muddle through' 2013 with

the country facing the possibility of a protracted democratic transition that could limit the potential of itseconomic growth, and, in turn, the IT market's outlook

Ghana's higher placing is a reflection of greater political stability and strong economic growth forecast,which combine with a good business environment outlook that should continue to attract investors Like itsWest African neighbour Nigeria, the country is well placed to be a regional hub for IT services A smallereconomy and population affect the ability of Ghana to move up our ratings, but a local focus on e-

government services bodes well for continued market developments

Kenya looks set to be East Africa's main IT hub with the government's National ICT plan part of thecountry's Vision 2030 plan, integrating IT into the country's continued development While Kenya is wellplaced to be the regional hub, its local market has some structural challenges A largely rural population andlow per capita spending suggest IT products and services will struggle to reach outside the country's maincities, at least in the short-to-medium term We believe the market will be the largest in East Africa and willattract international investment This will drive growth in the longer term, giving Kenya the potential tomove up our ratings

Table: Middle East And Africa Risk/Reward Ratings, Q313

-Middle East And Africa Risk/Reward Ratings, Q313 - Continued

Rewards Risks Average 50.6 64.6 48.8 56.4 54.9

Scores out of 100, with 100 highest The IT Risk/Reward Rating comprises two sub-ratings 'Rewards' and 'Risks' Scores are weighted as follows: 'Rewards': 70%, of which Industry Rewards 65% and Country Rewards 35%; 'Risks': 30%, of which Industry Risks 40% and Country Risks 60% The 'Rewards' rating evaluates the size and growth potential of an IT market in any given state, and country's broader economic/socio-demographic characteristics that impact the industry's development; the 'Risks' rating evaluates industry specific dangers and those emanating from the state's political/

economic profile, based on BMI's proprietary Country Risk Ratings that could affect the realisation of anticipated returns Source: BMI

Market Overview

Hardware

Israel's IT hardware market is forecast to decline by 0.2% in 2013 to ILS9.81bn However the medium-termgrowth outlook is stronger with CAGR of 3.5% over our forecast period 2013- 2017 In 2013 the value ofhardware sales will be squeezed by a weaker currency, price competition and the lower unit price of mid-range tablets hitting the market While there are factors limiting the increase in the total value of sales, there

will be a boost from the release of Microsoft's Window 8 operating system, launched in October 2012,

which set off greater competition and innovation in tablets, notebooks and hybrids

As well as economic and IT market trends, another

factor behind our pessimistic outlook for 2013 is the

risk of a further escalation of hostilities between

Israel and Gaza This uncertainty will drag on

confidence and curtail investments in some areas

Wider economic uncertainty means businesses are

now investing more to increase flexibility and realise

cost efficiencies rather than expand IT hardware

capabilities, but nonetheless there should be growth

areas However, as noted, lower average prices have

meant that revenue growth in most segments has

lagged shipments

BMI forecasts real GDP growth of 3.5% in Israel in

2013, a slight improvement from 3.1% real growth

in 2012 However, the more relevant figures for the

hardware market are the slower rate of real private

final consumption growth, at 2.5% in 2013 compared to 3.2% in 212, and the slowdown on real governmentspending from 4% in 2012 to 2.5% in 2013 The government's policies are less supportive of privateconsumption in 2013 The 1% rise in VAT that was part of the government's package of austerity laws,approved by parliament in August 2012, will have an impact on discretionary spending on items such asPCs and notebooks 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

Hardware Demand

2010-2017

e/f = BMI estimate/forecast Source: BMI

Despite the weak consumer outlook in Israel there are several factors which present an optimistic mediumterm outlook for continued hardware sales Current PC penetration, while high for the region, showspotential for organic growth Household penetration is estimated at around 75%, meaning there is somepotential for sales to first-time buyers However these new sales will be concentrated in lower incomesegments, which will mean low margins for vendors in this sub-segment.

Digital divide issues mean Israel currently has 600,000 children living below the poverty line, only 3% ofwhom have internet or home PC access, compared with 90% in the top-income group The Israeli

government has launched various initiatives to increase computer and internet penetration, includingComputer 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 industryinsiders as too low

Upgrades to new systems and purchases of personal computing devices will however remain the bulk ofmarket sales Mobile computing devices including tablets, slimline notebooks, ultrabooks and hybridspresent a growth opportunity for vendors as consumers buy personal products to complement the householddesktop or laptop This segment will be held back by a weak consumer outlook in 2013, but strengthen from2014

It is significant for medium term hardware sales that telecoms networking infrastructure in Israel continues

to receive investment This generates use cases for IT hardware, including desktops and mobile computingdevices and helps to increase demand

Meanwhile, the release of Windows 8 is expected to result in higher sales in the retail and enterprisemarkets In the retail market Windows 8 will deepen the tablet market, as well as introducing hybrids, while

in the enterprise market the new OS should trigger computer hardware tenders previously delayed because

of the economic situation In 2012, retailers claimed that many businesses and consumers were waiting for

the October 2012 release of Microsoft's new operating system before investing in an upgrade The launch

of Windows 8 in Israel coincided with the launch of the Surface tablet and a new suite of mobile handsetsusing Windows Mobile Microsoft CEO, Steve Ballmer, began an international promotional tour for thenew operating system in Israel in November 2012 An upgrade to Windows 8 was available to Israeliconsumers for US$40 to download or ILS280 installed in store

Evolving Form Factors

The Israeli IT market is relatively mature, but hardware still accounted for 42.9% of the total market in

2012 (excluding communications hardware) Prior to 2012, Notebooks were the fastest-growing segment ofthe market, although as recently as 2008 desktops still took around two-thirds of unit sales However in2010-2011 the share of desktops declined precipitously, and then in 2012 there was a shift from notebooks

to tablets as the fastest growing segment of the market

This trend of preference for mobility is expected to continue over the 2013-2017 forecast period Despite itsdeclining share of sales, however, the desktop sector is still significant, largely due to business and

government end-users One device category we believe to be on the way to becoming obsolete is thenetbook, which had been a driver of PC market growth in 2010, but have plateaued in the face of

competition from tablets and smartphones In particular, smartphones from Samsung, RIM, Apple and

other vendors are being offered as alternative connectivity solutions and often include a Wi-Fi option Thecompetition from tablets and smartphones is also driving innovation in notebook design, as slim-line andhybrid devices are increasingly the centre-piece of Windows vendors product ranges

The tablet market in Israel has been dominated by

Apple However, its relative position did weaken in

2012 and it faces much stronger competition in

2013 Data from Statcounter show Apple's iOS, run

on its tablets, accounted for 2.1% of Israeli PC

browsing traffic in March 2013 - a figure that was up

by 1.2pps y-o-y Meanwhile, Google's Android OS,

which is used on Samsung, Asus and Google's own

Nexus range accounted for less than 1% of PC

browsing traffic in March 2013 This recent data

reinforces Apple's dominance However, with the

widening range of Android devices - including the

Kindle Fire from Amazon, the Nexus 7 and 10 and

Samsung's Galaxy Tab range - competition will

continue to intensify

A key feature of the threat posed to Apple by Android vendors came only after the release of lower costtablets and were predominantly the smaller 7" form factor This contrasted with Apple's larger and moreexpensive iPad - and the popularity of these smaller, cheaper devices, catalysed the development of Apple's

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

March 2013

Source: Statcounter

own iPad Mini Apple is set to face competition throughout 2013 from rival Android vendors that will 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

The tablet market in Israel remains relatively undeveloped, with low penetration, and heavily dominated byWindows machines As such a significant development that will affect both the tablet market and thenotebook market is the arrival of Windows 8 In October 2012, with the launch of the new OS, Windowsvendors were able to introduce touch devices - with a number of tablets released in Q412 and Q113 Theaddition of more vendors and another touch OS will add to competition in the market - putting furtherpressure on prices

However the more significant development is the medium term impact on innovation and form factors.Windows has a traditional strength in productivity use cases and software, with the OS being central to theenterprise market and Microsoft's Office Suite ubiquitous There is therefore an opportunity for vendors toleverage this strength over rival iOS and Android devices by designing tablets with strong productivityfunctionality alongside 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-usedevice has scope to capture a share of the tablet market by offering a stronger value proposition to

consumers while not compromising on user experience

Another device category that should receive a boost from the launch of Windows 8 is the ultrabook Theyare higher-performance notebooks designed as a response to Apple's increasingly popular MacBooks, andare an emerging product category that Intel and certain vendors backed heavily Due to initially high prices,these devices failed to enjoy the hoped-for success, at least initially Vendors appear to have realised thisand are moving ahead with plans to supply low-end ultrabooks

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 growth in themobile PC segment, and in fact notebook sales declined and growth was solely driven by tablets according

to research from IDC IDC's data for 2012 show that laptop sales declined 16.4% from 2011 to 2012, falling

to 426,526, in contrast to a 20.2% increase in tablet sales to 225,767 In the laptop market Lenovo leaped totop 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 that Lenovo and Asus achieved 8.8% and 9.7% growth in

laptop unit sales respectively, in stark contrast to the 25.6% and 40.3% respective declines in laptop unitsales for HP and Dell

Meanwhile, the tablet market continues to be dominated by Apple, according to IDC data for 2012 Appletook a 49.8% share of tablet sales, more than double the share of second placed Samsung which had 20.1%share However, as impressive as this dominance is Apple's share of the tablet market declined 6.4pps y-o-yand units sold only increased 6.6% in 2012, versus 20.2% increase for the market as a whole The othervendors chasing Apple include Samsung and Asus, which we calculate from IDC data to have achieved27.9% and 138.5% unit growth in 2012 Asus is believed to have benefited from the manufacture of

Google's Nexus 7 alongside its own products

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

PC unit back in 2005 and in 2012 the company continued to increase its investment in Israel 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 early

2012, it was reported that iPad and Mac producer Apple was looking to open a research centre in Haifa The

new facility is located at the Matam technology district, which also houses facilities of Intel, Microsoft and Philips among others, and was due to become operational by March 2012 Apple's new investment

followed on the vendor's recent acquisitions of Israeli NAND flash technology manufacturer Anobit for a

reported US$390mn

In 2011, US PC leader Dell inaugurated a new Israeli R&D centre, which is part of the company's

Enterprise Storage Business The new centre is based on Exanet, which Dell acquired in 2010 The centre will focus on developing storage technologies and cloud computing solutions Meanwhile, Acer's inventory

problems resulted in the vendor losing ground in the regional market

Despite the uncertain global economic outlook for Israel's export-based economy, opportunities for softwarevendors continue to exist across a range of sectors from government to energy, financial services, telecoms

and utilities Large organisations investing in SAP-based systems included the Meitav Regional Water and Sewage Corporation and Israel Direct Insurance (IDI) Local IT leader Ness was among those

vendors reporting a rebound in Israeli market revenue growth, with the company's annualised revenuegrowth increasing in each quarter

Meanwhile, the SME segment, the mainstay of the Israeli business sector, has emerged in recent years as animportant growth area for enterprise systems Spending on enterprise solutions should continue to growsteadily, with reviving or emerging areas of opportunity including security, CRM solutions and businessintelligence However, in the current economic climate, vendors will continue to pitch the efficiency gainspotentially offered by these applications