Israel information technology report q3 2014

... International Page 32 Israel Information Technology Report Q3 2014 of the Ministry of Finance and has many of the same goals as Digital Israel However, Carmel Avner, Israel' s first chief information officer... Page 36 Israel Information Technology Report Q3 2014 Vendor Performance Israel PC Browsing Traffic By OS (%) And Y-o-Y Change (pps) The Israeli PC market has undergone significant April 2014 changes... 43 Israel Information Technology Report Q3 2014 IT Services Market 2011-2018 15,000 15 10,000 10 5,000 0 2011 2012 2013e 2014f 2015f 2016f 2017f 2018f Israel - Services sales, ILSmn (LHS) Israel

Q3 2014 www.businessmonitor.com

ISRAEL

INFORMATION TECHNOLOGY REPORT

INCLUDES 5-YEAR FORECASTS TO 2018

Report Q3 2014

INCLUDES 5-YEAR FORECASTS TO 2018

Part of BMI’s Industry Report & Forecasts Series

Published by: Business Monitor International

Copy deadline: May 2014

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BMI Industry View 7

SWOT 9

IT SWOT 9

Wireline SWOT 11

Political 12

Economic 13

Business Environment 14

Industry Forecast 15

IT Market 15

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

Broadband 20

Internet 20

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

Macroeconomic Forecasts 22

Table: Israel - Economic Activity 27

Industry Risk Reward Ratings 28

Table: Middle East And Africa RRRs - Q3 2014 31

Market Overview 32

Hardware 32

Software 38

Services 42

Industry Trends And Developments 46

Regulatory Development 50

Table: IT Regulatory Authorities 50

Table: Government Initiatives 53

Competitive Landscape 54

International Companies 54

Table: Intel 54

Local Companies 55

Table: Amdocs 55

Table: Check Point 56

Table: Imperva 57

Table: Retalix 58

Company Profile 59

Ness 59

Matrix 64

Regional Overview 68

Table: OSN Recent Content Developments 69

Demographic Forecast 73

Demographic Outlook 73

Table: Israel's Population By Age Group, 1990-2020 ('000) 74

Table: Israel's Population By Age Group, 1990-2020 (% of total) 75

Table: Israel's Key Population Ratios, 1990-2020 76

Table: Israel's Rural/Urban Population Split, 1990-2020 76

Methodology 77

Industry Forecast Methodology 77

Sources 78

Risk/Reward Ratings Methodology 79

Table: It Risk/Reward Ratings Indicators 80

Table: Weighting Of Components 81

BMI Industry View

BMI View: Israel's IT market is the most developed in the Middle East with a rich ecosystem of major

global investors, start-ups and universities engaged in cutting edge research These features compensate for the relatively small and mature market that drags growth rates below those of many other MEA markets.

We forecast IT spending to reach ILS23.4bn in 2014, with the software and services segments

outperforming hardware sales We forecast IT spending to continue growing throughout our five-year forecast period to 2018, accelerating in the later years as GDP and private consumption growth recover from government austerity measures imposed in 2013 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 36.8% of overall market spending by 2018.

Headline Expenditure Projections

Computer Hardware Sales: ILS9.55bn in 2013, rising 2% in local currency terms to ILS9.75bn in

2014 We expect a return to growth in 2014 to be driven by the launch of 4G mobile networks and ongoingmigration to the Windows 8 OS

Software Sales: ILS5.1bn in 2013, increasing 4.5% y-o-y to ILS5.3bn in 2014 Enterprise software

spending will be the main growth driver as device and data proliferation will result in increased spending oncustomer relationship management (CRM), databases and business intelligence

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

increasing from ILS7.9bn in 2013 to ILS8.3bn in 2014 Cyber security services will outperform in terms ofgrowth, but it will be stable sectors such as government and defence that continue to account for the

majority of spending

Key Trends And Developments

■ The growing emphasis of many multinational IT vendors on software and services revenues has ledseveral of them to direct more investment in R&D at the Israeli market Israel's strong reputation as ahotbed for innovative software development has made Israeli companies popular takeover targets formultinationals In April 2014, IBM announced the launch of its Alpha Zone technology accelerator in TelAviv, which will recruit start-ups to grow technologies across several areas, including big data, cloud,mobile, security and the Internet of Things Meanwhile, in the month before US-based Palo AltoNetworks confirmed the acquisition of privately held, Tel Aviv-based cyber security firm Cyvera Thefinancial terms of the acquisition were not confirmed, but industry experts expect the total value of thetransaction was around USD200mn

■ In April 2014 Israeli economic minister Naftali Bennett stated that Intel plans to invest around USD6bn

to upgrade its Kiryat Gat chip plant At the time of writing the company had not yet officially confirmedthe investment, but the development is in line with talks between the government and Intel in January

2014 on its investment plan for the country over the coming decade According to media reports, theMinistry of Economy's Investment Center is poised to offer Intel a grant of 5% of the company'sinvestment, approximately ILS750mn

IT SWOT

SWOT

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

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

■ Strong defence and government spending provides base for IT demand

■ Strong political support, with the government having implemented many policies toaid in the 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 focussed customers on the bottom line,

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

■ Digital divide, with just 30% of bottom-income group having home internet access

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

concerns of government and enterprises escalate

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

■ Despite the financial crisis, the financial services sector, which accounts for around15% of spending, will have to spend on compliance with new Israeli SecuritiesAuthority regulations, introduced in the wake of the economic crisis

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

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

SWOT - Continued

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

Threats ■ Government austerity measures will dampen consumer and business spending

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

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

Wireline SWOT

SWOT

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

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

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

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

■ Regulator has been slow to license new services eg WiMAX wireless broadband

■ VoIP licensing and triple-play for Bezeq placed on hold could hinder prospects

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

should stimulate much greater competition

■ Regulator is proposing a 76% reduction in fixed line interconnection fees; this couldstimulate increased service usage

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

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

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

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

SWOT Analysis

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

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

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

of political views is represented within government

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

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

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

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

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

exercises over a larger geographic area

Threats ■ 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 ongoing peace talks, finding a lastingsolution continues to pose a dilemma for Israel

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

SWOT Analysis

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

will help to keep the fiscal deficit under control over the coming years

■ 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, relatively elevated levels of employment will underpin private

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

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

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

Business Environment

SWOT Analysis

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

networks, as well as transparent legislation

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

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

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

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

country

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

and could regain strength in 2014

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

Industry Forecast

IT Market

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

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

Israel IT market value, ILSmn 20435.7 22299.5 22576.0 23354.8 24607.9 26490.5 27698.4 28895.0

Israel Computer hardware sales,ILSmn 8877.3 9560.8 9550.3 9745.0 10124.7 10743.3 11233.0 11718.2 Israel Personal computer sales,ILSmn 7208.4 7839.9 7907.6 8068.9 8383.2 8895.4 9301.0 9702.7 Israel Software sales, ILSmn 4540.8 5004.4 5117.3 5346.7 5689.8 6186.3 6369.6 6541.6 Israel Services sales, ILSmn 7017.6 7734.2 7908.4 8263.1 8793.5 9560.9 10095.8 10635.2

e/f - BMI estimate/forecast Source: BMI

We continue to hold the view that the Israeli IT market will experience only limited growth over themedium term and will decline as a percentage of GDP This is a product of saturation of the hardware andsoftware/services market and price competition between vendors, which will hold down the overall value ofthe market Nevertheless, Israel remains at the forefront of development of security services and continues

to attract investment in research and development centres from global IT firms

We believe the IT market reached a value of ILS22.6bn in 2013, equal to around US$6.3bn Despite ourexpectations of relatively weak growth in 2013 and 2014, we maintain an optimistic outlook for Israel's ITmarket over the long term 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 5.1% in Israeli new shekel terms for the period from 2014-2018

We expect IT services will be the fastest growing segment of the IT market, narrowly ahead of software,with both growing fast relative to hardware In terms of key verticals, the financial services sector isimportant, boosted by compliance requirements with the new regulations introduced in the wake of theeconomic crisis in 2008-2009 Defence and government will also continue to maintain the market's

sustained importance to the overall economy, with security an important source of growth The nature ofsales will change, however, as business becomes increasingly important and the hardware segment

contributes comparatively less to the market's overall growth Given Israel's relatively rich tech skillsresource base, many organisations prefer to conduct software development in-house.

2014 Outlook

We project real GDP growth of 3.2% in Israel in

2014, then forecast slow but steady acceleration in

GDP growth throughout our forecast period,

reaching 5.1% in 2018 BMI's Country Risk team

does not expect consumer confidence to drop sharply

in 2014, but forecast relatively weak expansion of

private consumption growth at 3.2% in 2014, mainly

as a result of the implementation of austerity

measures by the government Although there is now

a reduced likelihood of an attack on Syria and Iran,

political risk in Israel is still high, as the chances of

renewed conflict with Hamas and Hizbullah remain

significant

While government austerity and political instability

has weighed on Israel's economic outlook, we believe there will nonetheless be opportunities for vendors inthe IT market One such opportunity is in the provision of cyber and information security products andservices This is a growth area in IT markets globally, but there is a particularly large opportunity in Israelwhere regional political tensions and the uptick in cyber attacks in 2012 and 2013, affecting Israel, UAEand Saudi Arabia, have concentrated the minds of government and enterprise decision makers on

investments to protect their IT systems

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

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

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

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

Industry Trends - IT Market

2011-2018

IT market value, ILSmn (LHS)

IT market value, % of GDP (RHS)

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

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

2 2.1 2.2 2.3 2.4 2.5

e/f = BMI estimate/forecast Source: BMI

Company Following the global financial crisis, vendors reported demand had revived in the key financial

services vertical, with new projects including an US$11mn IT outsourcing tender by the First InternationalBank of Israel Healthcare, the public sector and utilities were also generating new projects or significantcontract extensions

Market Drivers

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

BMI's five-year forecast period to 2018 Although household computer penetration of 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 ILS2,986 in 2014 to ILS3,496 by 2018 However, spendingwill fail to keep pace with GDP growth in Israel as the economy becomes less heavily weighted towards thehigh-tech sector following gas exploration and growth in other sectors Some key IT spending verticals 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

Income Per Capita Breakdown

(2011-2018)

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

0 25,000 50,000 75,000

National Sources/BMI

Opportunities

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

key verticals and the opportunities presented by cloud computing, big data analytics and real-time enterpriseservices based on the internet of things In addition, growing enthusiasm for outsourcing is putting Israel onthe map, with some recent large tenders such as HP's contract for outsourced management of the Israelinavy's IT infrastructure The economic slowdown may reinforce this trend

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

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

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

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 support

and service infrastructures Cloud computing is a field which could gain traction with SMEs as the demand model fits well with their smaller budgets and lack of demand for bespoke in-house solutions andsoftware.

on-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

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 ILS9.6bn in 2013 to ILS11.2bn in 2017, with PC sales projected to rise from an estimated ILS7.9bn toILS9.3bn While growth will remain strong, the market will be increasingly dominated by IT service salesand software sales, indicating the maturity of the market

Internet

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

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

Main telephone lines in service, '000 3500.0 3594.0 3665.2 3702.2 3681.8 3646.8 3642.5 3668.3

Broadband internet subscribers, '000 1800.0 1950.0 2131.4 2240.0 2318.5 2385.7 2440.6 2482.0 Broadband internet subscribers/100 Inhabitants 23.9 25.5 27.6 28.6 29.3 29.7 30.0 30.0

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

We have revised our forecast for the development of

Israel's internet user and broadband subscriber

markets based on new data from the country's

service providers We revised down our YE13

estimate for the number of internet users to 5.33mn,

giving Israel a penetration rate of 68.9% We expect

steady, but slowing, growth in the number of internet

users to continue for the duration of our forecast,

resulting in 6.295mn internet users in 2018,

equivalent to a penetration rate of 76.1%

Meanwhile, owing to a lack of reliable data on the

number of mobile broadband subscribers

(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 telecoms operator Bezeq and alternative

operators HOT and Partner Communications suggests that the number of fixed broadband subscribers had increased to around 2.131mn at the end of 2013, up by 9.3% year-on-year (y-o-y) BMI believes that,

Industry Trends - Wireline Sector

2011-2018

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

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

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

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

by the end of 2014, Israel's broadband subscriber base will have risen to 2.24mn; this is equivalent to apenetration rate of 28.6% and reflects full year growth of 5.1%.

Over the next five years ending 2018 we envisage average annual growth of around 3.1% for the Israelibroadband sector This will see the subscriber base reach 2.48mn subscribers, equivalent to a penetrationrate of 30.0% We expect the growing popularity of mobile broadband services to result in slowing demandgrowth in the fixed broadband sector Nevertheless, we identify several developments which will sustainfixed broadband growth for the duration of our forecast and beyond These include the launch of wholesalebroadband services by the ViaEuropa-led consortium building a fibre network over the Israel ElectricCompany (IEC) infrastructure and Bezeq's ongoing deployment of its fibre-to-the-cabinet (FTTC), adevelopment which is helping to drive capacity for its residential and corporate customers' broadbandaccess Meanwhile, recent months have seen considerable reductions in the price of broadband tariffs beingoffered by the major operators Another development likely to stimulate growth is the introduction of LLU,which will give alternative operators access to Bezeq's network and will stimulate much greater

competition

Macroeconomic Forecasts

BMI View: We forecast real GDP growth in Israel of 3.2% and 3.5% in 2014 and 2015, respectively The

domestic economy will remain in a soft patch, while accelerating growth in the eurozone and the US will lead to an improvement in net exports Increasing exports underpin our relatively bullish medium-term outlook for the economy.

Recently released data reaffirms our view that growth in Israel will remain sluggish in 2014 Real GDPgrowth in seasonally adjusted terms came in at 3.3% y-o-y in Q313, compared to growth of 3.6% in H213.Moreover, estimates by the Bank of Israel (BoI) put annual growth in Q413 at only 2.3% y-o-y Although

we see exports and fixed investment growth picking up over the coming quarters, domestic economicgrowth will remain sluggish We project real GDP to increase by 3.2% and 3.5% in 2014 and 2015,

respectively, compared to our estimate of 3.3% growth in 2013

A moderation of austerity policies over the coming years, coupled with increasing exports and a subsequentacceleration in fixed investment growth, will ensure that the headline growth print accelerates over thecoming years We forecast real GDP growth averaging 4.0% over the 2014-18 period

Fixed Investment Picking Up

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

Source: BMI, Central Bureau of Statistics Israel

Private Consumption Outlook

Private consumption expanded by 4.7% y-o-y in seasonally adjusted terms in Q313, compared to growth of3.3% in H113 We expect the acceleration in growth of the component, which was largely a result of lowbase effects, to moderate over the coming quarters, and we forecast private consumption averaging 3.2% in

2014 and 3.5% in 2015 We have slightly increased our 2014 forecast from 3.0% previously, mainly as thegovernment decided at the end of 2013 to slash plans to hike income taxes, a measure which was due tocome into effect on January 1 2014

That said, government spending will remain modest in 2014, which will continue to hit consumer demand

In particular, while the private sector will likely benefit from increasing exports over the coming quarters,the government's austere policy stance will weigh on the expansion of private sector employment, and thepublic sector will also provide little additional employment opportunities As a result, we forecast theunemployment rate in Israel to average 6.7% and 6.5% in 2014 and 2015, respectively, compared to 6.4% in

2013 A further indication of sluggish private consumption growth is provided by Bank Hapoalim consumer

confidence index (CCI) The indicator averaged 122.4 points in 2013, a 4.2% decline compared to 127.8 in

2012, and we expect confidence to remain low over the coming quarters

Still Dovish In 2014

Israel - CPI Vs Policy Rate

Source: BMI, Bank of Israel

On the upside, the inflationary environment and the BoI's loose monetary policy will go some way towardssupporting household spending We forecast headline consumer price inflation averaging 1.6% in 2014,from 1.5% in 2013 The BoI cut benchmark interest rates by 25 basis points to 0.75% on February 24, and

we expect another 25 basis points cut to take place in 2015 (see 'Another Cut Likely In 2015', February 25).

Government Spending Outlook

Government consumption averaged 3.2% y-o-y in seasonally adjusted terms over the first three quarters of

2013, compared to 3.4% in 2012 We expect modest growth in the component over the coming quarters, asthe government seeks to reduce the burden of public services on the fiscal coffers We project governmentconsumption expanding by 2.8% and 3.0% in 2014 and 2015, respectively

Fixed Investment Outlook

Fixed capital formation increased by 3.4% y-o-y in seasonally adjusted terms in Q313, compared to a on-year contraction of 4.1% in H113 We expect the ongoing rebound in growth within the component tocontinue in 2014, and we forecast gross fixed capital formation expanding by 3.0% in both 2014 and 2015,compared to our estimate of a 1.0% contraction in 2013 In particular, developments in the energy sectorwill prompt the construction of new gas transmission and power generation infrastructure over the comingquarters A ruling from the Israeli Supreme Court in October 2013 confirmed a previous decision to allowthe export of 40% of the country's natural gas reserves, while 60% is to be maintained for domestic

year-consumption Following the decision, companies involved in Israel's offshore oil dealings, particularly withthe Tamar and Leviathan fields, are now in the position to move forward with their export developmentplans

Firmly In The Black

Israel - Net Exports

Source: BMI f= BMI Forecasts

Net Exports

We see Israel's net export position coming in surplus to the tune of ILS13.7bn (US$3.9bn) and ILS15.8bn in

2014 and 2015, respectively, from an estimated deficit of ILS12.4 in 2013 Total exports fell by 3.2% y-o-y

in Q313, compared to average quarterly growth of 0.7% in H113 and 1.0% in 2012 However, foreign tradedata indicate that goods exports renewed their increase in January, after a temporary decline in December,primarily in high technology and medium-high technology industries

Medium-Term Outlook Encouraging

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

Source: BMI, Central Bureau of Statistics Israel f= BMI Forecasts.

We expect export growth to rebound in 2014 due to a combination of low base effects and acceleratinggrowth in the eurozone and the US - which together accounted for approximately 48% of Israel's exports in

2013 We forecast the economy in the eurozone expanding by 1.0% in 2014, compared to a 0.4%

contraction in 2013, while we see real GDP growth in the US increasing 2.8% in 2014 from 1.9% growth in

2013 Our longer term outlook for exports is also benign, particularly as a result of the beginning of gasexports for the Leviatan and Tamar gas fields

We expect only small quantities of energy exports to take place over the next few years As an illustration,

US oil and gas major Noble Energy signed in February a gas sales agreement with Jordan-based companies NBL Eastern Mediterranean Marketing (an affiliate of Arab Potash Company) and the Jordan

Bromine Company to supply natural gas from the Tamar field Supplies are expected to begin in 2016,

once the required pipeline infrastructure is complete, with an agreement for an initial term of 15 years and atotal gross contract quantity of approximately 66 billion cubic feet of natural gas Much larger-scale exportswill in our view begin from 2018 onwards, particularly should political obstacles relating to building apipeline to export gas to Turkey be overcome, which will result in an uptick in the headline growth print inthe same year

Imports increased by 2.0% in Q313, having declined by 6.7% y-o-y in seasonally adjusted terms in H113.Given low base effects and our belief that fixed investment and export growth will accelerate, we forecasttotal imports increasing by 3.0% in both 2014 and 2015, from our estimate of a 3.0% contraction in 2013

Table: Israel - Economic Activity

Industry Risk Reward Ratings

BMI View: We forecast strong growth in the IT sector of the 13 countries in our MEA IT RRRs, albeit due

to low base effects in some cases, on the back of robust economic growth, rapid development of broadband infrastructure, and various government-led ICT initiatives and projects We also retain the view that governments and corporate organisations will remain the biggest buyers of IT products and services, although we expect rising income levels and shifts towards cloud-based software platforms to stimulate consumer demand in the latter states of our forecast period ending in 2018.

BMI's MEA IT RRRs compare the potential of a selection of the region's markets based on our

consideration of the market opportunities, political and economic risks, as well as industry-specific riskssuch as IT intellectual property (IP) rights protection and the implementation of state spending projects.Qatar retains the number one position on our table while Kenya is still the lowest ranked country in 13thposition

The regional average aggregate score fell marginally this quarter from 54.2 in Q214 to 53.8 owing to thechanges in the average scores in all four categories - Industry Rewards, Country Rewards, Industry Risksand Country Risks - of our ratings The industry rewards and country risks scores declined this quarter,while the regional average of the country rewards and industry risks scores improved relative to the

previous quarter The changes in the aggregate scores of some countries resulted in two changes in thebottom half of our rankings The first change was Nigeria moving ahead of Oman into 8th position while thesecond was Lebanon moving ahead of Ghana into 11th

Industry Rewards

Nigeria and South Africa are outperformers in the industry rewards category with scores of 63.3 and 61.7respectively This reflects the strong growth prospects of their respective IT markets, partly driven byincreasing economic activities and growing consumer demand for IT products and services, particularlylaptops and cloud-based software products Nigeria's IT sector is projected to record double-digit growthover the medium term, driven by the corporate segment, while South Africa remains a key regional marketfor investors given the maturity of key industry verticals such as financial services, retail and transportation

There is a wide gap between the highest and lowest scores of the GCC countries in this category, withBahrain and Oman underperforming their regional peers UAE and Qatar, the two highest ranked GCCcountries in the industry rewards category, are set to experience sustained growth over the next decade on

the back of increased investments in infrastructure, logistics, hospitality, transportation, and other relevantsectors in the run-up to the hosting of two major events - the Dubai 2020 World Trade Expo and the 2022FIFA World Cup in Qatar Bahrain and Oman's weak performances reflect sluggish IT market growth andconsiderably smaller IT market sizes compared to other countries in the region.

Country Rewards

Israel and the GCC countries perform strongly in the country rewards category mainly due to relatively high

urbanisation rates and GDP per capita These factors, BMI believes, are important gauges for the level of

consumer demand for IT products and services in any given market High urbanisation rates often translate

to greater internet access and IT usage among residents, while high income levels also point to the ability of

a greater proportion of the population to purchase expensive IT products and services However, thesefactors must be counterbalanced against the population size and, therefore, long-term growth potential of amarket considering that most high income and predominantly urban markets have relatively smaller

populations

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

USD84,000, USD54,000, USD45,000 and USD35,000 respectively, according to BMI data However, the

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

As a result, we highlight the long-term growth potential of countries such as Nigeria, Egypt, South Africaand Kenya, all of which have more than 40mn residents but GDP per capita of less than USD10,000 Thesecountries, along with Ghana, have the lowest scores in the country rewards category Kenya's score isfurther compounded by its predominantly rural population Kenya, with a score of just 10, had a GDP percapita of around USD980 in 2013, while 75% of the country's population live in rural areas With such lowpurchasing power among the country's consumers, the IT market will continue to depend on governmentspending and businesses in the few major cities in the country

Industry Risks

IT investors and vendors face elevated IP risks in MEA, driven by a combination of economic and politicalfactors On the economic front, the relatively low income levels in many countries suggest a high demandfor low-cost products, which, in most cases, are counterfeited or pirated On the political front, somegovernments in the region have not shown sufficient commitment towards stopping the local production orimportation of counterfeit products Some IT vendors have taken steps to counter this risk, such

as Microsoft's migration to cloud-based software and HP's counterfeiting deterrent measures in printers and

other accessories

Some of the wealthy GCC states and Israel have the highest scores in this category, as higher income levelsreduce appetite for counterfeit products while well developed formal distribution channels make it easier forvendors to reach customers Furthermore, these countries are implementing clearly defined ICT policiesaimed at increasing the contribution of that sector to overall economic growth In many cases, these policiesprovide protection for IT vendors against counterfeiting, as well as assurances of policy continuity

Country Risks

BMI's country risks ratings for the IT sector assess key external factors that could affect a country's overall

investment outlook and consequently growth prospects for the IT sector These factors include short-termexternal and financial risk, trade bureaucracy, ill-defined legal frameworks and corruption perception TheGCC countries and Israel each record scores higher than 60, mainly due to the favourable short-termexternal risk factor ratings and stronger corruption perception indices Countries with lower scores all battlewith weak corruption perception indices and lack of transparency in trade bureaucracy and legal

frameworks Although Nigeria's country risk score increased by 0.7pps on the back of a healthy short-termexternal risk score, it continues to be held back by a weak corruption perception score

Investors will be keenly watching events in the political arena in several countries over 2014, notably SouthAfrica, Egypt, Lebanon and Nigeria Although the ANC in South Africa was expected to win the country'sMay 7 general elections, the outcome of the elections could alter the ruling party's economic policies inorder to retain its dominance over the next five years Political tension is expected to rise in Egypt andNigeria in the run-up to presidential elections within the next 12 months, while Lebanon remains heavilyexposed to the war in Syria We expect these factors to weigh on investor sentiments on these markets, atleast in the short term

Table: Middle East And Africa RRRs - Q3 2014

Country Industry rewards rewards Country Industry risks Country risks IT Rating Rank Previous Rank

of an IT market in any given state, and country's broader economic/socio-demographic characteristics that affect 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 Country Risk Ratings, that could affect the realisation of anticipated returns Source: BMI

Market Overview

Hardware

BMI estimates Israel's IT hardware market declined by 0.11% in 2013 to ILS9.55bn However, we expect it

to return to growth in 2014 and forecast a CAGR of 4.8% over our five-year forecast from 2014 to 2018 In

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

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

systems will boost sales throughout the year

As well as economic and IT market trends, another factor behind our pessimistic outlook for 2014 is the risk

of a further escalation of hostilities between Israel and Gaza This uncertainty will drag on confidence andcurtail investments in some areas Wider economic uncertainty means businesses are now investing more toincrease flexibility and realise cost efficiencies rather than expand IT hardware capabilities, but nonethelessthere should be growth areas However, as noted, lower average prices have meant that revenue growth inmost segments has lagged shipments

BMI estimates real GDP grew 3.3% in Israel in 2013, slightly higher than our forecast of 3.2% growth in

2014 Likewise, real private consumption growth and real government spending are expected to slowslightly in 2014, falling from 3.3% and 3.0% in 2013 to 3.2% and 2.8% in 2014, respectively The decline

in private consumption is owing to government austerity measures, such as the 1% rise in VAT

implemented in June 2013 BMI expect that austerity measures will continue to have an impact on

discretionary spending on items such as PCs and notebooks in 2014 This has an obvious impact on thegrowth potential of the IT market, as consumers consider reigning in their spending and government facesfiscal constraints on new investments

Despite the weak consumer outlook in Israel there are several factors which present an optimistic mediumterm outlook for continued hardware sales The Israeli government has launched various initiatives toincrease computer and internet penetration, such as Computer for Every Child, now morphing into 'Tabletfor Every Child' according to Israeli Prime Minister Benjamin Netanyahu, and 'Digital Israel', a proposedinitiative to streamline the digitisation of public sector services, such as education, healthcare and socialservices The level of support, however, has been criticised by some industry insiders as too low Betweenits launch in 1995 and June 2013, the Computer for Every Child initiative reportedly distributed 55,000computers in around 2,000 localities Industry stakeholders see Digital Israel essentially as a duplication ofits Government Computing Center, which was established in February 2012 and operates under the auspices

of the Ministry of Finance and has many of the same goals as Digital Israel However, Carmel Avner,Israel's first chief information officer who headed the centre, announced her resignation in December 2013owing to the body's lack of power to implement digital initiatives.

Therefore, BMI expects upgrades to new systems and purchases of personal computing devices will remain

the bulk of market sales Mobile computing devices including tablets, slimline notebooks, ultrabooks andhybrids present a growth opportunity for vendors as consumers buy personal products to complement thehousehold desktop or laptop This segment will be held back by a weak consumer outlook in 2013, but willstrengthen from 2014

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 end of mainstream support for Windows 7 in January 2015 is expected to result in highersales of the Windows 8 OS in the retail and enterprise markets In the retail market Windows 8 will deepenthe tablet market, as well as introducing hybrids, while in the enterprise market the new OS should triggercomputer hardware tenders previously delayed because of the economic situation The launch of Windows 8

in Israel coincided with the launch of the Surface tablet and a new suite of mobile handsets using WindowsMobile Microsoft CEO, Steve Ballmer, began an international promotional tour for the new operatingsystem in Israel in November 2012 An upgrade to Windows 8 was available to Israeli consumers for US

$40 to download or ILS280 installed in store

e/f = BMI estimate/forecast Source: BMI

Evolving Form Factors

The Israeli IT market is relatively mature, but BMI estimates that hardware still accounted for 42.3% of the

total market in 2013 (excluding communications hardware) Prior to 2012, notebooks were the growing segment of the market, although as recently as 2008 desktops still took around two-thirds of unitsales However in 2010-2011 the share of desktops declined precipitously, and then in 2012 there was ashift from notebooks to tablets as the fastest growing segment of the market

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

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

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

65% of Israel's total mobile subscriber base at the end of 2013, with mobile penetration reaching around

130% The competition from mobile devices is driving innovation in notebook and tablet design, as line and hybrid devices are increasingly the centre-piece of Windows vendors product ranges

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

from a broadening pool of tablet vendors, it managed to maintained its dominance of Israel's tablet market

in 2013, a position we expect it to hold on to, at least for the duration of2014 Data from Statcounter showthat iOS, run on Apple's tablets, accounted for 75.3% of all tablet browsing traffic in Israel in April 2014,down by 1.9pps y-o-y By contrast, Google's Android OS, which is used on Samsung, Asus and Google'sown Nexus range, accounted for 24.2% of tablet browsing traffic, up by 2pps y-o-y Although Statcounterdata suggest that Apple devices remain by far the most popular among Israeli consumers, IDC estimatedthat Apple's share of tablet sales dropped considerably in 2013 to 31.4%, down from 49.1% a year earlier.Both data support the trend of a widening range of Android devices - including the Kindle Fire from

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

dent in Apple market share, without any other brand usurping its leading position The IDC estimates thatSamsung was the second largest tablet vendor in Israel, with a share of 25.5% in 2013, followed by Asuswith a 16.2% share, Lenovo with a 5% and Acer with 2.9%

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

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

However, the tablet market remains relatively undeveloped in Israel's hardware sector, which is heavilydominated by Windows machines When looking at the combined tablet and desktop/laptop computermarket, iOS and Android accounted for just 2.8% and 0.9% of total PC browsing traffic, respectively, inApril 2014 The event with the largest impact on Israel's PC market was the launch of Windows 8 inOctober 2012, which enabled Windows vendors to introduce touch devices - with a number of tablets

released in Q412 and Q113 The addition of more vendors and another touch OS has added to competition

in the market and put further downward pressure on prices

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

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

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

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

of lower cost Windows 8 powered PCs is reflected in the latest Statcounter data, which show that Window 8and Window 8.1 accounted for almost 10.6% of browsing traffic in Israel in April 2014, up 6.7pps from3.9% a year earlier By comparison, Mac OSX's share of browsing traffic increased by 1pp, to 3.7% overthe same period

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

the mobile 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 to top spot with a market

share of 21.2%, overtaking HP and Dell In second

position was Asus with 16% market share, up from 12.2% in 2011, also overtaking HP and Dell which both

had 15.2% market share in 2012 Based on these figures BMI estimates 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% respectivedeclines in laptop unit sales for HP and Dell

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 2012Apple opened a research centre in Haifa and in December 2013 it opened its third research centre in the

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

April 2014

Source: Statcounter

country in Ra'anana This trend is continuing in full force; in early 2014, IBM announced plans to open an

IT security centre in Beersheva and Cisco and Lockheed Martin both announced plans to increase theirinvestments in the development of country's IT sector

Software

BMI estimates Israeli software spending increased to ILS5.12bn in 2013, up 2.3% y-o-y We expect growth

in the software segment to accelerate, with a CAGR forecast of around 5.1% over the five years to 2018 Inthe past few years, there has been pick-up in demand for systems and upgrades in public and private sectors,with investments by government organisations such as the Israeli Ministry of Defence and Israeli Police,and from utilities leader Israel Electric Company Much of this growth is related to increasing use of cloudservices and related rising demand for security services

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

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

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

revenues from the Israel market, experienced a decline in its revenues and profits in 2013, due largely toseasonal factors (See Matrix Company Profile for further details.)

With the economic outlook in developed markets beginning to brighten, there are opportunities for softwarevendors across a range of sectors from government to energy, financial services, telecoms and utilities.Major customers for software solutions in Israel include large and medium enterprises such as commercialbanks, loan and mortgage banks, credit card companies, insurance companies, telecoms service providers,hi-tech companies, and the Israeli Defense Forces, government ministries and public agencies Large

organisations investing in SAP-based systems included the Meitav Regional Water and Sewage

Corporation and Israel Direct Insurance (IDI).

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

e/f = BMI estimate/forecast Source: BMI

Microsoft Israel has an annual turnover of around US$1bn It hoped its Windows 8 operating system,launched in October 2012, will continue to boost sales throughout 2013, with support for the Windows XPoperating system due to be withdrawn in 2014 Israel also hosts an important research and developmentcentre for Microsoft, one of its 3 largest global facilities In 2010, the centre launched Microsoft's newunified access gateway (UAG) product for the Windows 2008 Server R2 The UAG product is already used

in the Windows 7 operating system to provide PCs with online access to enterprise servers The productpositions Microsoft to make a play for the Software-as-a-Service (SaaS) market opportunity About 70% ofthe centre's work is now focused on cloud computing, with Microsoft Israel expecting to hire up to 100 newworkers for cloud computing projects

Migrations to the Windows 8 operating system are believed to have had a positive impact on 2013 salesdespite business caution and the fact that the pre-launch publicity for Windows 8 was more low-key than forits predecessor Windows 7 Microsoft touted the touchscreen capabilities of Windows 8 and Q412 saw therelease of a new wave of Windows 8 tablets and notebooks Although a large portion of Israeli computerusers are estimated to still be using the Windows XP operating system, accounting for 16.8% of PC

browsing traffic in April 2014, this fell from more than 25% a year earlier, while Window 8 browsingtraffic increased by 6.7pps to 10.6% of PC browsing traffic over the same period, according to data from

Statcounter BMI believes this trend will continue over our forecast period, as support for XP will be

withdrawn in 2014 and mainstream support for Windows 7 will end in early 2015

Current areas of enterprise demand include management of Microsoft systems and servers, as well assystems management, basic data management, firewalls, enterprise resource planning (ERP)

implementation and CRM CRM is a particularly buoyant area, while in 2012 vendors continued to sign upnew business intelligence customers The sheer volume of data that enterprises must now handle as a result

of device proliferation is fuelling investments in business analytics In May 2013, Arad Group, a world

leader in water meter technology, announced a partnership with IBM to help customers and water utilitiesmanage resources more efficiently through use of big data and analytics technology The analytics

technology was developed by IBM in Israel

The security software segment is another important opportunity, potentially worth hundreds of millions ofdollars over the medium term, as awareness of security issues grows in tandem with the rise of cloudcomputing Owing to its geopolitical situation, Israeli companies, organisations and the government arehighly sensitive to cyber threats and local IT firms have responded to the heightened demand by developing

some of the world's most advanced IT security software BMI believes research and spending is likely to

continue across all software segments, although with security content and threat management remaining thecurrent priorities

In October 2012 Israel's Prime Minister Benjamin Netanyahu announced that the government was working

to create a 'digital Iron Dome' to protect vital infrastructure from hackers and viruses (the Iron Dome isIsrael's anti-rocket defence system) This included the establishment of the National Cyber Bureau to defendthe nation against computer terrorism This policy should see vendors win public contracts, while alsoserving to focus the minds in the private sector, although at the time of writing no major contracts had beenpublicly announced

Due to its sensitive geopolitical position and supported by its well-educated population, Israel has a vibrant

domestic cyber security market Check Point and Imperva are listed companies, while in March 2013 Israeli security services company Incapsula, an Imperva subsidiary, was valued at around US$950mn after

proving successful among small- and medium-sized businesses Incapsula provides high-end firewalls toassess incoming traffic and identify possible bugs Incapsula was established in 2009 and was created bythree Imperva employees