Israel information technology report q4 2012

... any information hereto contained Israel Information Technology Report Q4 2012 © Business Monitor International Ltd Page Israel Information Technology Report Q4 2012 CONTENTS Executive Summary... Business Monitor International Ltd Page Israel Information Technology Report Q4 2012 Executive Summary BMI View: Israeli IT spending is expected to reach US$6.0bn in 2012, up 5% In Q112, several indicators... military conflict between Israel and the Islamic republic could erupt in the coming years ƒ ƒ © Business Monitor International Ltd Page Israel Information Technology Report Q4 2012 Israel Economic SWOT

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TECHNOLOGY REPORT Q4 2012

INCLUDES 5-YEAR FORECASTS TO 2016

Part of BMI’s Industry Report & Forecasts Series

Published by: Business Monitor International

Copy deadline: October 2012

CONTENTS

Executive Summary 5

SWOT Analysis 7

Israeli IT Sector SWOT 7

Israel Telecommunications Sector SWOT 8

Israel Political SWOT 9

Israel Economic SWOT 10

Israel Business Environment SWOT 11

MEA IT Risk/Reward Ratings 12

Table: Middle East And Africa IT Risk/Reward Ratings Table, Q412 14

MEA IT Markets Overview 15

IT Penetration 15

Sectors And Verticals 18

Market Overview 22

Government Authority 22

Table: Government Initiatives 23

Hardware 23

Software 25

Services 27

Outsourcing 28

Industry Developments 28

Industry Forecast 31

Table: Israel IT Sector – Historical Data & Forecasts (US$mn Unless Otherwise Stated), 2009-2016 33

Industry Forecast Internet 34

Table: Internet Data And Forecasts, 2009-2016 34

Macroeconomic Forecast 36

Table: Israel – Economic Activity, 2011-2016 38

Competitive Landscape 39

Internet Competitive Landscape 42

Company Profiles 44

Ness 44

IBM 47

Hewlett-Packard 52

Matrix 58

Microsoft Corporation 61

Country Snapshot 66

Table: Israel's Population By Age Group, 1990-2020 ('000) 67

Table: Israel's Population By Age Group, 1990-2020 (% of total) 67

Table: Israel's Key Population Ratios, 1990-2020 68

Table: Israel's Rural And Urban Population, 1990-2020 68

BMI Methodology 69

How We Generate Our Industry Forecasts 69

IT Industry 69

IT Ratings – Methodology 70

Table: IT Business Environment Indicators 71

Weighting 72

Table: Weighting Of Components 72

Sources 72

Executive Summary

BMI View: Israeli IT spending is expected to reach US$6.0bn in 2012, up 5% In Q112, several

indicators suggested moderating consumer demand, but vendors still reported a solid trading

environment for IT services across industrial, government, defence and financial services segments The current rate of PC penetration, while high for the region, represents potential for organic growth

Household penetration is estimated at around 75% The Israeli IT market should gain enough momentum

from key sectors to expand at a CAGR of 7% over BMI's 2012-2016 forecast period, due to momentum

from key segments

Headline Expenditure Projections

Computer Hardware Sales: US$2.5bn in 2011 to US$2.6bn in 2012, +3% in US dollar terms Forecast

in US dollar terms downwardly revised due to macroeconomic factors, but Israeli businesses are investing more to facilitate expansion and development

Software Sales: US$1.3bn in 2011 to US$1.3bn in 2012, +6% in US dollar terms Forecast in US dollar terms downwardly revised due to analyst modification, but device and data proliferation will drive

spending on customer relationship management (CRM), databases and business intelligence

IT Services Sales: US$2.0bn in 2011 to US$2.1bn in 2012, +6% in US dollar terms Forecast in US

dollar terms downwardly revised due to analyst modification but key segments such as government and defence will be a continued source of opportunities

Risk/Reward Ratings: Israel's IT rating score was 66.3 out of 100.0, up on the previous quarter Israel

has regained first place in our latest RRR table, ahead of both Qatar and the UAE.

Key Trends & Developments.

ƒ BMI forecasts overall solid growth for the Israeli IT market for 2012, despite a deteriorating

external economic environment Businesses will maintain a cautious attitude to IT investments due to uncertainty about a sustainable global economic recovery in key export markets There should, however, be growth in areas such as business intelligence, server virtualisation, mobile devices and cloud computing

ƒ New cloud computing offerings and increased competition in this segment should fuel further demand from users Particular areas of opportunity for cloud computing include banking and retailing as organisations in those fields look to save money on hardware investments

Businesses will, not only seek to make cost savings, but will look to boost efficiency and increase flexibility of response to customer needs.

ƒ The growing emphasis of many multinational IT vendors on software and services revenues, has

led companies like Dell and SAP to direct more investment in R&D at the Israeli

market However Israel's domestic IT service companies have strong advantages owing to local

knowledge and contacts For example, Ness Israel's long-term relationship with the Israeli

Department of Defence makes it a strong player in the defence and homeland security vertical Despite their global ambitions, Israel remains an important market for these companies and typically accounts for 40-50% of revenue

SWOT Analysis

Israeli IT Sector SWOT

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

ƒ Strong defence and government spending provides base for IT demand

ƒ Relatively mature IT market, with services accounting for an estimated 33% of spending in 2009 Despite this, the market for basic IT hardware and software is far from saturated

ƒ Strong political support, with the government having implemented many policies

to aid in the development, success and expansion of the IT sector

Weaknesses ƒ 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 to pressure on pricing and margins

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

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

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

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

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

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

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

ƒ Healthcare IT will be a growing source of opportunity

business sentiment

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

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

Israel Telecommunications Sector SWOT

ƒ Liberal mobile market consisting of four operators

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

slowed considerably and operators must look for alternative revenue sources

ƒ Lack of competition in all telecoms sectors

ƒ Regulator has been slow to license new services, such as WiMAX wireless broadband

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

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

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

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

Threats ƒ Continued interconnection tariff reduction could have a devastating effect on

Israel Political SWOT

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

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

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

risks, although violence in the West Bank has been reduced significantly

Strategies to minimise or end the conflict are domestically divisive

ƒ Frequent change to the composition of the coalition government often leads to policies becoming fragmented or significantly diluted

ƒ 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 ƒ A warming of relations with Greece has given Israel the ability to engage in

military exercises over a larger geographic area

of the Gaza Strip and Israel's military incursion into the territory in December 2008/January 2009 have added to uncertainty Finding a lasting solution poses

a dilemma for Israel, which has previously said it will not talk to the militant organisation

ƒ The construction of the West Bank barrier and the continued home-building in some West Bank settlements antagonises the Palestinians and stands in the way of the peace process

ƒ Iranian President Mahmoud Ahmadinejad's refusal to give up his country's nuclear programme raises concerns that an open military conflict between Israel and the Islamic republic could erupt in the coming years

Israel Economic SWOT

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

measures will help to keep the fiscal deficit under control

ƒ The workforce is highly educated and skilled

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

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

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

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

Opportunities ƒ In the long term, high levels of employment will underpin private consumption

pipeline has been targeted frequently in 2011, forcing the country to buy more expensive fuels from alternative sources

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

Israel Business Environment SWOT

communication networks, as well as transparent legislation

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

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

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

Opportunities ƒ Corporate tax rates, at 25%, have not increased markedly as a result of social

protests in 2011

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

the past two years

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

MEA IT Risk/Reward Ratings

There is just one change in the ranking of countries in our Q412 IT Risk/Reward Ratings (RRR) table for Middle East and Africa (MEA), despite changes in the aggregate scores of most countries in this quarter's update The average overall score fell by 0.2pts to 51.1, driven by declines in the industry rewards, market risks and country risks categories The average score in the country rewards category remained unchanged at 72.3, although there were changes in some countries' individual scores

BMI estimates the total value of the IT markets in our coverage was US$35.2bn in 2011 We forecast it to

grow to US$37bn in 2012 to just over US$56.5bn by 2016 Notable growth drivers for IT services in the MEA include governments' economy diversification efforts and the increasing integration of IT services with other industry verticals In the consumer segment, rising income levels and improvement in literacy rates are also potential growth drivers The key risks to outlook are mainly political and economic as they have a significant impact on the disposition of individuals and businesses to purchase high-value IT products and services Our ratings reflect our assessment of key growth drivers and risks to outlook in the

IT markets of the 11 countries in our regional coverage

Israel remains at the top of our

RRR table although its

aggregate score falls slightly

from 66.5 in the previous

quarter to 66.3 this quarter

Israel's country rewards and

country risks scores decreased

this quarter due to a slowdown

in the economy because of

concerns in the eurozone and

the US, but this was offset by

an upgrade to its industry risks

rating to reflect an

improvement in its IP

protection policies Israel has

one of the most developed IT

markets in the region, reflected

by household computer

penetration of more than 75% and significant government and military expenditure on IT projects Israel's well-educated population, strong policies for IP protection, stable political environment and developed telecoms infrastructure also make it an attractive location for global IT players to site key R&D and production facilities

South Africa In The Lead

IT Market Values (US$bn), 2011

Source: BMI

The UAE reclaims second position from Qatar following an increase in its aggregate score and a decrease

in Qatar's This was the only change to our RRR table this quarter The UAE's score was boosted by an upgrade to its country risks score, which increased from 67 in the previous quarter to 68.3 this quarter The UAE's country risks rating is the highest in the region and reflects our positive outlook for economic growth, supported by strong performances in non-oil sectors such as tourism and trade industries By contrast, we downgraded Qatar's country risks score this quarter to reflect the gradual increase in Qatar's risk profile as a result of its increasing regional clout and considerable influence on the changing political dynamic in the region That aside, Qatar remains a regional outperformer in terms of economic growth and political stability – two key factors that make it an attractive destination for IT investments in the region

Kuwait, along with Qatar, is the only other country with a rating of 100 in the country rewards category, a situation that demonstrates relatively high GDP per capita, high public sector wages and, consequently, strong private consumption and lower unemployment rates The Kuwaiti government and major

businesses are huge buyers of IT services In February 2012, US-based technology firm Booz Allen Hamilton entered Kuwait to provide specialist services to government and commercial clients However,

Kuwait's small population means there is limited growth opportunities in the consumer segment

Saudi Arabia and Turkey, in fifth and sixth positions respectively, saw increases to their aggregate score this quarter but this did not affect their rakings on our table this quarter Saudi Arabia's score increased 0.7pts to 52.2 following an upgrade to its country rewards rating, while Turkey's overall score benefited from an upgrade to its country risks rating Saudi Arabia's country structure is benefiting from increased government spending and rising oil revenues For its part, Turkey is highly vulnerable to economic woes

in Europe and the political crisis in the Middle East However, a strong economic base has resulted in the upward revision of its GDP growth forecast for 2012 from 1.8% to 3%

Bahrain and Oman have the two lowest industry rewards scores in the region, which reflect the size of their domestic markets We forecast robust growth in Bahrain and Oman's IT markets over the next five years as a result of significant investments in next generation telecoms infrastructure, but small

population sizes and less aggressive government IT policies will make them less attractive IT investment destinations compared to other GCC states

South Africa and Egypt have the largest populations among the 11 countries in our MEA IT coverage but are underperformers, sitting in ninth and 11th (last) positions respectively on our RRR table Both

countries are held back by relatively low GDP per capita values, making them score considerably below average in the country rewards category South Africa is further held back by a low industry risks score, which reflects its weak IP protection policies and lack of a clear ICT policy Egypt also scores below average in the industry risks category for similar reasons, although the country's volatile political

environment and precarious economic outlook present the biggest downside risk to growth

Lebanon remains in 10th position but risks moving back into last position if the political and economic environments in Egypt improve over the next few months Lebanon has the lowest score in the region in both the country risks and industry risks categories, two factors that significantly reduce its attractiveness

to investors despite its advantages in the form of a youthful and relatively educated population as well as attractive geographical location that could make it a regional hub

Table: Middle East And Africa IT Risk/Reward Ratings Table, Q412

Country

Industry Rewards

Country Rewards Rewards

Industry Risks

Country

IT Risk/Rew ard Rating

Regional Ranking

Previous Ranking

anticipated returns Source: BMI

MEA IT Markets Over

IT Penetration

The Middle East region divide

groups in terms of information

development In the first group

and more technologically adva

countries, such as Israel and th

where internet penetration is r

high and many households hav

broadband services In more e

markets such as Egypt, on the

computers remain a luxury for

Across the MEA region, the n

internet users is expected to gr

significantly South Africa is p

advance the most in percentag

with penetration rising from ab

report due to updated forecasts

forecast, will have 55.4% pene

ready states in the region, with

Growth in the number of inter

increase between 2012 and 20

Similar contrasts are apparent

major driver of overall penetra

proliferation of mobile connec

which currently ranges from 5

Government initiatives are afo

deploy fibre-optic cables exten

have been downgraded in man

penetration see as the highest i

second and third highest respe

Internet and broadband penetr

regional telecoms markets Mo

erview

ides into two ion society oup are richer dvanced the UAE,

s relatively have access to

e emerging

he other hand, for many

number of grow

is projected to tage terms, about 16.3% in 2012 to 24.1% by 2016 (note: figures maasts after time of writing) Egypt, where the second biggesenetration by 2016, up from 40.1% in 2012 The UAE is oith internet penetration seen as reaching 78.1% within theternet subscribers is also forecast to pick up in Saudi Arab

2016

nt in relation to broadband penetration, where mobile broatration, due to 3G mobile service roll-outs across the regioectivity devices such as smartphones and tablets Broadba 5.8% in Kuwait to 41.4% in Saudi Arabia

afoot in most places, ranging from wireless broadband in D

tensively in countries such as Kuwait BMI's broadband p

any markets as a result of the economic downturn, with S

st in 2016 Israel is projected to reach 28%, ahead of Qata

pectively among the countries covered by BMI

etration growth will receive boosts from continued efforts Moves towards telecoms market liberalisation have contin

Internet Penetrat

Per 100 Populati

f = forecast Source: BMI

may vary elsewhere in est increase is

s one of the most the forecast period rabia, with a 21%

e-roadband is now a gion, and a dband penetration,

in Dubai to plans to

d penetration forecasts Saudi Arabia's 55.5% atar with 26.6%, the

rts to liberalise tinued in Qatar, Egypt,

ation

ation

Saudi Arabia and other countr

segments, due to the growing

There is also considerable PC

growth potential as the current

computerisation is estimated a

50% in every country in the re

penetration in Egypt is estimat

around 10% and is forecast to

above 20% by 2016 In Saudi

penetration is currently above

should increase to around one

2016 Even in Israel, where ho

penetration is estimated at abo

there is potential for further gr

Government initiatives will dr

use of computers in education

the Egyptian government anno

provide opportunities for IT su

In the UAE, the Ministry of E

Meanwhile, the South African

all school children in the coun

Governments in the region hav

Qatari government has outline

services as part of its ICT-201

next four years, in an attempt t

aims to make 200 government

Meanwhile, Qatar's e-governm

investment in computer hardw

IFMS (Integrated Financial M

systems to support interoperab

Another key policy priority th

particular small and medium-s

vendors are capitalising on is t

quality notebooks available to

ntries Broadband penetration has become a driver of PC o

g variety of multimedia and communication services avai

C market ent level of

d at less than region PC ated at

to rise to

di Arabia, PC

ve 25% and ne-third by household bove 75%, growth

drive more

on In 2011, nounced a new school building programme worth EGP15 suppliers Around 25% of Egypt's schools are not equipp Education is leading an initiative to supply computers to

an Department of Education has announced a target of roluntry by 2014

have also allocated significant budgets for e-government dined plans to invest QAR6bn (US$1.6bn) in information te

015 strategy The Kuwaiti government plans to spend US$

pt to diversify the economy away from oil and boost the pent services available soon online through a new e-governm

nment programme and Hukoomi e-services portal will condware across government agencies and client organisation Management Systems) project manages the evolution of grability and e-government service development

throughout the region is to increase utilisation of IT by busized enterprises (SMEs) One of the Saudi government

is the United Instalment Scheme (USI) finance option, wh

to SMEs Qatar's ICT governing body, ictQatar, has made

Broadband Penetra

Per 100 Populati

f = Forecast Source: BMI

C ownership in some vailable

150bn, which should pped with computers

to state schools rolling out laptops to

t development The

n technology and IT S$104.3bn over the private sector Egypt rnment portal

continue to drive ions South Africa's

f government IT

businesses and in

nt policies that which makes high-ade increasing SME

tration

ation

utilisation of IT a key policy o

in Egypt and elsewhere

Drivers are increasing econom

diversification and strong spen

non-oil sectors such as govern

finance and enterprise By 201

should be more evident, with I

of GDP rising in many countri

Saudi Arabia, for example, go

driven investments in transpor

property constructions and wa

power plants will drive opport

IT vendors

An expected recovery in popu

growth underpins our IT mark

projections for markets such a

and Kuwait, which saw an exo

growth gives Saudi Arabia an

forecast period

Across much of the MEA regi

growth An evolving retail lan

smaller stores having been dilu

and mono-brand stores in mall

In many Middle Eastern states

increases in oil output and pric

sector giants such as Saudi A

efficiency, optimise cost struc

The banking sector will also re

organisations look to become

for technology spending, as se

generation from new services

In the wake of the political un

spending is expected to help a

some cases To help maintain

y objective However, access to credit remains a barrier fo

omic pending from ernment,

016, this

th IT's share tries In government-ortation, water and ortunities for

pulation arket growth

h as the UAE exodus of expat workers in 2009 In particular, strong posi

an advantage, with growth expected to reach 10% by the e

egion, youthful population demographics and rising PC pelandscape will also help to stimulate sales, with the traditiodiluted by the appearance of multi-brand electronics sectioalls

tes, the hydrocarbon sector remains a key one for IT spendrices should provide support for higher IT budgets in this

Aramco and Kuwaiti leader KNPC are investing in IT to

uctures and boost overall business agility

o remain a major user of technology as banks and other fin

e more efficient and launch new services Telecoms is an service providers look to exploit the potential for increase

es by implementing tools that facilitate more personalised

unrest that swept the Arab world in the first half of 2011, g

p address economic concerns that may have underpinned d

in social stability, the Saudi government has announced U

Market Size

As % Of National G

f = forecast Source: BMI

for smaller companies

ositive population

e end of our five-year

penetration will drive itional domination of tions in hypermarkets

ending Expected

is vertical Regional

to enhance operational

financial services another growth area ased revenue

ed offers to customers

1, government

d dissatisfaction in US$93bn in handouts,

l GDP

including wage increases, whi

However, a further deterioratio

disruptions to distribution netw

The highest growing IT marke

MEA IT market over the forec

is expected to be Egypt, with c

growth of 89% for 2012-2016

room for considerable growth

country in the next few years,

current low level of computeri

which is much higher in the bu

sector than in the population a

BMI highlights strong growth

countries, including Qatar (47

the decision to award Qatar th

FIFA World Cup is expected t

wave of investment in IT prod

services Government spendin

investment and private consum

growth reaches a projected 28

include the UAE (72%) and S

Sectors And Verticals

Hardware will continue to dom

steadily over the forecast perio

the popularity of notebooks T

of the economic situation

Sales of notebooks are growin

retailers reported a surge in de

stronger than previously expec

The notebook sector was the m

consumer sales felt the benefit

more than 60% of total sales o

still account for around half of

hich should boost consumer spending on electronic itemsation of political stability in countries such as Egypt couldetworks and have an impact on outsourcing operations

rket in the recast period

th compound

16 There is

th in the

rs, given the terisation, business

n at large

th for GCC 47%), where the 2022

d to fuel a roducts and ing, umption growth are all expected to trend upwards in 201228.6% in US dollar terms Other high-growth opportunitie South Africa (66%)

ominate MEA IT spending as the number of personal comriod This will be driven by growing affordability, govern There could be a boost from computer hardware tenders

ing roughly twice as fast as desktops in many markets In demand mobile PCs, in many cases fuelled by price cuts

pected, although this growth was driven in part by promot

e main factor driving retail segment growth across the regefits of aggressive channel promotions Notebooks are exp

s over the forecast period However, in a few markets such

of the total PC market in volume terms

IT Market Compound

2012-2016 (%)

Source: BMI

ms such as PCs uld potentially cause

12, as Qatari real GDP ities are forecast to

omputer users rises ernment initiatives and

rs delayed as a result

In 2011, Saudi

ts PC sales were otional price cutting

egion in 2011 as xpected to account for uch as Egypt, desktops

d Growth

%)

Much of the growth of notebooks has been driven by price cuts In 2011, average notebook costs dropped

by up to 25% for some models Many notebooks now retail in the price range of US$544 to US$680, down from an average price of around US$800 before the financial crisis The launch of notebooks based

on the Android operating system has supported this trend, as Android netbooks are often cheaper than Windows 7 ones

However, the growing popularity of tablets is expected to provide a growth area in 2012, after the product

category enjoyed a surge of popularity in 2011, fuelled by Apple's iPad Tablets will be a growth area

across the region in 2012, and the devices, originally seen as primarily for consumers, are forecast to experience increasing take-up in the business segment However, the popularity of alternative

connectivity devices such as tablets and smartphones has undercut replacement sales of notebooks

Government programmes in Egypt and Saudi Arabia have made low-price computers available in easy instalment payment schemes Government investment in education and e-services will mean desktop purchases for schools, colleges and government offices

Spending on software as a share of total IT spending is as low as 14% in Egypt and below 20% in a majority of MEA markets As the regional economy improves, more investment is likely to be driven by plans for expansion, rather than merely to realise cost efficiencies Similarly the growing regional

ambitions of South African companies will be a factor driving corporate spending on software in that market,

Across the region however, many businesses remain focused on costs, and software vendors will pitch efficiency gains from virtualisation and cloud computing, as companies focus on return on investment

Market Structure

% Of Total IT Market

f = forecast Source: BMI

2012 should, however, see a boost from systems upgrades deferred from 2009 Migrations to the

Windows 7 operating system and new Intel core technology could trigger a new cycle of hardware

upgrades, although much will depend on business and consumer confidence Around half of Saudi

businesses still use computers based on the Windows XP operating system Meanwhile, about one-third

of computers in the UAE are still based on the Windows XP operating system

BMI predicts plenty of room for software market growth over the forecast period as numerous untapped

sectors still exist Key verticals will include telecoms, finance, retail, healthcare and the public sector There has been growing demand in the market for applications tailored towards particular verticals SMEs are likely to lead spending growth, with manufacturing and trading firms seeking efficiencies by making the transition from manual environments to full automation of back-office systems Customer relationship management (CRM) will be a growth area, and other high-growth categories are set to include business intelligence, storage and security products The security software market is important throughout the region as increased investments in IT hardware over recent years are now driving spending on secure content management technologies

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

countries such as Egypt, championed by IBM and other vendors

Over BMI's five-year forecast period, software-as-a-service (SaaS) business models are expected to provide a growing opportunity for vendors, with increasing demand for industry-specific applications Government adoption will also be a key driver in many countries, such as the UAE where cloud services are central to the emirates government's e-government strategy for the next three years

BMI predicts that demand for IT services will grow strongly during the 2012-2016 period The regional

IT services market is dominated by demand from oil and gas, government, finance and telecoms sectors, which many markets account for more than half of total spending In markets such as Saudi Arabia, most enterprise application spending still comes from segments such as oil and gas and banks However, more projects are expected in segments such as education and health

Currently, IT services' share of IT spending ranges from around 25% to 37% in the MEA countries covered by BMI Support and maintenance account for around one-third of spending on IT services, but demand for more complex services has increased, with large outsourcing deals in the UAE, Israel and elsewhere There is also demand for services such as hosting, facilities management and disaster

recovery

Vendors have reported an evolution in demand for services, with a shift away from the dominance of product implementation and installation to greater interest in managed services, value-added services,

facilities management, hosting and business continuity and disaster recovery Even in less mature markets such as Egypt, larger customers are becoming more demanding in terms of their IT expectations

In the private and public sectors, MEA organisations are looking for help to utilise efficiencies from cloud computing services such as SaaS and infrastructure-as-a-service (IaaS) Surveys suggest that cloud spending was an IT investment priority for around one-quarter of MEA businesses in 2011 Cloud

services are central to the UAE's e-government strategy for the next three years In 2011, Kuwaiti data

communications services providers such as Zajil signed agreements with partners to expand their

cloud-based product offerings Particular areas of opportunity for cloud computing include government, banking and retailing as organisations in those fields look to save money on hardware investments

Cloud computing is also becoming viable in markets such as South Africa due to improved and cost bandwidth availability

lower-Market Overview

Government Authority

The Ministry of Science and Technology has undergone numerous name changes and received its current name following the election of Binyamin Netanyahu's government in March 2009

The ministry's responsibilities include forming a national science and technology policy, coordinating research areas and technological analysis and organisation

The main priorities for the ministry are as follows:

ƒ Establishing a national policy and priorities for R&D;

ƒ Developing scientific and technological infrastructure;

ƒ Establishing and strengthening foreign scientific relations;

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

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

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

ƒ Developing digital infrastructure (facilitating access to information);

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

Background

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

IBM has its only IBM Global Services regional subsidiary in Petach Tikva and employs around 2,000 staff at its Haifa Labs and various IBM facilities in Rehovot and Jerusalem HP has as many as 4,000 employees and offers services and support through its subsidiary HP-OMS Other vendors such as Oracle and EDS also have a sizeable presence

Foreign direct investment (FDI) first started to play a key role in Israel's economy in the mid-1990s as the country's high-tech sector underwent a rapid expansion As well as the opening up of the financial and telecoms sectors, the high-tech sector succeeded in attracting large FDI inflows The government's policy made foreign high-tech companies eligible for government grants covering 38% of the cost of new

research and development facilities Today, Israel has more offshore R&D centres of US high-tech companies than any other country

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

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

Israel typically accounting for 40-50% of their revenue

Table: Government Initiatives

Gov@Net – Government intranet

ƒ A cross-government intranet planned to connect more than 80 governmental networks and hundreds of

institutes The implementation will create the largest Israeli IP-VPN The project will allow efficient internal communication and resource sharing

Mercava – Government ERP

ƒ Mercava is the largest ever IT project implemented in Israel It will gradually replace the assortment of

unique legacy systems currently operating in governmental bodies with a central, unified enterprise

resource planning (ERP) system running on SAP system software

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

Government EIP

ƒ This project is intended to promote enterprise portals within the government Since a cross-government

portal will be based on information received from the different bodies, the first step involves the

construction of a ministry-level portal This portal will draw information from Merkava, ministry-specific

operational systems, and intra-government shared resources

Tehila – Government ISP

ƒ The Government ISP project has been operational since 1998, providing essential infrastructure for government communication

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

Shoham – E-commerce infrastructure and service

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

processed more than ILS250mn in its first year

Lehava project

ƒ Group of initiatives to help close digital divide

Hardware

The Israeli computer hardware market, including desktops, notebooks, servers and accessories, is

forecast to reach US$2.6bn in 2012 The market is expected to grow at a CAGR of 6% over the forecast period to reach US$3.2bn in 2016, higher than previously forecast

BMI has downwardly revised its Israeli PC hardware market forecast as of Q412, due in part to global

economic headwinds Businesses are now investing more to facilitate expansion and development, rather

than purely to realise cost efficiencies, but there should be growth areas However, lower average prices have meant that revenue growth in most segments has lagged shipments

As the Israeli economy's growth cools in 2012, enterprises will remain cautious about capital spending, but there could be a boost from computer hardware tenders previously delayed because of the economic

situation Migrations to Microsoft's Windows 7 operating system, and its anticipated successor Windows

8, due in late 2012, and new Intel core technology, should stimulate new cycles of hardware upgrades

Much will depend on business and consumer confidence Israeli PC shipments recorded a strong

recovery in 2010 from the effects of the economic slowdown, and the recovery continued in 2011, but a moderation is expected in 2012

Consumer spending is also expected to moderate in 2012, having been the main growth area in 2011 The current rate of PC penetration, while high for the region, represents potential for organic growth

Household penetration is estimated at around 75% Digital divide issues mean Israel currently has

600,000 children living below the poverty line, only 3% of whom have internet or home PC access, compared with 90% in the top-income group The Israeli government has launched various initiatives to increase computer and internet penetration, including Computer for Every Child, Window to Tomorrow's World, Tapuah (the Israeli Society for the Advancement of the Information Age) and others The level of support, however, has been criticised by some industry insiders as too low Meanwhile, there were signs

in early 2012 of a consumer slowdown, although low unemployment and inflation, and a wage rise for public sector workers, should prevent this from being too severe

The Israeli IT market is relatively mature, but hardware still accounts for around half of the total market, excluding communications hardware Notebooks are the fastest-growing segment of the market, although

as recently as 2008 desktops still took around two-thirds of unit sales In 2010-2011, however, the share

of desktops declined precipitously, due in large part to demand for non-PC form factors such as

smartphone and tablets

This trend of preference for mobility is expected to continue over the 2012-2016 forecast period Despite its declining share of sales, however, the desktop sector is still significant, largely due to business and government end-users Netbooks were a driver of PC market growth in 2010, but have plateaued in the

face of competition from form factors In particular, smartphones from Palm, RIM, Apple and other

vendors are being offered as alternative connectivity solutions and often include a Wi-Fi option

Tablet notebooks first emerged as a significant market factor in 2010, spearheaded by Apple's iPad In October 2010, Apple released the Hebrew-compatible version of its operating system for the tablet, which was expected to boost imports of the device to Israel Previously Israeli users of the iPad were obliged to pay for a less than optimal Hebrew keyboard application

In August 2010, iDigital, the Israeli importer of the iPad, had announced the availability of the device for

sale in Israel, but, as of October 2010, the cellular companies were still not offering the device The Israel

Ministry of Communications had cleared import of the Apple iPad for Israel in April, after previous concerns that iPads were in non-compliance with Israeli wireless standards One Israeli chain was selling the iPad at a retail price of ILS3,800, or around US$1,000, about twice the price of the device in the United States

Other vendors such as Samsung with its Galaxy series have followed Apple in releasing tablet devices, which have a form factor between the size of a smartphone and a netbook Tablets are being designed to appeal to consumers who find a smartphone inconvenient for consuming video media or surfing the web, but for whom a netbook is still too big or heavy Tablets are expected to be significantly more expensive than smartphones, but, despite a previous mixed record with this form factor, are seen as a continued growth area While tablets were initially positioned as consumer devices, there has been an increasing level of procurement from the enterprise sector

Another area vendors will watch is the e-reader market Like iPads, Kindles are not yet readily available

in Israel, but that situation is expected to change Currently Amazon, Barnes and Noble and Apple do

not permit the use of an Israeli credit card at their online bookstores However, Amazon now offers Israeli consumers the ability to download content directly to their PC or Kindle using an Israeli credit card

Software

Israeli software spending is projected at US$1.3bn in 2012, up 6% year-on-year The packaged software segment is expected to grow at a CAGR of around 10% over the forecast period In 2011, the pick-up in demand for systems and upgrades continued in both public and private sectors, with investments by government organisations such as the Israeli Ministry of Defense and Israeli Police, and from utilities

leader Israel Electric Company

Despite the uncertain global economic outlook for Israel's export-based economy, opportunities for software vendors 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 revenue growth increasing in each quarter

Meanwhile, the SME segment, the mainstay of the Israeli business sector, has emerged in recent years as

an important growth area for enterprise systems Spending on enterprise solutions should continue to grow steadily, with reviving or emerging areas of opportunity including security, CRM solutions and business intelligence However, in the current economic climate, vendors will continue to pitch the efficiency gains potentially offered by these applications

Migrations to the Windows 7 operating system, and the expected launch towards the end of the year of its successor, Windows 8, should have a positive impact on 2012 sales despite business caution More

than 50% of Israeli computer users are estimated to still be using the Windows XP operating system, and this represents a significant potential market, as support for XP will be withdrawn by 2014

2012 should, in any event, see a boost from systems upgrades previously deferred as a result of the impact

of the economic crisis in public and private sectors Current areas of enterprise demand include

management of Microsoft systems and servers, as well as systems management, basic data management, firewalls, enterprise resource planning (ERP) implementation and CRM CRM is a particularly buoyant area, while in 2011 vendors continued to sign up new business intelligence customers

The security software segment is an important opportunity, potentially worth tens of millions of dollars, and awareness of security issues has grown with the rise of cloud computing Israel has also become more aware of the growing threat and sophistication of cyber attacks and has been encouraging government and private sector organisations to take action Spending is likely to continue across all segments, with

security content and threat management the current priorities

Given the current focus on many businesses of controlling costs, the pay-on-demand SaaS model has grown in popularity and spread beyond the initial core application area of CRM The economic crisis may have provided a lasting boost to the SaaS model, particularly as broadband penetration grows More vendors are looking for channel partners to help them offer cloud computing and rented software services

to local organisations

New cloud computing offerings and increased competition in this segment should fuel further demand from users As well as cost savings, businesses will look to boost efficiency and increase flexibility of response to customer needs Large businesses are most likely to put IT applications such as mail, phone systems and document management into the cloud However, enterprise applications that require a high level of customisation, or which are subject to regulatory or data-sensitivity constraints, are more likely to stay on premise

In terms of verticals, the financial sector has been a mainstay of demand, with other key areas including defence and healthcare These three sectors are somewhat immunised against the consequences of the global slowdown Despite the current financial crisis, regulatory compliance and demand for new services will continue to drive IT spending by banks Vendors reported in Q110 that the key financial services segment had started to see demand recovery Similarly, defence spending on new systems is likely to be maintained given the current security situation

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

of US$3bn representing around two-thirds of the value of the entire domestic IT sector Almost all global vendors are active in the domestic market, selling licences alongside integration and applications services Global vendors control more than three-quarters of the market, with SAP in first place In the past, the Israeli SME segment was dominated by local software companies Now international players, including

market leaders such as SAP and Oracle, are entering with appropriate software packages Microsoft is also designing a software package for this market segment

Services

The IT services segment is forecast to reach a value of US$2.1bn in 2012, and this is expected to grow at

a CAGR of 8% over the forecast period to reach US$2.8bn in 2016 In 2011, vendors reported a

continued flow of new projects in sectors such as government, financial services, homeland security and utilities Key sectors such as government and financial services had driven a pick-up in growth in

2010 after demand was hit by a slowdown in 2009

In 2011, demand for IT services continued to be healthy, according to leading vendors, with new projects across public sector, industrial and financial verticals The defence and homeland security sector was also solid However, much will depend on confidence in the global economic recovery, particularly in key Israeli export markets Vendors have had to adapt to an environment where some projects are

commissioned more in response to immediate needs and with a focus on cost reduction

Defence and government spending represent a significant component of Israeli IT demand and have some immunity to economic vicissitudes In 2011, the Ministry of Defense awarded a number of multimillion dollar IT contracts, including a US$10mn tender in H111 for a new command and control system Among other smaller government projects in 2011, the Israeli Police awarded a US$6mn contract

Meanwhile, healthcare and utilities were also generating outsourcing projects in 2011, such as the award

of a US$17mn deal by Israel Electric Company The development of a natural gas sector should be one driver of opportunities in the utilities vertical Following a recovery in 2010 from the economic

slowdown, vendors reported that demand had revived in the key financial services vertical, where new

projects included an US$11mn IT outsourcing tender by the First International Bank of Israel

Government agencies were also commissioning or extending IT contracts, including a US$2.6mn

outsourcing contract extension awarded by Israel's Ministry of Environmental Protection

Growth is expected to reach a higher trajectory in the second half of our five-year forecast period Key Israeli IT services spending verticals include the financial sector, where international regulatory

compliance and structural and market reforms have driven substantial IT investment The sector accounts for around 25% of total IT services spending, while the government accounts for another quarter

Along with defence, these two key sectors are likely to be a continued source of opportunity because the factors driving spending in each case are not particularly sensitive to the economic downturn The new administration will likely feel pressure to ramp up government spending to combat lower private

consumption and rising unemployment Another key area of opportunity is healthcare IT

One potential demand driver will be organisations looking for help to utilise efficiencies from cloud computing such as SaaS and Infrastructure-as-a-Service (IaaS) Particular areas of opportunity for cloud computing include banking and retailing as organisations in those fields look to save money on hardware

investments In 2011, vendors such as Alcatel-Lucent have continued to invest in new cloud computing

facilities in Israel, leveraging the country's expertise

While large organisations still dominate, SMEs have also 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 Similar factors are driving an increase in demand for managed services, with businesses reluctant to invest in internal IT capabilities, or deterred from doing so by a lack of available skills

Outsourcing

Outsourcing has become a bigger factor and was forecast to account for about 20% of IT services

spending, or at least US$320mn, in 2011 Key sectors for IT outsourcing include:

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

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

ƒ The financial sector is another leading vertical for outsourcing In 2006, a deal between First

International Bank of Israel and EDS Israel was the largest outsourcing contract in the Israeli banking industry and a milestone at the time Tata Consultancy Services' decision to open a

local branch also underlines the potential attraction of the financial sector, now benefiting from economic recovery and greater security

ƒ The retail sector offers further opportunities, with IBM Israel having a 10-year outsourcing contract with Clubmarket Marketing Chains The contract includes computer systems for the

supermarket chain's branches and point-of-sale terminals

Although Israel seemingly possesses many advantages as an outsourcing destination (in particular a technologically literate, linguistically skilled workforce and low labour costs relative to most developed countries), the country has failed to capitalise on these strengths in the past Aside from Israel's small size, another issue is security However, the government is now actively promoting Israel to multinationals, and there has been a spate of call-centre construction The work seems to be paying off, with Israel starting to emerge as a desirable location for packaged applications and localisation services

Industry Developments

IT is an important element of the Israeli government's socio-economic policy framework The National Economic Council submitted a policy agenda to the government that specified two main policy tracks to

reduce poverty and achieve balanced growth The first track is expected to emerge as the main priority for the government The digital divide is both a symptom and an aggravator of relative poverty In May 2010, the Israeli Ministry of Finance launched a programme called 'Relative Advantage' to provide a boost to Israel's high-tech sector

IT will be harnessed to the second goal of achieving balanced, long-term economic growth Israel's software sector has long been one of the country's economic pillars and a magnet for inward investment The Israeli Association of Electronics and Software Industries has projected that the software sector will generate US$3.2bn annually by the end of the decade The government hoped the high-tech sector would generate US$3.0bn for the nation's economy by 2010

Offshoring

Israel is working hard to ensure it benefits from the global offshoring trend, which it sees as an area of potential Despite an often unstable political and security situation, Israel has marketed its IT skills with some success and attracted outsourcing operations from major IT corporations such as Intel, IBM and

Microsoft, as well as Motorola One factor in this, of course, has been incentives that the Israeli

government started to offer back in 2006, with subsidies of up to ILS1,000 per employee per month Several major public and private sector outsourcing deals have also highlighted the growing importance

of outsourcing

However, there are fears of a skills bottleneck In 2007, the government said Israel hoped to produce 10,000 engineers a year by 2010, up from the present graduation rate of 4,900, a small number by the standards of China, India and the US, but a big challenge for Israel The number of jobs in the sector rose

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

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

E-Services

As part of its modernisation agenda, the government is also pressing ahead with various other strands of its e-government project Among other initiatives, there has also been spending on computers in

healthcare and the nationwide paperless court initiative The e-government programme is leading to

increased demand for computers, with the Israeli government reaching a supply agreement with Dell and

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

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

December 2008, HP was awarded a contract to produce 5mn ID cards; however, it is yet to receive the go-ahead from the Knesset, which is deliberating over the passing of the biometric database bill The ID cards, set to cost Israel US$67.49mn, would use 'smart' identification methods involving fingerprints and digital photography

The 2005-2007 masterplan of the government's ERP project called for implementation in around 90 government units by the end of 2007 The project leveraged mySAP ERP (content delivery software) and had a focus on financial, logistics and human resource components Dubbed Merkava, the project cost an estimated ILS800mn since its launch in 1999

Israel's Digital Divide

It has been estimated that Israel currently has around 600,000 children living below the poverty line, and the Gini co-efficient has been estimated as among the highest of any Organisation for Economic

Cooperation and Development (OECD) country A 2007 survey found only 30% of children living in poverty have internet or home PC access, compared with 90% in the top-income group Alarm at such statistics has helped to make tackling the digital divide central to the government's key policy goal of reducing poverty There is also an ethnic dimension to digital inequalities Recent research by the

University of Haifa showed a consistent gap in internet access between the Jewish and Arab populations, with 72.5% of the former using the internet in Israel compared with 52.5% of the latter

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

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

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

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

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

Industry Forecast

BMI projects that the Israeli IT market will grow to a value of US$6.0bn in 2012, and the market is

forecast to reach US$8.1bn in 2016 In Q112, several indicators suggested moderating consumer demand, but vendors still reported a solid trading environment for IT services across industrial, government, defence and financial services segments

The Israeli IT market should gain enough momentum from key sectors to expand at a CAGR of 7% over

BMI's 2012-2016 forecast period, thanks to stable demand from defence and government sectors as well

as opportunities in verticals such as financial services and small and medium-sized enterprises (SMEs)

2012 Outlook

Spending on IT products and services is expected to moderate in 2012 In 2011 PC sales bounced back with modest single-digit year-on-year (y-o-y) growth However, growth momentum is expected to ease because of shifts in the global economic environment The Israeli economy continues to cool and sluggish external demand and weaker consumer spending are likely to weigh on headline growth throughout the year

BMI forecasts overall solid growth for the Israeli IT market for 2012 With IT spending highly correlated

wtih GDP growth, businesses will maintain a cautious attitude to IT investments this year There should, however, be opportunities for vendors around business intelligence and cloud computing Sales could receive a boost from computer purchases previously delayed as a result of the economic situation The move to mobility and new form factors such as tablets will help to drive demand in the consumer

segment, while to some extent undermining demand for traditional notebooks

Consumer spending continued to slow in Q112, after spending on durable goods such as PCs showed signs of falling off in 2011 Per capita consumption of durable goods contracted by an annualised 14.5% quarter-on-quarter in Q211 However, consumer spending should be supported by stimulatory fiscal spending as well as falling unemployment and low inflation and interest rates

Meanwhile, in 2011, vendors reported a continued pick-up in the flow of IT projects, with new large

tenders from the Israeli Ministry of Defense and the Israel Electric Company Vendors reported demand

had revived in the key financial services vertical, continuing a trend established in 2010, when new

projects included 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 7 operating system, and its eagerly-anticipated successor Windows 8,

could trigger a new cycle of hardware upgrades in 2011, although much will depend on business and

consumer confidence More than 50% of Israeli computer users are estimated to still be using the

Windows XP operating system

Market Drivers

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

BMI's five-year forecast period Household computer penetration of around 75% offers potential for

further growth High internet penetration and growing broadband penetration are drivers for the retail segment, along with interest in multimedia and mobile computing applications and the new popularity of mini-computers

Per capita IT spending is expected to rise from US$784mn in 2012 to US$1.0bn by 2016 Spending by key IT spending verticals such as defence and financial services are somewhat insulated from economic vicissitudes Vendors will target projects across a range of sectors from government to financial services, telecoms and utilities Regulatory compliance will continue to necessitate IT spending by banks and 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 a relatively low sensitivity to economic downturn compared with the commercial sector Government IT and digital-divide initiatives are important sources of opportunity for vendors, with recent projects

ranging from government e-services portals to healthcare The government remains determined to

preserve the country's status 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 by financial sector organisations should mean more large outsourcing deals Other sectors of opportunity will include healthcare and telecoms, as well as infrastructure, transport and the small office and home office sector

Opportunities

As a result of this activity, IT services are expected to display the highest growth over the forecast period 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

One potential demand driver will be organisations looking for help in using efficiencies from cloud computing, such as SaaS and Infrastructure-as-a-Service Particular areas of opportunity for cloud

computing include banking and retailing, as organisations in those fields 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

Summary

Although the Israeli economy is vulnerable to continued global economic headwinds, BMI believes that

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

hardware market is forecast to grow from US$2.6bn in 2012 to US$3.2bn in 2016, with PC sales

projected to rise from an estimated US$2.1bn to US$2.6bn Over the period, software spending is

expected to increase from an estimated US$1.3bn to US$1.8bn and services from an estimated US$2.1bn

to US$2.8bn

Table: Israel IT Sector – Historical Data & Forecasts (US$mn Unless Otherwise Stated), 2009-2016

Industry Forecast Internet

Table: Internet Data And Forecasts, 2009-2016

No of internet users, '000 4,585 4,982 5,341 5,644 5,906 6,149 6,358 6,522

No of internet users/100

e/f = BMI estimate/forecast Source: ITU, 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 2016 We estimate that there were a total of 5.34mn users as of 2011, giving Israel a penetration rate of 70.6% We expect steady, but slowing, growth in the number of internet users to continue for the duration of our forecast, resulting in 6.52mn internet users in 2016, equivalent to a penetration rate of 79.7%

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 1.874mn at the end of September

2011, up by 3.5% from 1.81mn at the end

of 2010 BMI estimates that, by the end

of 2011, Israel's broadband subscriber

base had risen to 1.893mn; this is equivalent to a penetration rate of 25% and reflects full year growth of 4.6%

Industry Trends – Internet Sector

2009-2016

e/f = BMI estimate/forecast Source: BMI

Over the next five years ended 2016 we envisage average annual growth of 3.9% for the Israeli

broadband sector This will see the subscriber base reach 2.29mn subscribers, equivalent to a penetration rate of 28% 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 fixed broadband 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 and corporate customers' broadband access Meanwhile, recent months have seen considerable reductions in the price of broadband tariffs being offered 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 Forecast

Growth To Slow Heading Into 2013

BMI View: Israel's economy will slow in H212 and early 2013, as the government is set to rein in

spending, while leading indicator data paint a relatively negative picture for private consumption and fixed investment As a result, we have lowered down our forecasts for real GDP to grow 2.8% and 3.3%

in 2012 and 2013 respectively, from 2.9% and 3.5% previously

The Israeli economy remains in a soft patch, with real GDP growth averaging 3.3% in H112, compared to real growth of 4.8% in 2011 We see private consumption and government spending slowing in H212 and early 2013 compared to the first half of the year, while the country's net export position will continue to weigh on headline growth As a result, we forecast real GDP increasing 2.8% and 3.3% in 2012 and 2013 respectively, down from our previous forecasts of 2.9% and 3.5% That said, we maintain our relatively bullish view on Israel's medium-term growth outlook, with real growth projected to average 4.1% over the 2013-2016 period

Private Consumption Outlook

Private consumption grew 3.6% o-y in seasonally adjusted terms in Q212, after increasing only 1.9% o-y in both Q411 and Q112 The inflationary outlook will certainly prove conducive to supporting

y-household spending, with our baseline scenario seeing headline CPI averaging only 2.2% this year More importantly, data from the Central Bureau of Statistics show that the unemployment rate fell to 6.5% of the active population in July, from 7.1% in June

That said, we do not see private consumption increasing at a rapid clip over the coming quarters The government's policies will be less supportive of private consumption, with parliament having approved in August a package of austerity laws that included a 1.0% rise in the value-added tax to 17.0% from

September 1 (see our online service, August 3, 'Further Austerity Measures Unlikely') In addition, there

are indications that consumption could be on the wane, with Bank Hapoalim's Consumer Confidence Index falling 3.4% m-o-m in August to 125.6 points, while Bank Hapoalim's Purchasing Managers Index (PMI) for July 2012 fell 5.9% m-o-m to 41.9%, mainly as a result of slowing manufacturing activity As a result, we forecast private consumption growing 3.2% and 3.3% in 2012 and 2013 respectively, down from our previous forecasts of 3.5% and 4.0%

Fixed Investment Outlook

Fixed capital formation grew 7.1% y-o-y in Q212, compared to its quarterly average of 17.5% in 2011, and we expect the current downtrend to continue heading into 2013 That said, fixed investment growth will outpace other segments of the economy The prospects for the real estate sector are encouraging in this regard, with the total volume of real estate transactions – which fell throughout much of 2011 –

having increased approximately 20.0% y-o-y in Q112, and 17.0% in May (see 'Housing Market In Better