Israel information technology report q4 2013

... information workers ■ Aid to be given to the less wealthy to make them part of Israel' s information industry © Business Monitor International Page 47 Israel Information Technology Report Q4 2013. .. 14 Israel Information Technology Report Q4 2013 overall growth Given Israel' s relatively rich tech skills resource base, many organisations prefer to conduct software development in-house 2013. .. International Page 21 Israel Information Technology Report Q4 2013 Macroeconomic Forecasts Macroeconomic Forecast BMI View: We project real GDP growth in Israel to come in at 3.7% and 3.8% in 2013 and 2014

Q4 2013 www.businessmonitor.com

ISRAEL

INFORMATION TECHNOLOGY REPORT

INCLUDES 5-YEAR FORECASTS TO 2017

Report Q4 2013

INCLUDES 5-YEAR FORECASTS TO 2017

Part of BMI’s Industry Report & Forecasts Series

Published by: Business Monitor International

Copy deadline: August 2013

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BMI Industry View 7

SWOT 9

IT SWOT 9

Political 11

Economic 12

Business Environment 13

Industry Forecast 14

IT Market 14

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

Internet 20

Table: Table: Internet Data And Forecasts, 2010-2017 20

Macroeconomic Forecasts 22

Macroeconomic Forecast 22

Industry Risk Reward Ratings 28

Table: Middle East And Africa Risk/Reward Ratings Q413 30

Market Overview 31

Hardware 31

Software 36

Services 40

Industry Trends And Developments 45

Regulatory Development 49

Table: IT Regulatory Authorities 49

Table: Government Initiatives 52

Company Profile 53

Ness 53

Matrix 58

Regional Overview 62

PC Market Feels The Squeeze 64

Demographic Forecast 66

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

Table: Israel's Population By Age Group, 1990-2020 (% of total) 68

Table: Israel's Key Population Ratios, 1990-2020 69

Table: Israel's Rural/Urban Population Split, 1990-2020 69

Methodology 70

Methodology 70

IT Industry Forecasts 70

IT Risk/Reward Ratings - Methodology 71

Table: IT Business Environment Indicators 72

Weighting 73

Table: Weighting Of Components 73

Sources 73

BMI Industry View

BMI View: IT spending is expected to reach ILS22.6bn in 2013, with relatively stronger growth in software

and services, compared to hardware as the market matures Although vendors reported a seasonal dip in new projects in Q113, BMI believes IT spending will remain on a positive trajectory this year The market will increasingly be driven by software and services in key sectors such as government, defence and

financial services - resulting in IT services accounting for 36.4% of the overall market spending by 2017

Headline Expenditure Projections

Computer Hardware Sales: ILS9.56bn in 2012 to ILS9.55bn in 2013, down 0.1% in local currency terms.

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

Software Sales: ILS5.0bn in 2012 to ILS5.1bn in 2013, an increase of 2.3% y-o-y Device and data

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

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

ILS7.73bn in 2012 to ILS7.90bnin 2013 Stable sectors such as government and defence offer continuedrevenue opportunities, while growth will be derived from cyber and data security, cloud computing andoutsourcing

Key Trends & Developments

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

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

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

■ BMI also highlights the potential for of continued financial sector spending in Israel as a result of a

number regulatory changes introduced in the wake of the economic crisis of 2008-2009.Israeli financialservices regulatory body the Israeli Security Authority has increased supervision of companies offering

advice with respect to pensions, insurance and other financial products This, in turn, has generatedadditional IT spending, with banks and other organisations often needing to implement solutions toensure compliance within a set time.

IT SWOT

SWOT Analysis

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

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

■ Strong defence and government spending provides base for IT demand

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

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

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

Weaknesses ■ The recession at the beginning of the 2000s created a client mentality of focusing on

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

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

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

sales growth in data security as well

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

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

SWOT Analysis - Continued

■ Defence and government projects should be less sensitive to fiscal retrenchment,with a major Savings and Insurance Exchange project rolled out by the Ministry ofFinance in 2013

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

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

■ Healthcare IT will be a growing source of opportunity

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

sentiment

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

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

SWOT Analysis

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

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

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

of political views is represented within government

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

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

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

■ With the civil war in Syria intensifying, risks of a spill over into Israel are increasing

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

exercises over a larger geographic area

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

Gaza Strip and Israel's military incursion into the territory in December 2008/January

2009 have added to uncertainty Despite the ongoing truce between Jerusalem andGaza city, finding a lasting solution continues to pose a dilemma for Israel

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

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

SWOT Analysis

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

will help to keep the fiscal deficit under control

■ The workforce is highly educated and skilled

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

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

can have an immediate impact on domestic confidence, tourism receipts, theexchange rate and foreign investment

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

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

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

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

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

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

■ Competition from emerging Chinese and Indian producers of high-tech goods andpolished diamonds, as well as sluggish growth in the eurozone, could underminedemand for Israeli exports

Business Environment

SWOT Analysis

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

networks, as well as transparent legislation

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

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

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

Opportunities ■ The Qualified Industrial Zone agreements with Jordan and Egypt boost the potential

for trade

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

and could regain strength in 2013

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

- PC 6,844 7,208 7,840 7,908 8,069 8,383 8,895 9,301

- Servers 760 799 860 860 877 911 967 1,011 o/w Software 4,225 4,541 5,004 5,117 5,347 5,690 6,186 6,370 o/w Services 6,529 7,018 7,734 7,908 8,263 8,793 9,561 10,096

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

e/f = estimate/forecast Source: BMI

We have made a minor adjustment to our forecast in the Q413 update on the basis of the macroeconomicenvironment, but our assessment of the underlying trends in the market is unchanged We continue to holdthe view that the Israeli IT market will experience only limited growth over the medium term and decline as

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

We believe the IT market reached a value of ILS22.3bn in 2012, equal to around US$5.7bn Our lowerexpectations of growth in 2012 and 2013 have caused the decrease in our forecasts, although the latter yearssee little change to overall growth expectations Israel remains a robust IT market with plenty of

development across industrial, government, defence and financial services spending

Our five-year CAGR sees growth around 5.2% in Israeli new shekel terms for the period from 2013-2017

We expect IT services will be the fastest growing segment of the IT market, narrowly ahead of software,with both growing fast relative to hardware In terms of key verticals, financial services remains an

important vertical, boosted compliance with new regulations introduced in the wake of the economic crisis

in 2008-2009 Defence and government will remain key in the market's sustained importance to the overalleconomy, with security an important source of growth The nature of sales will change however as businessbecomes increasingly important and the hardware segment contributes comparatively less to the market's

overall growth Given Israel's relatively rich tech skills resource base, many organisations prefer to conductsoftware development in-house.

2013 Outlook

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

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

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

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

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

on investments to protect their IT systems

Other areas we expect to see growth include business intelligence and cloud computing, with the latterlikely to gain traction among SMEs as a lower cost alternative to bespoke systems Meanwhile sales ofhardware and software will receive a boost from Windows-8 driven upgrades and computer purchasespreviously delayed as a result of the economic situation The move to mobility and new form factors such astablets, hybrids and ultrabooks will help to drive demand in the consumer segment, while to some extentundermining demand for traditional notebooks

Meanwhile, despite the challenging trading conditions, vendors have reported a continued flow of ITprojects, with large tenders from the Israeli Ministries of Finance and Defence and the Israel ElectricCompany Following the global financial crisis, vendors reported demand had revived in the key financialservices 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

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

2013, although much will depend on business and consumer confidence A substantial share of Israelicomputer users are estimated to still be using the Windows XP operating system Windows 8 could also fuel

the ultrabook market as tablet makers leverage its capabilities to offer devices with touch screens andconvertible designs.

Market Drivers

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

BMI's five-year forecast period to 2017 Although household computer penetration of around 75% offers

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

Per capita IT spending is expected to rise from ILS2,965 in 2013 to ILS3,459 by 2017 However, spendingwill fail to keep pace with GDP growth in Israel as the economy becomes less heavily weighted towards thehigh-tech sector following gas exploration and growth in other sectors Some key IT spending verticals willhowever keep pace, for instance defence and financial services, which are somewhat insulated from

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

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

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

BMI expects IT services will display the highest

growth over the forecast period to 2017, due to

growth in key verticals and the opportunities

presented by cloud computing, big data analytics and

real-time enterprise services based on the internet of

things In addition, growing enthusiasm for

outsourcing is putting Israel on the map, with some

recent large tenders such as HP's contract for

outsourced management of the Israeli navy's IT

infrastructure The economic slowdown may

reinforce this trend

Israel is also emerging as a location for some

business process outsourcing (BPO) functions

helped by government incentives However, much

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

environment

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

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

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

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

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

Summary

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

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

Industry Trends - IT Market

2010-2017

e/f = BMI estimate/forecast Source: BMI

sufficient strength in key demand verticals to maintain a positive trajectory over the medium term.

However, we do not expect growth to keep pace with GDP as market saturation and price competitionbetween vendors limit increases in the total value of the market The hardware market is forecast to growfrom ILS9.6bn 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

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

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

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

e/f = BMI estimate/forecast Source: BMI

As with our fixed-line and mobile telephony

forecasts, we have revised and extended our forecast

for the development of Israel's internet user and

broadband subscriber markets Our new set of

forecast figures runs to the end of 2017 There were

approximately 5.115mn users as of 2011, giving

Israel a penetration rate of 67.6% We expect steady,

but slowing, growth in the number of internet users

to continue for the duration of our forecast, resulting

in 6.356mn internet users in 2017, equivalent to a

penetration rate of 77.7%

Meanwhile, owing to a lack of reliable data on the

number of mobile broadband subscribers

(specifically those subscribers who use USB dongles

and data cards to access the internet via laptops, PCs

and smartphones), our forecast for the Israeli

broadband sector is currently based on fixed broadband connections only Data published by incumbent

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

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

Industry Trends - Internet Sector

2010-2017

e/f = forecast Source: BMI

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

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

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

Accelerating Despite Weak Domestic EconomyIsrael - Components Of GDP (ILSbn) & Real GDP Growth, % chg y-o-y

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

Private Consumption Outlook

Private consumption grew 2.9% y-o-y in seasonally adjusted terms in Q113, after increasing 3.1% y-o-y inQ412 The inflationary outlook will certainly prove conducive to supporting household spending, with ourbaseline scenario seeing headline CPI averaging 1.9% this year, slightly higher than 1.7% in 2012

Moreover, the Bank of Israel (BoI) cut benchmark interest rates by 25 basis points to 1.25% on May 26, amove which follows a 25 basis points cut which took place on May 13 We believe that the BoI's dovishmonetary policy stance will continue, and we forecast the benchmark interest rates coming in at 1.00% and0.75% in 2013 and 2014, respectively, a trend which will support private consumption growth over the

coming quarters (see 'Chart of Day: Further Rate Cuts On The Cards').

Increasing In AprilIsrael - Unemployment Rate

Source: BMI, Central Bureau of Statistics

That said, Israel's Finance Ministry released on May 7 the draft 2013-2014 budget, which includes severaltax hikes and cuts to expenditure in a view to bring the budget deficit to below 4.65% of GDP in 2013 and3.0% in 2014, respectively, from a 4.2% deficit in 2012 Although drastic cuts are unlikely, we believe that

consumer demand will be hit in H213 (see 'Austerity Measures Hitting Domestic Consumption', May 14).

For instance, Finance Minister Yair Lapid won a concession from union leaders to delay until 2015 a 1.0%scheduled pay increase for public employees, which was originally due in July 2013 Moreover, According

to latest data released by Israel's Central Bureau of Statistics, the unemployment rate came in at 6.9% inApril, from 6.6% in March Given relatively weak consumption patterns, while fiscal cuts could hit publicsector job creation in H213, we project the unemployment rate coming in at 6.7% this year, the same level

as 2012 We forecast private consumption increasing 3.1% in 2013 and 2.5% in 2014, when we expect themajority of spending cuts to take place

Dovish Monetary Policy Supporting Private Consumption

Israel - CPI Vs Policy Rate

Source: BMI, Bank of Israel

Government Spending Outlook

Government consumption growth declined 0.7% y-o-y in Q113, compared to quarterly average growth of2.9% in 2012 Given the aforementioned cuts to expenditure, we believe that government consumption willremain relatively subdued over the coming quarters For instance, the government is planning significantcuts for the Education Ministry's budget, which will likely lead to a freeze of several programs which aim toreduce the financial burden on middle-class parents on their children's education, as well as cuts to funding

for ultra-Orthodox religious students We forecast government consumption expanding 2.0% and 1.4% in

2013 and 2014, respectively

Imports and Fixed Investment Declining Steadily

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

Source: BMI, Central Bureau of Statistics Israel

Fixed Investment Outlook

Fixed capital formation declined 8.3% y-o-y in Q113, compared to quarterly average growth of 4.0% in

2012 and 17.5% in 2013 That said, while fixed investment will increase at a slow pace this year, base

effects will ensure that growth returns to positive territory over the coming quarters Moreover, BMI's

Infrastructure research team sees significant prospects in the energy sector The discovery of the Leviathanand Tamar gas fields, which comprise some of the Mediterranean's largest gas finds, has attracted interest

from oil majors such as Russian outfit Gazprom, and we see investment in the segment picking up in H213 Finally, the Israeli government approved in April the construction of 500 new homes in the West

Bank, which will form part of a proposed new city on the site of the Gush Ezion settlement, a move whichreaffirms Jerusalem's commitment to lowering house prices We forecast gross fixed capital formationexpanding 4.0% in 2013 and 6.0% in 2014

Net Exports

We see Israel's net export position coming in surplus to the tune of 0.7% and 0.8% of GDP in 2013 and

2014, respectively, up from a deficit of 0.8% of GDP in 2012 Total exports increased 2.5% y-o-y in Q113,compared to average quarterly growth of 0.1% in 2012 and 5.2% in 2011 Base effects will ensure that

exports expand at a faster pace this year compared to 2012 Moreover, recent cuts to interest rates (see above) have significantly slowed the appreciation of the shekel, which gained 11.4% as of June 8, 2013

since hitting multi-year lows in July 2012 We see the unit trading sideways over the coming quarters,which will benefit Israeli exporters

That said, we do not expect exports to increase dramatically, mainly due to slow growth in the US economyand the eurozone - which together account for approximately 60% of the country's exports Indeed, weproject the economy in the eurozone contracting 0.3% this year, from a 0.6% contraction in 2012, while we

see real GDP growth in the US increasing 2.1% in 2013 from 2.2% in 2012 (see April 29, 'Global

Assumptions - Q3 2013 - Update') We forecast total exports increasing 2.4% in 2013 and 3.0% in 2014 in

Imports have been declining steadily over the past quarters, mainly as a result of slow expansion in privateconsumption and fixed investment As we see growth in those components unlikely to pick up significantlythis year, imports will continue to grow at a modest pace In addition, Israel will start pumping gas from theTamar field by June, which will enable the country to reduce its dependence on imported gas for much of itselectricity generation and allow for a significant improvement in the country's balance of payments position.

We forecast total imports increasing 1.0% in 2013 and 1.2% in 2014

Industry Risk Reward Ratings

There are minor changes in the scores of some countries in BMI's IT Risk/Rewards Ratings (RRRs) for the

Middle East and Africa (MEA) The regional average score across all four categories of our ratings haschanged this quarter, with decreases in the industry rewards, country rewards and country risks averagescores and an increase in the industry risks score As a result, the overall aggregate score has fallen

marginally to 54.3, from 54.9 in the previous However, the only change in the country rankings on ourtable is a swap between Saudi Arabia and South Africa for the fifth and sixth positions The former hasmoved up one place into fifth, while the latter has dropped one place into sixth

BMI has a positive outlook for the IT sector across the entire MEA region based on key macroeconomic

and industry-specific growth factors These include strong economic growth and, consequently, real privateconsumption growth, increasing disposable among a rapidly expanding middle class, increasing access tonext generation broadband technologies and high public spending on IT-related projects Although thesefactors create significant growth opportunities for IT vendors and their channel partners, there are somerisks that threaten to prevent the region's IT market from reaching its full potential The most notable risksare a weak regulatory environment, evidenced by poor IP and piracy, low income levels and lack of

connectivity among the majority of the population in less affluent countries

Qatar's reign at the top of our ratings has continued this quarter with an aggregate score of 68.4, unchangedfrom the quarter The country sits above Israel, which is in a close second position with an aggregate score

of 68.2 Qatar's best score is in the country rewards category where, along with Kuwait, it registers themaximum score of 100 to reflect its high GDP per capita and relatively low unemployment rate, especiallyamong locals The country also benefits from a rate of urbanisation and access to power Qatar's industryrewards score is the third highest in the region Although it will continue to be held back by the country'srelatively small population, we highlight the potential for an upgrade in the future to reflect the plannedpublic spending on infrastructure and IT projects in preparation for the hosting of the 2022 FIFA World Cuptournament

Israel remains in second place with strong scores in the country rewards, industry risks and country riskscategories The Israeli IT market is ahead of all other countries in the region in many regards, PC literacyand penetration rate, e-governance and domestic production of IT products and services Israel also hosts alarge number of IT research and development facilities while consumer spending on IT products in thecountry is the highest in the region

The UAE and Kuwait retain third and fourth places this quarter The UAE has the highest score in thecountry risks category in the region, reflecting a combination of political stability, economic growth andstrong private consumption We have reined in Kuwait's industry rewards score this quarter to reflect acautious outlook for capital expenditure (capex), which has tended to miss government targets by widemargins in recent years The average implementation rate of the CAPEX budget has been approximately75% over the last five years, weighed down by recurrent disputes between the government and the

legislature, red tape and an inefficient bureaucracy, as well as chronic dissolutions of parliament

Saudi Arabia has moved up to fifth position this quarter, although there was no change to its score in any ofour four categories The country has benefited instead from changes to South Africa's score in three out offour categories, resulting in the decrease of its aggregate score from 58.3 to 57.6 The country's industryrisks score increased by 10pts to 55.0 to reflect improvements in the regulatory environment However, thiswas offset by a 16.7pt decrease in its country risks score over continued economic uncertainty and itsimpact on private consumption growth

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

government will continue to drive growth in the IT sector in the markets through public spending andinvestments in various e-governance projects Nigeria and Ghana, two of the new countries in our expandedcoverage, remain in ninth and 11th positions with no changes to their scores in any of our four categories.Nigeria has the joint highest score in the industry rewards score, with South Africa, owing to its largepopulation and strong government IT procurement

Nigeria and the four countries ranked below it on our table all score below the regional average in theindustry risks category, highlighting low scores for IP protection with the counterfeit software segment stillquite high Lebanon has the lowest score in this category, with software piracy in that country among thehighest in the region Efforts at taming this trend are undermined by the country's political and securityinstability Lebanon remains a key logistics and distribution centre for IT products within the region

considering the country's geographic location, which puts it in close proximity to major markets in Europe,Middle East and North Africa

Egypt and Kenya occupy the two last positions on our table, both of them held back by weak countryrewards scores despite relatively high scores in the industry rewards category Egypt's industry rewardsscore is boosted by the size of its population, the second biggest in the region after Nigeria, while Kenya

benefits from strong public spending in ICT as reflected by the government's multibillion dollar schoolcomputerisation project and various other e-governance initiatives However, Egypt is hamstrung by itseconomic woes and high unemployment rate Although its country risks score is unchanged this quarter,there is potential for a downgrade in subsequent updates on the back of uncertainties surrounding the recentchange of government in the country.

For its part, Kenya's low rate of urbanisation and GDP per capita are two key downsides risks to the

country's ambitious vision 2030 plan of integrating IT into every aspect of national development Thecompany is progressing with plans to be a sub-regional hub in East Africa by attracting major global ICT

players Global IT services giant IBM established an innovation centre in Kenya, the third in Africa after Morocco and South Africa and in Kenya in May 2013, while Vodafone Global Enterprises announced

plans in July 2013 to establish two new regional hubs in Nairobi, Kenya, and Accra, Ghana

Table: Middle East And Africa Risk/Reward Ratings Q413

Country Industry Rewards Country Rewards Industry Risks Country Risks Rating IT Rank Previous Rank

Qatar 55.8 100.0 55.0 66.3 68.4 1 1 Israel 55.0 95.0 65.0 67.0 68.2 2 2 UAE 52.5 90.0 60.0 68.3 65.4 3 3 Kuwait 42.5 100.0 40.0 66.0 60.5 4 4 Saudi Arabia 45.8 75.0 55.0 67.7 58.0 5 6 South Africa 63.3 50.0 55.0 45.0 57.6 6 5 Oman 31.7 80.0 52.5 60.5 51.2 7 7 Bahrain 28.3 80.0 57.5 61.8 50.5 8 8 Nigeria 63.3 30.0 45.0 44.7 49.6 9 9 Lebanon 46.7 65.0 20.0 42.2 47.2 10 10 Ghana 51.7 35.0 40.0 50.8 46.0 11 11 Egypt 53.3 25.0 45.0 43.4 43.6 12 12 Kenya 53.3 10.0 55.0 33.6 39.4 13 13

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

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

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

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

As well as economic and IT market trends, another

factor behind our pessimistic outlook for 2013 is the

risk of a further escalation of hostilities between

Israel and Gaza This uncertainty will drag on

confidence and curtail investments in some areas

Wider economic uncertainty means businesses are

now investing more to increase flexibility and realise

cost efficiencies rather than expand IT hardware

capabilities, but nonetheless there should be growth

areas However, as noted, lower average prices have

meant that revenue growth in most segments has

lagged shipments

BMI forecasts real GDP growth of 3.5% in Israel in

2013, a slight improvement from 3.1% real growth

in 2012 However, the more relevant figures for the

hardware market are the slower rate of real private

final consumption growth, at 2.5% in 2013 compared to 3.2% in 212, and the slowdown on real governmentspending from 4% in 2012 to 2.5% in 2013 The government's policies are less supportive of privateconsumption in 2013 The 1% rise in VAT that was part of the government's package of austerity laws,approved by parliament in August 2012, will have an impact on discretionary spending on items such asPCs and notebooks This has an obvious impact on the growth potential of the IT market, as consumersconsider reigning in their spending and government faces fiscal constraints on new investments

Hardware Demand2010-2017

e/f = BMI estimate/forecast Source: BMI

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

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

government has launched various initiatives to increase computer and internet penetration, includingComputer for Every Child, Window to Tomorrow's World, Tapuah (the Israeli Society for the Advancement

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

Upgrades to new systems and purchases of personal computing devices will remain the bulk of marketsales Mobile computing devices including tablets, slimline notebooks, ultrabooks and hybrids present agrowth opportunity for vendors as consumers buy personal products to complement the household desktop

or laptop This segment will be held back by a weak consumer outlook in 2013, but strengthen 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 release of Windows 8 is expected to result in higher sales in the retail and enterprisemarkets In the retail market Windows 8 will deepen the tablet market, as well as introducing hybrids, while

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

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

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

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

Evolving Form Factors

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

2012 (excluding communications hardware) Prior to 2012, notebooks were the fastest-growing segment of

the market, although as recently as 2008 desktops still took around two-thirds of unit sales However in2010-2011 the share of desktops declined precipitously, and then in 2012 there was a shift from notebooks

to tablets as the fastest growing segment of the market

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

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

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

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

The tablet market in Israel has been dominated by

Apple However, its relative position did weaken in

2012 and it faces much stronger competition in

2013 Data from Statcounter show Apple's iOS, run

on its tablets, accounted for 2.1% of Israeli PC

browsing traffic in March 2013 - a figure that was up

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

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

Nexus range accounted for less than 1% of PC

browsing traffic in March 2013 This recent data

reinforces Apple's dominance However, with the

widening range of Android devices - including the

Kindle Fire from Amazon, the Nexus 7 and 10 and

Samsung's Galaxy Tab range - competition will

continue to intensify

A key feature of the threat posed to Apple by Android vendors came only after the release of lower costtablets and were predominantly the smaller 7" form factor This contrasted with Apple's larger and moreexpensive iPad - and the popularity of these smaller, cheaper devices, catalysed the development of Apple'sown iPad Mini Apple is set to face competition throughout 2013 from rival Android vendors that will offerconsumers a wider choice in terms of price and size, as well as specifications and features

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

March 2013

Source: Statcounter

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

The tablet market in Israel remains relatively undeveloped, with low penetration, and heavily dominated by

Windows machines BMI forecasts Israeli market PC tablet sales at 279,000 units in 2013 and projects that

sales could pass 500,000 in 2017 As such a significant development that will affect both the tablet marketand the notebook market is the arrival of Windows 8 In October 2012, with the launch of the new OS,Windows vendors were able to introduce touch devices - with a number of tablets released in Q412 andQ113 The addition of more vendors and another touch OS will add to competition in the market - puttingfurther pressure on prices

However the more significant development is the medium term impact on innovation and form factors.Windows has a traditional strength in productivity use cases and software, with the OS being central to theenterprise market and Microsoft's Office Suite ubiquitous There is therefore an opportunity for vendors toleverage this strength over rival iOS and Android devices by designing tablets with strong productivityfunctionality alongside the passive media consumption features Early examples have been hybrid devices

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

Although design innovation has some way to go, and prices of hybrids will need to decline, the multi-usedevice has scope to capture a share of the tablet market by offering a stronger value proposition to

consumers while not compromising on user experience

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

Vendor Performance

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

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

Samsung - as well as the shift to tablets Most PC market growth in 2012 was driven by growth in 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 totop spot with a market share of 21.2%, overtaking HP and Dell In second position was Asus with 16%market share, up from 12.2% in 2011, also overtaking HP and Dell which both had 15.2% market share in

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

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

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

Google's Nexus 7 alongside its own products

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

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

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

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

greentech, and digital media technology and applications

Lenovo is far from the only multinational PC vendor to be increasing its R&D investment in Israel In early

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

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

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

reported US$390mn

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

Enterprise Storage Business The new centre is based on Exanet, which Dell acquired in 2010 The centre

will focus on developing storage technologies and cloud computing solutions Meanwhile, Acer's inventory

problems resulted in the vendor losing ground in the regional market

In H113, leading software vendors in the Israeli market reported steady, single-figure growth, much in linewith our forecast Leading Israeli software and services group Formula Systems announced that its revenueswere up by 6% in Q113, compared with the same period of the previous year However group companyMatrix, which derives most of its revenues from the Israel market, experienced a decline in its operations,due largely to seasonal factors In Israel, the first quarter usually reflects a decline following an active fourthquarter, during which companies seek to utilise budgets before the end of the fiscal year The third quarter isalso generally a slower quarter, reflecting reduced activities during the summer months

Despite the uncertain global economic outlook for Israel's export-based economy, opportunities for softwarevendors continue to exist across a range of sectors from government to energy, financial services, telecomsand utilities Major customers for software solutions in Israel include large and medium enterprises such ascommercial banks, loan and mortage banks, credit card companies, insurance companies, telecoms serviceproviders, hi-tech companies, and the Israeli Defence Force and 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) Local IT leader Ness was among those vendors reporting

a rebound in Israeli market revenue growth, with the company's annualised revenue growth increasing ineach quarter

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

Microsoft Israel has an annual turnover of around

US$1bn It hopes its Windows 8 operating system,

launched in October 2012, will continue to boost

sales throughout 2013, with support for the

Windows XP operating system due to be withdrawn

in 2014 Israel also hosts an important research and

development centre for Microsoft, one of its 3

largest global facilities As of Q111, the centre,

which employs 600 workers, was reported to be

developing 13 new products in various areas In

2010, the centre launched Microsoft's new unified

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 product

positions Microsoft to make a play for the

Software-as-a-Service (SaaS) market opportunity About 70%

of the centre's work is now focused on cloud computing, with Microsoft Israel expecting to hire up to 100new workers for cloud computing projects

Migrations to the Windows 8 operating system should have a positive impact on 2013 sales despite businesscaution and the fact that the pre-launch publicity for Windows 8 was more low-key than for its predecessorWindows 7 Microsoft is touting the touchscreen capabilities of Windows 8 and Q412 saw the release of anew wave of Windows 8 tablets and notebooks A large portion of Israeli computer users are estimated tostill be using the Windows XP operating system, accounting for over 25% of PC browsing traffic in March

2013, and this represents a significant potential market, as support for XP will be withdrawn by 2014

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 utilities

Software Sales (ILSmn)

2010-2017

e/f = BMI estimate/forecast Source: BMI.