Israel information technology report q4 2014

... International Page 37 Israel Information Technology Report Q4 2014 Israel PC Browsing Traffic By OS (%) And Y-o-Y Change (pps) July 2014 Source: Statcounter Vendor Performance The Israeli PC market... Industries technology campus in the Negev and expand its computer services segment in Israel © Business Monitor International Page 49 Israel Information Technology Report Q4 2014 Israeli Start-Ups... International Page 21 Israel Information Technology Report Q4 2014 Macroeconomic Forecasts Economic Analysis BMI View: We forecast real GDP growth in Israel of 3.2% and 3.6% in 2014 and 2015, respectively,

Q4 2014 www.businessmonitor.com

ISRAEL

INFORMATION TECHNOLOGY REPORT

INCLUDES 5-YEAR FORECASTS TO 2018

Report Q4 2014

INCLUDES 5-YEAR FORECASTS TO 2018

Part of BMI’s Industry Report & Forecasts Series

Published by: Business Monitor International

Copy deadline: July 2014

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BMI Industry View 7

SWOT 9

IT SWOT 9

Wireline SWOT 11

Political 12

Economic 13

Business Environment 14

Industry Forecast 15

IT Market 15

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

Broadband 20

Internet 20

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

Macroeconomic Forecasts 22

Economic Analysis 22

Table: Economic Activity (Israel 2009-2018) 26

Industry Risk Reward Ratings 27

Table: MEA IT Risk/Reward Ratings Table, Q414 31

Market Overview 33

Hardware 33

Software 39

Services 44

Industry Trends And Developments 48

Regulatory Development 53

Table: IT Regulatory Authorities 53

Table: Government Initiatives 56

Competitive Landscape 57

International Companies 57

Table: Intel 57

Local Companies 58

Table: Amdocs 58

Table: Check Point 59

Table: Imperva 60

Table: Retalix 61

Company Profile 62

Ness 62

Matrix 67

Regional Overview 71

Demographic Forecast 76

Demographic Outlook 76

Table: Israel's Population By Age Group, 1990-2020 ('000) 77

Table: Israel's Population By Age Group, 1990-2020 (% of total) 78

Table: Israel's Key Population Ratios, 1990-2020 79

Table: Israel's Rural/Urban Population Split, 1990-2020 79

Methodology 80

Industry Forecast Methodology 80

Sources 81

Risk/Reward Ratings Methodology 82

Table: It Risk/Reward Ratings Indicators 83

Table: Weighting Of Components 84

BMI Industry View

BMI View: Although Israel's small and mature IT market is expected to grow more slowly than most others

in MEA, its combination of a skilled workforce, rich start-up culture and university engagement in edge research has attracted the investment of nearly all major global IT vendors We forecast IT spending

cutting-to rise by 3.5% cutting-to ILS23.4bn in 2014, with the software and services segments outperforming hardware sales IT spending is projected to continue growing throughout our five-year forecast period to 2018, accelerating in the later years as Israel's economy recovers from a downward trend between 2010 and

2014 BMI does not expect the escalation in violence between Israel and Hamas in the Gaza Strip to drag

on GDP growth for 2014, but we do expect increasing tensions throughout the region to result in rising demand for security solutions in key sectors such as government, defence and financial services This will contribute to the software and services segments accounting for an increasing share of the IT market, reaching 65.0% of overall market spending by 2018.

Headline Expenditure Projections

Computer Hardware Sales: Forecast to reach ILS9.225bn in 2014, up from ILS9.143bn in 2013 We

expect a return to growth in 2014 to be driven by the launch of 4G mobile networks and ongoing migration

to the Windows 8 OS

Software Sales: ILS5.867bn in 2014, up 4.5% year-on-year (y-o-y) from ILS5.524bn in 2013 Enterprise

software spending will be the main growth driver as device and data proliferation will result in increasedspending on customer relationship management (CRM), databases and business intelligence

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

reaching ILS8.26bn in 2014, up from ILS7.91bn in 2013 Cyber security services will outperform in terms

of growth, but it will be stable sectors such as government and defence that continue to account for themajority of spending

Key Trends And Developments

Israel's defence, public and private installations are prime targets for cyber attacks, partly due high

geopolitical tensions The recent uptick in regional conflicts and Israel's military activities in Gaza haveamplified the threat level in recent months, and is expected to result in growing demand for cutting-edgesolutions from public and private institutions Local and international companies are already positioning

themselves to take advantage of this opportunity by investing in various efforts to develop new solutions for

the market In July 2014, Microsoft and cloud services provider Akamai partnered to launch a cyber security-focused start-up accelerator program in Israel, in partnership with venture capital firm Jerusalem Venture Partners In June, Israeli security analytics company Fortscale announced that it raised

USD10mn in funding from Intel Capital and Blumberg Capital to expand its R&D program Also in June, cyber security startup Hexadite announced a USD2.5mn in seed funding for its operations In April 2014 Israeli economic minister Naftali Bennett stated that Intel plans to invest around USD6bn to upgrade its

Kiryat Gat chip plant At the time of writing the company had not yet officially confirmed the investment,but the development is in line with talks between the government and Intel in January 2014 on its

investment plan for the country over the coming decade According to media reports, the Ministry ofEconomy's Investment Center is poised to offer Intel a grant of 5% of the company's investment,

approximately ILS750mn

IT SWOT

SWOT

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

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

■ Strong defence and government spending provides base for IT demand

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

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

Weaknesses ■ The recession at the beginning of the 2000s focussed customers on the bottom line,

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

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

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

concerns of government and enterprises escalate

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

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

■ 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

Threats ■ Government austerity measures will dampen consumer and business spending

SWOT - Continued

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

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

Wireline SWOT

SWOT

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

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

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

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

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

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

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

should stimulate much greater competition

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

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

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

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

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

SWOT Analysis

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

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

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

of political views is represented within government

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

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

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

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

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

exercises over a larger geographic area

Threats ■ Finding a lasting solution with the Palestinians continues to pose a dilemma for Israel,

and we think a final agreement will remain elusive

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

SWOT Analysis

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

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

■ The workforce is highly educated and skilled

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

Weaknesses ■ A sharp deterioration in the security situation can have an immediate impact on

domestic confidence, tourism receipts, the exchange rate and foreign investment

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

Opportunities ■ In the long term, relatively elevated levels of employment will underpin private

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

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

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

Business Environment

SWOT Analysis

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

networks, as well as transparent legislation

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

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

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

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

country

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

and could regain strength over the next years

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

f = BMI forecast Source: BMI

We continue to hold the view that the Israeli IT market will experience only limited growth over themedium term and will gradually decline as a percentage of GDP This is a product of saturation of thehardware and software/services market and price competition between vendors, which will hold down theoverall value of the market Nevertheless, Israel remains at the forefront of development of security servicesand continues to attract investment in research and development centres from global IT firms

We forecast the IT market to reach a value of ILS23.355bn in 2014, equal to USD6.597bn and up fromILS22.6bn in 2013 Despite our expectations of relatively weak growth in 2013 and 2014, we maintainoptimistic more positive outlook for Israel's IT market over the long term Israel remains a robust IT marketwith plenty of development across industrial, government, defence and financial services spending

Our five-year CAGR sees growth around 4.8% in Israeli new shekel terms for the period from 2014-2018

We expect IT services will be the fastest growing segment of the IT market, narrowly ahead of software,with both growing fast relative to hardware In terms of key verticals, the financial services and defencesectors drive growth, with rising geopolitical tensions likely to result in even stronger demand for ITsecurity solutions The nature of sales will change, however, as business becomes increasingly importantand the hardware segment contributes comparatively less to the market's overall growth Given Israel'srelatively rich tech skills resource base, many organisations prefer to conduct software development in-house

2014 Outlook

We project real GDP growth of 3.2% in Israel in 2014, then forecast slow but steady acceleration in GDP

growth throughout our forecast period, reaching 4.2% in 2018 At the time of writing, BMI's Country Risk

team does not expect the sharp escalation in violence between Gaza and Israel to impact the latter's GDPgrowth in 2014 However, an extended period of violence poses a downside risk to this outlook

BMI also forecasts relatively weak expansion of private consumption growth at 3.1% in 2014, mainly as a

result of the implementation of austerity measures by the government This could also be negatively

impacted by ongoing violence between Israel and Gaza

While government austerity and political instability have weighed on Israel's economic outlook, we believethere will nonetheless be opportunities for vendors in the IT market, most notably in demand for cyber andinformation security products and services This is a growth area in IT markets globally, but there is aparticularly large opportunity in Israel where regional political tensions and the uptick in cyber attacks in

2012 and 2013, affecting Israel, UAE and Saudi Arabia, have concentrated the minds of government andenterprise decision makers on investments to protect their IT systems

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

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

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

projects, with large tenders from the Israeli ministries of finance and defence and the Israel Electric Company In December 2013 VMware won a data centre contract from the Israel Defence Forces valued at

USD27mn in the local media

Industry Trends - IT Market

2011-2018

IT market value, ILSmn (LHS) IT market value, % of GDP (RHS)

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

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

2 2.1 2.2 2.3 2.4 2.5

f = BMI forecast Source: BMI

Market Drivers

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

BMI's five-year forecast period to 2018 Although household computer penetration of more than 75% offers

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

Per capita IT spending is expected to rise from ILS2,986 in 2014 to ILS3,496 by 2018 However, spendingwill fail to keep pace with GDP growth in Israel as the economy becomes less heavily weighted towards thehigh-tech sector following gas exploration and growth in other sectors Some key IT spending verticals willhowever keep pace, for instance defence and financial services, which are somewhat insulated from

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

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

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

Income Per Capita Breakdown

2011-2018

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

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

25,000 50,000 75,000

e/f = BMI estimate/forecast Source: BMI, national sources

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

key verticals and the opportunities presented by cloud computing, big data analytics and real-time enterpriseservices based on the internet of things In addition, growing enthusiasm for outsourcing is putting Israel 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

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

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

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

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

opportunity Many SMEs are waking up to the need to compete through more direct investment in 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

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

over the medium term However, we do not expect growth to keep pace with GDP as market saturation andprice competition between vendors limit increases in the total value of the market The hardware market isforecast to grow from ILS9.1bn in 2013 to ILS10.1bn in 2018, with PC sales projected to rise from anestimated ILS7.8bn to ILS8.9bn While growth will remain strong, the market will be increasingly

dominated by IT service sales and software sales, indicating the maturity of the market BMI forecasts

software sales to account for 28.2% of Israel's IT market by 2018, up from 24.5% in 2013, while servicesare forecast to rise from 35.0% of the IT market to 36.8% over the same timeframe

Inhabitants 23.9 25.5 27.6 28.6 29.3 29.7 30.0 30.0

f = BMI forecast Source: BMI

We have revised our forecast for the development of Israel's internet user and broadband subscriber marketsbased on new data from the country's service providers We revised down our YE13 estimate for thenumber of internet users to 5.33mn, giving Israel a penetration rate of 68.9% We expect steady, but

slowing, growth in the number of internet users to continue for the duration of our forecast, resulting in6.295mn internet users in 2018, equivalent to a penetration rate of 76.1%

Meanwhile, owing to a lack of reliable data on the number of mobile broadband subscribers (specificallythose subscribers who use USB dongles and data cards to access the internet via laptops, PCs and

smartphones), our forecast for the Israeli broadband sector is currently based on fixed broadband

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

2014, Israel's broadband subscriber base will have risen to 2.24mn; this is equivalent to a penetration rate of28.6% and reflects full year growth of 5.1%

Industry Trends - Wireline Sector

2011-2018

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

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

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

f = BMI forecast Source: BMI

Over the next five years ending 2018 we envisage average annual growth of around 3.1% for the Israelibroadband sector This will see the subscriber base reach 2.48mn subscribers, equivalent to a penetrationrate of 30.0% We expect the growing popularity of mobile broadband services to result in slowing demandgrowth in the fixed broadband sector Nevertheless, we identify several developments which will sustainfixed broadband growth for the duration of our forecast and beyond These include the launch of wholesale

broadband services by the ViaEuropa-led consortium building a fibre network over the Israel Electric Company (IEC) infrastructure and 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' broadbandaccess Meanwhile, recent months have seen considerable reductions in the price of broadband tariffs beingoffered by the major operators Another development likely to stimulate growth is the introduction of LLU,which will give alternative operators access to Bezeq's network and will stimulate much greater

competition

Macroeconomic Forecasts

Economic Analysis

BMI View: We forecast real GDP growth in Israel of 3.2% and 3.6% in 2014 and 2015, respectively, from

3.3% in 2013 Slow growth in private consumption will depress the economic expansion this year However,

a moderation of austerity policies and increasing exports underpin our relatively bullish medium-term outlook for the economy.

We have revised downward our 2014 real GDP growth forecast for Israel to from previously, and seethe economic expansion accelerating to in 2015 Growth in the Israel economy slowed to 1.7% y-o-y inQ214 according to Central Bureau of Statistics (CBS)'s estimates, from 2.8% y-o-y in Q114 The ongoinghostilities in the Gaza Strip will result in a sharp, if temporary, drop in the expansion of the economy inQ314 We expect the economy to rebound in Q414, and low base effects and a gradual improvement inexports will result in an acceleration in growth next year

In a Soft Patch this Year

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

e/f: BMI estimate/forecast Source: Central Bureau of Statistics Israel, BMI.

Private Consumption Outlook

Private consumption will expand slowly over the coming quarters, and we forecast real growth in thesegment of 3.1% and 3.5% in 2014 and 2015, respectively Consumer spending slowed to 1.8% y-o-y inH114, less than half the 4.0% rate in the second half of 2013 We expect private consumption to remain low

in Q314 amidst declining consumer sentiment resulting from the conflict in the Gaza strip, and tighter fiscalpolicy from the government's attempts to offset the cost of the war

Modest Fiscal Spending In 2014

Israel - Government Revenues & Expenditure, ILSbn

Fiscal revenue, ILSbn (LHS) Fiscal expenditure, ILSbn (LHS) Budget balance, % of GDP (RHS)

2009 2010 2011 2012e 2013e 2014f 2015f 2016f 2017f 2018f 0

100 200 300 400

-5 -4 -3 -2 -1

e/f: BMI estimate/forecast Source: Israeli Ministry of Finance, BMI

The conflict will also result in tighter fiscal policy in 2015, as the government will have to make up forhigher-than expected spending in 2014 by increasing taxes We also expect the defence budget to increasesignificantly next year Defense Ministry Director General Dan Harel recently spoke of a 19.1% increase innext year's defense budget to ILS62bn, as the war highlighted the elevated risks which the Israeli state issubject to

Government Spending Outlook

Public Spending averaged 3.6% in H114, and we expect growth in the component to slow over the comingquarters as the government attempts to absorb the costs of the conflict That said, spending will not declinedrastically; the budget deficit came in at 2.6% of GDP in annualised terms in H114 - compared to thegovernment's end-of-Year target of 3.0% - which will allow some room for manoeuvre before cutting publicspending We project government consumption to expand by 2.6% and 3.2% in 2014 and 2015,

respectively

Fixed Investment Outlook

We expect growth in gross fixed capital formation to rebound over the coming quarters after declining by1.5% in 2013, owing to low base effects and increasing exports For one, developments in the energy sectorwill prompt the construction of new gas transmission and power generation infrastructure in 2014 In the

latest development, Delek Drilling and Avner Oil and Gas, subsidiaries of Israeli conglomerate Delek Group, raised USD2bn in an international bond offering to fund field development of the Leviathan natural

gas field offshore Israel The companies said the offering was over-subscribed by 650%, with demand ofUSD13.5bn representing the largest ever for an Israeli enterprise Investment in the Israeli technology andpharmaceutical segments will also contribute to the expansion in fixed investment As an illustration, US-

based biopharmaceutical company Hyperion Therapeutics signed a share purchase agreement to acquire Israeli diabetes drug developer Andromeda Biotech in a deal worth around USD600mn in April We

project gross fixed capital formation expanding by 2.0% in 2014 and 6.0% in 2015

Solid Import Growth In The Coming Years

Israel - Net Exports

e/f: BMI estimate/forecast Source: Central Bureau of Statistics Israel, BMI.

Net Exports

We see Israel's net export position coming in surplus to the tune of ILS16.0bn and ILS17.2bn in 2014 and

2015, respectively, from an estimated ILS12.4bn in 2013 Exports of goods and services expanded by 6.3%y-o-y in Q114, a sharp slowdown from a 21.9% rise in the previous quarter However, much of the volatilitywas a product of diamond exports - which accounted for 28% of total exports in 2012 Conversely, non-diamond industrial exports and services exports rose by 2.8% and 4.8% y-o-y, respectively, in the firstquarter of 2014 We expect Israeli exports to expand by 3.0% in 2014 and 3.5% in 2015, largely a result ofaccelerating economic expansion in key export markets

Europe - particularly the UK, Belgium, the Netherlands and Germany - accounted for 45.2% of total Israeliexports in 2013, and we expect an improvement in macroeconomic conditions in those markets to benefitIsraeli exporters this year and the next Export growth in 2015 will also be supported by the beginning ofgas exports, albeit on a low scale Large-scale gas exports will begin only in 2019 in our view, which willresult in an uptick in the headline growth print in the same year

Total imports are unlikely to accelerate dramatically this year owing to a projected decline in consumerspending That said, accelerating growth in exports and fixed investment will lead to imports expanding by2.0% in 2014 and 3.3% in 2014 and 2015 in our view, from an estimated decline of 2.0% in 2013 Importgrowth will remain robust over the medium term, partially offsetting the projected acceleration in exportgrowth.

Table: Economic Activity (Israel 2009-2018)

2009 2010 2011 2012e 2013e 2014f 2015f 2016f 2017f 2018f

Nominal GDP, USDbn 196.7 222.9 246.3 238.9 268.0 289.5 314.3 334.3 357.1 382.7 Real GDP growth, % y-o-y 1.1 5.0 4.6 3.4 3.3 3.2 3.6 3.7 3.9 4.2 GDP per capita, USD 27,047 30,035 32,658 31,255 34,653 37,008 39,692 41,637 43,842 46,299 Industrial production, % y-o-y,

ave -5.9 8.1 7.0 3.2 -2.0 2.1 3.9 5.3 6.0 6.0Population, mn 7.3 7.4 7.5 7.6 7.7 7.8 7.9 8.0 8.1 8.3 Unemployment, % of labour

force, eop 7.2 6.6 5.4 6.7 5.9 6.7 6.5 6.5 6.4 6.4

National Sources/BMI

Industry Risk Reward Ratings

BMI View: The IT sector in most countries in the Middle East and Africa (MEA) will witness high levels of

activity and value growth over the short-to-medium, mainly driven by government and enterprise spending Demand for IT products and services will also benefit from increasing broadband access, the adoption of IT solutions by small and medium-sized enterprises (SMEs), and overall economic growth across the region

Our positive outlook for the region's IT sector will spur investments from leading international vendorslooking to expand in the region as well as established local vendors looking to strengthen their position intheir domestic markets In Q414 IT Risk/Reward Ratings (RRR), we analyse the potential rewards forinvestors in 13 markets in the region alongside associated industry-related and macroeconomic risks Incomparison to our previous RRR analysis, the average regional aggregate score rose 0.2 points 54.0

following increases in Qatar, Kuwait and Saudi Arabia's aggregate scores However, there were no changes

to rankings of the countries, with Qatar remaining in the position with a score of 69.4 and Kenya remaining

in 13th place with a score of 39.5

Wealthy Markets Remain The Most Attractive

MEA IT Markets Rewards/Risks Outlook, 2014

Source: BMI

Industry Rewards

Saudi Arabia and Kuwait saw upgrades to their Industry Rewards score this quarter, leading to a 0.5 pointrise in the regional average score for this category to 48.7 Saudi Arabia's score increased by 5 points to50.8, reflecting increased IT spending by various government departments and agencies In May 2014, the

Ministry of Education selected Mobily and IBM to provide managed and cloud security services via IBM's Security Operations Center In June, the Health Ministry awarded a contract to South Korea's SK

Telecom and Seoul National University Hospital Bundang to deploy the former's patented medical

information and checking system at six state hospitals in Saudi Arabia For its part, Kuwait's IndustryRewards score, which increased by 1.7 points to 49.2, reflects strong value growth following an increasegovernment and private sector IT spending in the first half of 2014

Overall, Nigeria and South Africa remain the highest ranked countries in the Industry Rewards categorywith scores of 63.3 and 61.7 respectively We are bullish on growth prospects of the IT markets in bothcountries in view of strong economic growth, in the case of Nigeria, and high government spending inSouth Africa It is worth mentioning that the high sector growth rate Nigeria, Ghana, and Kenya is largelydue to low base effects As a result, we believe these countries, along with Egypt, offer long term growthopportunities for investors considering the low level of development of their IT markets relative to the moredeveloped GCC states

Bahrain and Oman have the lowest scores in the Industry Rewards category, at 28.3 and 33.3 respectively,with Lebanon sitting just above them with a score of 35.0 Bahrain and Oman are held back by relativelylow public IT spending, compared to other GCC countries, and the small sizes of their respective consumermarkets Although Lebanon has a bigger consumer market than Bahrain and Oman, the country's overall ITsector is held back by the underdevelopment of high-speed broadband networks and, consequently, the slowuptake of internet-reliant services such as cloud computing We expect the UAE and Qatar, the two highestranked GCC countries in the industry rewards category, to record sustained growth over the next decade onthe back of increased investments in infrastructure, logistics, hospitality, transportation, and other relevantsectors in the run-up to the hosting of two major events - the Dubai 2020 World Trade Expo and the 2022FIFA World Cup in Qatar

Country Rewards

Our Country Rewards rating assesses the potential for consumers and businesses to spend on IT productsand services based on a number of key macroeconomic indicators, including GDP per capita and the rate ofurbanisation These factors are important gauges for the level of consumer demand for IT products andservices in any given market High urbanisation rates often translate to greater internet access and IT usageamong consumers and businesses, while high income levels also point to the ability of a greater proportion

of the population to purchase expensive IT products and services Unsurprisingly, Israel and the GCC statesperform strongly in this category However, these factors must be viewed against backdrop of populationsize and, therefore, long-term growth potential of a market considering that most high income and

predominantly urban markets have relatively smaller populations

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

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

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

Although the African countries and Egypt score all below 50.0 in this category, we highlight their growthpotential for investors with a long-term outlook Nigeria, Egypt, South Africa and Kenya all have

population sizes of more than 40mn and have the potential attract significant interest from investors with

consumer-centric solutions SAP, Microsoft and IBM are among leading global IT software and services firms ramping up their presence in the region, while Dell and Lenovo have recently launched their

respective financing solutions to tap in South Africa to tap into the budding SME sector It is worth

mentioning that Kenya's score, at just 10, is particularly low given its GDP per capita of around USD980and 2013 urbanisation rate of just 25%

Industry Risks

Intellectual property (IP) risk is generally high

across the region According to a survey by BSA,

published in June 2014, the average rate of

unlicensed software use in MEA in 2013 was around

59%, compared to 29% in Western Europe and 19%

in North America Among the countries in our RRR

table, Nigeria and Kenya had the highest unlicensed

software installation rates in 2013 at 81% and 78%

respectively However, the commercial value of

unlicensed software during the same period was

highest in Saudi Arabia and South Africa, at

USD421mn and USD385mn respectively

We believe economic and political factors are

mainly responsible for elevated IP risks in the

region On the economic front, the relatively low

income levels in many countries suggest a high demand for low-cost products, which, in most cases, arecounterfeited or pirated On the political front, some governments in the region have not shown sufficientcommitment towards stopping the local production or importation of counterfeit products Some IT vendorshave taken steps to counter this risk, such as Microsoft's migration to cloud-based software and HP'scounterfeiting deterrent measures in printers and other accessories

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

GCC countries and Israel each record scores higher than 60, mainly due to the favourable short-termexternal risk factor ratings and stronger corruption perception indices Countries with lower scores all battlewith weak corruption perception indices and lack of transparency in trade bureaucracy and legal

frameworks

Qatar's Country Risks score increased by 1.4 points this quarter to 67.7 as rapid population growth andprogress on the government's large-scale infrastructure programme continue to make Qatar one of theeconomic outperformers of the region Preliminary data released by the Qatar Statistics Authority (QSA) onJune 30 2014 shows that the Qatari economy grew by 6.2% in real terms in the first quarter of 2014, marked

by strong growth in construction activity and the services sector

The most salient Country Risk factors for investors in the short- to- medium term are political in nature Theescalation of the political crisis in Iraq and the possible spill over into neighbouring countries, such as SaudiArabia, as well the Israel-Gaza crisis and the potential for other countries in the region, including Lebanonand Egypt, to be drawn into the conflict will be major sources of concern for investors In Africa, theincreasing insurgency in Nigeria and Kenya weigh heavily on their risk perception, while the heightening ofethnic and political tensions in the run-up to Nigeria's general elections in early 2015 pose considerable risk

to political stability in that country

Although South Africa and Egypt's presidential elections in H114 were generally regarded as peaceful,investors would be concerned about the continued strike in South Africa's mining sector and the energysubsidy reforms in Egypt considering their impact on consumer spending and overall business confidence

Table: MEA IT Risk/Reward Ratings Table, Q414

Country Industry rewards rewards Country Industry risks Country risks IT Rating

Qatar 57.5 100.0 55.0 67.7 69.4 1 1 Israel 53.3 100.0 65.0 67.0 68.6 2 2 UAE 52.5 90.0 60.0 68.3 65.4 3 3 Kuwait 49.2 100.0 40.0 66.7 63.7 4 4 Saudi Arabia 50.8 80.0 55.0 67.7 61.5 5 5 South Africa 61.7 45.0 45.0 59.1 55.1 6 6 Bahrain 28.3 85.0 57.5 61.8 51.7 7 7 Nigeria 63.3 30.0 45.0 45.4 49.7 8 9 Oman 33.3 70.0 52.5 58.5 49.2 9 8 Egypt 53.3 30.0 45.0 46.1 45.3 10 10

MEA IT Risk/Reward Ratings Table, Q414 - Continued

Country Industry rewards rewards Country Industry risks Country risks IT Rating

Lebanon 35.0 65.0 20.0 42.9 42.0 11 12 Ghana 41.7 35.0 40.0 49.5 41.2 12 11 Kenya 53.3 10.0 55.0 34.2 39.5 13 13

Scores out of 100, with 100 the 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 affect the industry's development; the 'Risks' rating evaluates industry specific dangers and those emanating from the state's political/economic profile, based on BMI's Country Risk Ratings, that could affect the realisation of anticipated returns Source: BMI

Market Overview

Hardware

BMI estimates Israel's IT hardware market declined by 2.6% in 2013 to ILS9.143bn However, we expect it

to return to growth in 2014 and forecast a CAGR of 3.0% over our five-year forecast from 2014 to 2018 In

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

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

systems will boost sales throughout the year

As well as economic and IT market trends, the escalation of hostilities between Israel and Gaza in Julyposes a potential downside risk to the country's GDP growth for 2014 At the time of writing, BMI's countryrisk team had not yet altered its growth forecast of 3.2% for 2014, as bombing between Israel and Gaza hadextended for less than a month, a period of time which historically has not affected Israel's GDP growth.Nevertheless, wider economic uncertainty means businesses are now investing more to increase flexibilityand realise cost efficiencies rather than expand IT hardware capabilities, but nonetheless there should begrowth areas Yet, as noted, lower average prices have meant that revenue growth in most segments haslagged shipments

BMI expects Israel's real GDP growth to continue on its gradual downward trend, falling from 3.3% in

2013 to 3.2% growth in 2014 However, we forecast a return to growth beginning in 2015 Likewise, realprivate consumption growth and real government spending are expected to slow slightly in 2014, fallingfrom 3.4% and 3.1% in 2013 to 3.1% and 2.6% in 2014, respectively The decline in private consumption is

owing to government austerity measures, such as the 1% rise in VAT implemented in June 2013 BMI

expect that austerity measures will continue to have an impact on discretionary spending on items such asPCs and notebooks in 2014 This has an obvious impact on the growth potential of the IT market, asconsumers consider reigning in their spending and government faces fiscal constraints on new investments

Despite the weak consumer outlook in Israel there are several factors which present an optimistic mediumterm outlook for continued hardware sales The Israeli government has launched various initiatives toincrease computer and internet penetration, such as Computer for Every Child, now morphing into 'Tabletfor Every Child' according to Israeli Prime Minister Benjamin Netanyahu, and 'Digital Israel', a proposedinitiative to streamline the digitisation of public sector services, such as education, healthcare and socialservices The level of support, however, has been criticised by some industry insiders as too low Between

its launch in 1995 and June 2013, the Computer for Every Child initiative reportedly distributed 55,000computers in around 2,000 localities Industry stakeholders see Digital Israel essentially as a duplication ofits Government Computing Center, which was established in February 2012 and operates under the auspices

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

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

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

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

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

Meanwhile, the end of all support for Windows XP in April 2014 and of mainstream support for Windows 7

in January 2015 is expected to result in higher sales of the Windows 8 OS in the retail and enterprisemarkets In the retail market Windows 8 will deepen the tablet and hybrid PC markets, while in the

enterprise sector the new OS should trigger computer hardware tenders previously delayed because ofweakening economic growth The launch of Windows 8 in Israel coincided with the launch of the Surfacetablet and a new suite of mobile handsets using Windows Mobile Microsoft CEO, Steve Ballmer, began aninternational promotional tour for the new operating system in Israel in November 2012 An upgrade toWindows 8 was available to Israeli consumers for USD40 to download or ILS280 installed in store

Hardware Market

2011-2018

Personal computer sales, ILSmn Servers sales, ILSmn

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

2,500 5,000 7,500 10,000

f = BMI forecast Source: BMI

Evolving Form Factors

The Israeli IT market is relatively mature, but BMI estimates that hardware will still account for 39.5% of

the total market in 2014 (excluding communications hardware) Prior to 2012, notebooks were the growing segment of the market, although as recently as 2008 desktops still took around two-thirds of unitsales However in 2010-2011 the share of desktops declined precipitously, and then in 2012 there was a

fastest-shift from notebooks to tablets as the fastest growing segment of the market BMI forecasts notebooks will

account for 78% of total PC sales in Israel in 2014, up from 60% in 2009

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

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

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

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

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

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

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

in 2013, a position we expect it to hold on to, at least for the duration of2014 Data from Statcounter showthat iOS, run on Apple's tablets, accounted for 72.0% of all tablet browsing traffic in Israel in July 2014,down by 6.7pps y-o-y By contrast, Google's Android OS, which is used on Samsung, Asus and Google'sown Nexus range, accounted for 27.4% of tablet browsing traffic, up by 6.8pps y-o-y Although Statcounterdata suggest that Apple devices remain by far the most popular among Israeli consumers, IDC estimatedthat Apple's share of tablet sales dropped considerably in 2013 to 31.4%, down from 49.1% a year earlier.Both data support the trend of a widening range of Android devices - including the Kindle Fire from

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

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

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

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

However, the tablet market remains relatively undeveloped in Israel's hardware sector, which is heavilydominated by Windows machines When looking at the combined tablet and desktop/laptop computermarket, iOS and Android accounted for just 3.7% and 1.3% of total PC browsing traffic, respectively, inJuly 2014 (This is nevertheless up from 2.0% and 0.7% of browsing traffic a year earlier.) The event withthe largest impact on Israel's PC market was the launch of Windows 8 in October 2012, which enabled

addition of more vendors and another touch OS has added to competition in the market and put furtherdownward pressure on prices.

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

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

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

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

of lower cost Windows 8 powered PCs is reflected in the latest Statcounter data, which show that Window 8and Window 8.1 accounted for almost 11.9% of browsing traffic in Israel in July 2014, up 6.8pps from5.1% a year earlier By comparison, Mac OSX's share of browsing traffic increased by 1.1pp, to 3.7% overthe same period

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

July 2014

Source: Statcounter

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 the mobile PCsegment, and in fact notebook sales declined and growth was solely driven by tablets according to researchfrom IDC IDC's data for 2012 show that laptop sales declined 16.4% from 2011 to 2012, falling to around427,000, in contrast to a 20.2% increase in tablet sales to around 226,000 In the laptop market Lenovo leapt

to top spot with a market share of 21.2%, overtaking HP and Dell In second position was Asus with 16%market share, up from 12.2% in 2011, also overtaking HP and Dell which both had 15.2% market share in

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

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

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

PC unit in 2005 and in 2012 the company continued to increase its investment in Israel In 2012, Lenovoclaimed that it had top spot in the commercial laptop market in the country, and that it was the secondlargest PC vendor overall Acquisitions and strategic investments are part of Lenovo's strategy to

consolidate its position in the Israeli market, and in February 2012 the vendor announced that it would

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

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

greentech, and digital media technology and applications

Lenovo is far from the only multinational PC vendor to be increasing its R&D investment in Israel In 2012Apple opened a research centre in Haifa and in December 2013 it opened its third research centre in thecountry in Ra'anana This trend is continuing in full force; in early 2014, IBM announced plans to open an

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

Software

BMI forecasts Israeli software spending to increase to ILS5.87bn in 2014, up 6.2% y-o-y We expect

growth in the software segment to accelerate, with a CAGR forecast of around 3.8% over the five years to

2018 In the past few years, there has been a pick-up in demand for systems and upgrades in public andprivate sectors, with investments by government organisations such as the Israeli Ministry of Defence andIsraeli Police, and from utilities leader Israel Electric Company Much of this growth is related to increasinguse of cloud services and related rising demand for security services

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

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

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

revenues from the Israel market, experienced a decline in its revenues and profits in 2013, due largely toseasonal factors With seasonal factors no longer an issue, Matrix reported improved performance in thefirst quarter of 2014 (See Matrix Company Profile for further details.)

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

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

Corporation and Israel Direct Insurance (IDI).

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

Software Market

2011-2018

Software sales, mn

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

10,000

2,500 5,000 7,500

f = BMI forecast Source: BMI

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