Israel information technology report q4 2015

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Q4 2015 www.bmiresearch.com

ISRAEL

INFORMATION TECHNOLOGY REPORT

INCLUDES 5-YEAR FORECASTS TO 2019

INCLUDES 5-YEAR FORECASTS TO 2019

Part of BMI’s Industry Report & Forecasts Series

Published by: BMI Research

Copy deadline: July 2015

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BMI Industry View 7

SWOT 9

IT 9

Political 11

Economic 12

Operational Risk 13

Industry Forecast 15

Table: IT Industry - Historical Data And Forecasts (Israel 2012-2019) 15

Macroeconomic Forecasts 20

Economic Analysis 20

Expenditure Breakdown 21

Table: Economic Activity (Israel 2010-2019) 25

Industry Risk Reward Index 26

Middle East And Africa Risk/Reward Index 26

Table: MEA IT Risk/Reward Index - Q415 29

Market Overview 30

Hardware 30

Software 36

Cloud Computing 43

Services 45

Industry Trends And Developments 48

Regulatory Development 54

Table: IT Regulatory Authorities 54

Table: Government Initiatives 55

Competitive Landscape 56

International Companies 56

Table: Intel 56

Local Companies 57

Table: Amdocs 57

Table: Check Point 58

Table: Imperva 59

Table: Mellanox 60

Regional Overview 61

Middle East And Africa 61

Demographic Forecast 64

Table: Population Headline Indicators (Israel 1990-2025) 65

Table: Key Population Ratios (Israel 1990-2025) 66

Table: Urban/Rural Population & Life Expectancy (Israel 1990-2025) 66

Table: Population By Age Group (Israel 1990-2025) 67

Table: Population By Age Group % (Israel 1990-2025) 68

Methodology 69

Industry Forecast Methodology 69

Sources 70

Risk/Reward Index Methodology 71

Table: It Risk/Reward Index Indicators 72

Table: Weighting Of Components 73

BMI Industry View

BMI View: We revised our estimate for Israel's IT market size in 2014 in the Q415 update, in addition to

making a small downward revision to the growth outlook The new forecast better reflects the maturity of the Israeli IT market, including a greater share for IT services spending and the reduced growth prospects offered by Israel's mature IT hardware market Growth rates will underperform emerging markets in the Middle East 2015-2019, but Israel will continue to be a lucrative market in per capita spending terms Israel also sits at the technological frontier with a vibrant ICT start-up community and highly skilled tech workers, which have continued to attract high levels of investment in 2015 following a record-breaking year

in 2014 We expect this trend to continue, as global IT firms look to leverage innovative solutions emerging from Israel's start-up ecosystem to accelerate their transition towards high-growth software and services such as cloud computing and big data analytics.

Headline Expenditure Projections

■ Computer Hardware Sales: Forecast to reach ILS6.3bn in 2015, up from ILS6.2bn in 2014 Spending

forecast to grow in local currency terms, but contract by 6% in US dollar terms due to depreciation as aresult of deferred purchases and substitution for cheaper devices in the retail market

■ Software Sales: ILS5.9bn in 2015, up from ILS5.5bn in 2014 Enterprise software spending will be the

main growth driver as device and data proliferation will result in increased spending on customerrelationship management, databases and business intelligence

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

reaching ILS10.8bn in 2015, up from ILS10.1bn in 2014 Cloud computing adoption gaining momentum,while cybersecurity services are expected to outperform, with stable sectors such as government anddefence that will continue to account for the majority of spending

Hardware Spending To Underperform In 2015 Due To Depreciation

IT Market Spending By Segment Forecast

Israel - Computer hardware sales, ILSmn, % y-o-y Israel - Software sales, ILSmn, % y-o-y

Israel - Services sales, ILSmn, % y-o-y

2013 2014e 2015f 2016f 2017f 2018f 2019f

-5 0 5 10

-10

e/f = BMI estimate/forecast Source: BMI

IT

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 fibre-to-the-home and wireless data networks provide basis for cloudcomputing growth 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

■ High penetration of computer devices limits growth opportunities mostly to newproducts and replacement sales

Opportunities ■ Cybersecurity 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 hybridsnotebooks

SWOT - Continued

Threats ■ Government austerity measures will dampen consumer and business spending

■ Shekel depreciation forecast for 2015 will erode Israeli purchasing power in globalmarkets and result in some deferred purchases and substitution for cheaper models

■ Intensifying regional tensions could increase operational risk

■ Limited size of workforce could curb attractiveness as an research and developmenthub over the longer term

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

■ Israeli defence forces (IDF) are amongst the strongest in the region, thus shielding thecountry from most spillovers from the Syrian crisis

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 in the form of terroristattacks 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 Risks of a radicalisation in theWest Bank are thus prominent

SWOT Analysis

Strengths ■ The workforce is highly educated and skilled, which will continue to attract investment

in the IT and pharmaceutical sectors

■ 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 next five years, relatively elevated levels of employment will underpin robust

private consumption growth

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

■ The gradual coming onstream of Israeli offshore gas fields will bring an influx inforeign investment, push up exports and is expected to serve the country's energyneeds for decades

Threats ■ Competition from emerging Chinese and Indian producers of high-tech goods and

polished diamonds could undermine demand for Israeli exports

■ The ultra-Orthodox population's pattern of attaining education inadequate with labourmarket requirements is marginalising an increasing share of the labour force, and thistrend could slow down long-term productivity growth

Operational Risk

SWOT Analysis

Strengths ■ The good standard of education contributes to a highly skilled labour force

■ Israel's high quality and well-connected road network is able to meet the demand ofsupply chains

■ Financial incentives are in place to encourage investment in certain economic sectors,including high technology and research and development industries

■ The risk of criminal activity affecting foreign workers and business property is nothigh, meaning expensive extra security measures will not need to be taken

Weaknesses ■ The quality of education varies between secular Israelis and the ultra-Orthodox

(Haredi) community and Arab areas, limiting the number of highly skilled Haredim andArab workers in the labour pool

■ Strikes and other disputes have disrupted supply chains using Israel's ports andairports

■ Israel's attractiveness as a location for investment is diminished by its high corporatetax rates

■ Israel faces several external threats from both state and non-state actors

Opportunities ■ The quality of tertiary education is high and ensures a constant supply of well

qualified graduates

■ Short lead times and low costs make Israel one of the most attractive locations for

SWOT Analysis - Continued

Threats ■ The unionisation of the workforce means that there is a high risk of strikes and labour

disputes disrupting business activity

■ Extended fuel supply chains increase the risk of disruption causing fuel shortages

■ The long delays associated with registering property and obtaining constructionpermits will deter investors looking to launch business in the country

■ Increasing regional instability due to the activities of the Islamic State in Syria and Iraqposes further risks on Israel's borders

IT market value, % of GDP 2.2 2.0 2.0 2.0 2.0 2.0 1.9 1.9

e/f = BMI estimate/forecast Source: BMI

BMI undertook a significant revision to our Israel IT market forecast in the Q415 update, including a

reassessment of market growth dynamics in 2013 and 2014 We now estimate a smaller hardware market,and revised up our estimate for the size of the IT services market We now estimate the IT market grew by3.5% in local currency terms to a value of ILS21.8bn in 2014, equal to 2% of GDP

Under our revised outlook, we continue to hold the view that the Israeli IT market will experience slow andsteady growth over the medium term, with a compound annual growth rate (CAGR) of 4.4% forecast2015-2019 Growth will be subdued relative to emerging markets in the Middle East as a result of thesaturation of the hardware and software/services market in Israel, a characteristic that is exacerbated by

price competition between vendors BMI forecasts the Israeli IT market will reach a total value of almost

ILS27.1bn in 2019

2015 Outlook

BMI forecasts IT market growth of 5.7% in 2015 to a value of ILS23.1bn, but as a result of depreciation we

expect a contraction of 3% in US dollar terms Our in-house Country Risk team for Israel forecasts shekeldeprecation against the US dollar from an average of ILS3.6/USD in 2014 to ILS3.9/USD in 2015 This willerode Israeli purchasing power in global markets, ie for imported products, and result in some deferredpurchases, but more prominent will be increased price sensitivity and substitution for lower cost

alternatives The impact of depreciation will be most significant in the hardware segment, where we forecast

a contraction of 6.1% in US dollar terms in 2015

Aside from depreciation the economic environment in Israel will remain broadly supportive in 2015 Weforecast real GDP growth of 3.1% in Israel in 2015, while private final consumption growth is forecast at5.8%, with both stronger than the figures for 2014

In the IT market it is cloud computing that is expected to outperform in terms of growth in 2015 Theunderlying driver continues to be organisations looking for efficiencies turn to more flexible and affordablesoftware-as-a-service and infrastructure-as-a-service Particular areas of opportunity for cloud computinginclude banking and retail, as organisations in those fields look to save money on hardware and improvecustomer services

In the hardware segment, household computer penetration of 85% at YE2013 illustrates the limited potentialfor growth derived from first time buyers, but there are several factors pushing multiple device ownership.Innovation in form factors, including tablets and hybrids will push sales of personal devices, while

investments by telecoms operators to expand the reach of high capacity wireless and wireline broadbandservices will catalyse demand for personal devices With the full launch of 4G LTE networks in 2015,spending will continue to move away from notebooks as consumers favour more mobile devices such as

smartphones and tablets Despite the shift from notebooks toward tablets, BMI expects the hardware

segment to maintain growth, owing in no small part to Israel's relatively wealthy consumer base and their

preference for premium Apple and Samsung devices.

Industry Trends - IT Market

(2012-2019)

IT market value, ILSmn

2012 2013 2014e 2015f 2016f 2017f 2018f 2019f

0 10,000 20,000 30,000

e/f = BMI estimate/forecast Source: BMI

Over the remaining years to 2019, we expect slow but steady growth in the economy Our in-house Country

Risk team forecast average annual GDP growth of 2.8% 2016-2019, and BMI also forecasts

underwhelming expansion of private consumption growth at an average of 3.0% annually 2016-2019 We

do however point to the prospects of stronger performance over the longer term as gas resources currentlyunder development come online from 2019

In the Q4 update, BMI has introduced a medium-term household income analysis to the IT market forecast,

Over the medium term, the most prominent trend will be the migration of mid-market Israeli households.This should help alleviate some of the price sensitivity pressure on vendors in the mass market, a shift fromrecent years when the hardware market has been characterised by tablet cannibalisation of notebook

volumes, as well as price erosion as lower cost tablets made headway among price-sensitive populationsegments Our analysis of household income trends indicates potential for an easing of price pressure on PCvendors over the medium term, as they have the potential to up-sell higher-value models as householdsacquire additional disposable income and purchasing power in global markets

Israel Household Income Distribution (%) LHS And Change By Income Level

('000)

2015f (LHS) & 2015-2019f (RHS)

f = BMI forecast Source: BMI, national sources

Segments

BMI expects IT services will display the fastest growth over the forecast period to 2019 owing to the

opportunities presented by cloud computing, big data analytics and real-time enterprise services based onthe internet of things The financial sector and defence continue to be the primary verticals for IT softwareand services, with rising geopolitical tensions in the Middle East likely to drive strong demand for cyberand information security solutions World Bank data show that Israel's military expenditure accounted for

5.6% of GDP in 2013, among the highest in the world, underpinning the IDF's ability to make a majorcontribution to IT spending in Israel.

Meanwhile, intensifying competition in Israel's telecoms sector is driving operators to pursue convergencestrategies through acquisitions and to generation operational efficiencies through network sharing

agreements This will require operators to spend on integrating separate IT systems, while also encouragingthem to reduce their operating costs by outsourcing more business operations to managed service providers,thus creating opportunities for IT vendors Other sectors of opportunity will include healthcare,

infrastructure, transport and the small office and home office sector

While large organisations still dominate, small- and medium-sized enterprises (SMEs) have been investingmore and represent a growth opportunity Many SMEs are waking up to the need to compete through moredirect investment in support and service infrastructures Cloud computing is a field which could gaintraction with SMEs as the on-demand model fits well with their smaller budgets and lack of demand forbespoke in-house solutions and software There is a sizeable potential customer base for vendors to tap into,with World Bank data showing an average of more than 15,000 new businesses a year registered in Israelbetween 2005 and 2012

Macroeconomic Forecasts

Economic Analysis

BMI View: The Israeli economy will see a slight uptick in growth in H215, driven primarily by private

consumption, as government expenditure remains capped by the absence of a budget for 2015 From 2016,

we expect public spending and gross fixed capital formation to return to higher levels, thus contributing more significantly to economic growth Overall, the Israeli economy will expand by 3.1% in 2015 and 3.4%

in 2016, from 2.6% in 2014.

Israeli economic growth will moderately accelerate in H215, driven primarily by private consumption As

we had expected, the impact, and rebound, from the Gaza conflict has run its course, with growth returning

to a more stable trajectory: economic growth fell to an annualised 2.5% quarter-on-quarter (q-o-q) in Q115,from 6.6% in Q414 We forecast economic growth to reach 3.1% in 2015 and 3.4% in 2016, compared to2.6% in 2014 In 2015, private consumption will be the key driver of the economy, as government spendingremains limited by the absence of a budget for 2015, while gross fixed capital formation (GFCF) remainssubdued, despite the Bank of Israel maintaining an ultra-low interest rate throughout the year

Sustained strong growth in private consumption, coupled with increasing exports and a subsequent

acceleration in GFCF growth, underpin our positive view for the Israeli economy over the next five years:

we forecast real GDP growth to average 3.4% over this period

Limited Acceleration Ahead

Israel - Real GDP Growth, %

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015f 2016f 2017f 2018f 2019f

1 2 3 4 5 6 7

f= BMI forecast Source: BMI, Central Bureau of Statistics

Expenditure Breakdown

Government Spending Outlook: Binjamin Netanyahu's dissolution of the Knesset in late 2014 led to the

parliament being unable to adopt a budget for 2015 As a result, public spending has been capped and willremain so until a budget is approved (in the meantime, public expenditure is limited to last year's budgetfigures) We therefore expect government consumption to increase by only 1.5% in 2015, and this view hasbeen supported by the latest relevant data released by the Central Bureau of Statistics: public spending grew

by a mere 0.7% year-on-year in Q115, compared to an average of 4.5% in the past 10 years

Absence Of 2015 Budget To Create Two Years Of Volatility

Israel - Government Final Consumption, Real Growth % chg y-o-y

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015f 2016f 2017f 2018f

2 4 6

0 8

f= BMI forecast Source: BMI, Central Bureau of Statistics

Due to the absence of a 2015 budget, the new coalition government is currently instating a biennial statebudget that will cover this year and next, to be ratified within 175 days of the formation of the government

We expect to see a sharp increase in public spending taking place in 2016, increasing by 6.5%, partly as aresult of this year's cap and induced low base effect but also as the newly re-elected prime minister

promised the different parties that joined his coalition to push through policies that will cost more thanUSD2.0bn to the state's budget - in particular reducing VAT on food products and rolling back on reformsthat cut subsidies to the ultra-Orthodox community

Private Consumption Outlook: We expect consumer spending to be the main driver of the economy in

2015, and remain strong in 2016, growing respectively by 5.8% and 4.3% This year's strong growth willcome as a result of inflation remaining subdued - partly on the back of low global oil prices - and theunemployment rate staying at a very low level The joblessness decreased to a record-low 4.9% in April,after it reached 5.4% in Q115, compared to 5.7% for 2014 In addition, the monthly private minimum wagewas raised to ILS4,650 in April and will again be increased by ILS175 within 18 months, and a year later byanother ILS175, reaching ILS5,000 by December 2017 Finally, monetary policy will remain

accommodating in H215 as inflation reaches 1.0% by the end of 2015, the bottom end of the government'starget range of 1-3% As a result, the Bank of Israel (BOI) will maintain its policy rate at 0.10%.

Private Consumption Key Driver Of Growth

Israel - Contribution To Real GDP Growth By Expenditure, %

f=BMI forecast Source= Central Bureau Of Statistics, BMI

Fixed Investment Outlook: Despite extremely low interest rates - the Israeli repo rate currently stands at

0.1% - GFCF decreased in Q115 by 5.8% q-o-q annualized - making it the fourth quarter in five that thefigure has been in negative territory We still expect GFCF to pick up in the next quarters - investment inresidential construction rose by 1.7% in Q115, the first such increase in seven quarters - given very lowlending rates However, this will take place at a slower pace than we had previously anticipated

No Impact For Now

Israel - Policy Rate, % And GFCF, % chg q-o-q Annualised (LHS) And GCFC, % chg y-o-y (RHS)

f=BMI forecast Source: National Sources, BMI

Our five-year outlook for gross fixed capital formation remains positive, with an annual growth of 3.7%over the period In particular, the energy sector will attract high-levels of investment: in November 2014,

Israel-based Delek Drilling outlined a major upgrade programme for the Tamar gas field, with the plan

estimated to cost between USD1.5bn and USD2 bn In addition, we expect that the Leviathan gas field Israel's largest proven gas reserves - will come onstream in 2019, requiring large amounts of capital beinginvested in the country

-Net Exports Outlook: We believe Israeli exports will expand by 4% in 2015 and 4.1% in 2016 For 2015, a

gradual improvement in macroeconomic conditions in the European Union - which accounted for 15% oftotal Israeli exports in 2013 - and a relatively weak shekel will support growth From 2016, Israel will beginexporting gas and this will offset the negative impact of a modest appreciation of the shekel

Imports will expand by 5.0% in 2015 and by 7.5% in 2016, at a faster rate than exports This acceleration inimport growth - from 2.3% in 2014 - will come as a result of an uptick in domestic consumption and fixedinvestment, on the back of stronger economic growth

Table: Economic Activity (Israel 2010-2019)

2010 2011 2012 2013 2014 2015f 2016f 2017f 2018f 2019f

Nominal GDP, USDbn 233.3 258.4 257.3 290.6 303.8 291.7 320.4 349.5 371.5 396.3 Real GDP growth, % y-o-y 5.8 4.2 3.0 3.2 2.8 3.1 3.3 3.5 3.4 3.6 GDP per capita, USD 31,438 34,261 33,664 37,584 38,835 36,829 39,916 42,910 44,947 47,240 Population, mn 7.4 7.5 7.6 7.7 7.8 7.9 8.0 8.1 8.3 8.4 Industrial production, % y-o-y,

ave 8.1 1.9 3.6 -1.3 1.3 0.5 3.2 5.2 5.9 6.0Unemployment, % of labour

force, eop 6.6 5.4 6.7 5.9 5.7 5.8 6.0 6.0 6.0 6.0

f=BMI forecast Source: National Statistics, BMI

Industry Risk Reward Index

Middle East And Africa Risk/Reward Index

The Q415 update to the Middle East and Africa (MEA) IT Risk/Reward Index (RRI) is consistent with theprevious quarter, with only a few changes to market scores and positional changes The region continues to

be highly diverse, with Israel and the lucrative Gulf Cooperation Council (GCC) markets - which are amongthe highest per capita incomes globally - in stark contrast to the low-income sub-Saharan Africa (SSA)

markets that make up the lower positions in BMI's Index.

Each country's overall IT score is based on four distinct categories evaluating the growth prospects forhardware, software and IT services vendors across the region The Industry Rewards category evaluates thegrowth potential and maturity of the market, based on our proprietary forecasts, as well as the level ofgovernment initiative in development of the IT sector The Country Rewards index assesses the potential forconsumers and businesses to spend on IT products and services based on a number of key macroeconomicindicators, including GDP per capita and the rate of urbanisation These factors are important gauges for thelevel of consumer demand for IT products and services in any given market The Industry Risks categoryreflects the strength of intellectual property (IP) protection and ICT policy in a market, an importantdeterminant in the rate of software piracy and counterfeiting Finally, the Country Risks category assessesexternal factors that could affect a country's overall investment outlook and consequently the growthprospects for the IT sector These factors include short-term external and financial risk, trade bureaucracy,legal frameworks and corruption perception

Israel continues to top the MEA RRI in Q4, with an unchanged score of 69.6 points Israel's well-developedretail and enterprise markets mean it is a high-spending market, including demand for the latest productsand solutions Security risks aside, the IT market benefits from regulatory certainty and political economicstability that has helped to attract significant investment in a local IT ecosystem that is of global

significance An additional pull factor for IT vendor investment is Israel's highly-skilled IT labour force and

the strong culture of innovation that makes it a centre for start-ups Recent investments include Infosys' USD100mn budget to invest in or acquire Israeli start-ups, PayPal's acquisition of CyActive ahead of the launch of a security centre in Israel, and SoftBank Ventures Korea and Akamai Technologies' strategic investment in mobile network function virtualisation software specialist Saguna.

Positions two through to six in the MEA RRI are occupied by the GCC states, with contrasting profiles toregional leader Israel The strength of the GCC markets are derived to a much greater extent from highincomes per capita, which make them among the most lucrative retail hardware markets globally There is

also a considerably smaller and less complex enterprise segment - with the oil & gas sector dominating theeconomies of most GCC states Finally, the GCC states have weak reputations as technological innovatorsand incubators, with a lack of competitively priced skilled labour, regulatory uncertainty and high operatingcosts all significant barriers to closing the gap with Israel.

One area where Israel and the GCC states have common ground in our RRI is the elevated risk of

cybersecurity incidents when compared to other developed markets in less volatile regions BMI has long

highlighted the threat of political and criminally motivated cyberattacks in the Middle East, with futureattacks having the potential to undermine confidence in networked solutions, from cloud computing to e-government However, cybersecurity is also a regional opportunity, as enterprises and governments invest

to increase cybersecurity capabilities, attracting inward investment to the region from leading IT vendors,

security firms and telecoms operators including Symantec, McAfee, Lockheed Martin, Telefónica, Etisalat and Ooredoo.

While the GCC states contrast with Israel's strengths and weaknesses - and cybersecurity is a commontheme - they are far from a homogeneous grouping of markets The highest income markets of Qatar and theUAE occupy second and third position in the Q4 RRI based on the lucrative nature of their retail markets

Local consumers have a strong preference for premium-oriented conspicuous consumption, a boon to Apple

through its iPad and Mac range, while short replacement cycles and tourist electronics spending alsosupport a buoyant retail market There is, however, some downside as local retailers pointed to the potentialfor an easing of sanctions imposed on Iran as likely to result in a decline in retail hardware sales

The large African markets - South Africa, Nigeria and Egypt - occupy positions seven to 10 in the table,with Oman splitting them in eighth position The three markets score well in the Industry Rewards category,and far ahead of Oman, which suffers due to its small market size It should however be noted that thelargest African markets score highly in Industry Rewards due to their potential and populations, rather thanthe existing size of the market, which is limited due to low incomes This is illustrated in the chart below

comparing per capita US dollar IT spending by market, forecast by BMI for 2015 The low level of per

capita spending explains why the large African markets score very close to the GCC markets in terms of

IT Spending Per Capita (USD)

2015f

f = BMI forecast Source: BMI

There are positive signs for an acceleration of IT sector development in the larger African markets, which

BMI believes will contribute to faster growth and assist with the creation of stronger regulatory

environments Egypt particularly stands out through its promotion of the IT outsourcing industry in theyears following political crisis, which by 2015 employed a total of 90,000 people in Egypt In May

2015, the country's Information Technology Industry Development Agency announced that 6,000 new jobs

would be created in the offshore outsourcing sector after it completed agreements with IBM, Procter & Gamble, HSBC, Nestlé, Axxcelera, Mobinil Contact Services, Teleperformance and EMC BMI

believes Egypt's outsourcing industry is on a strong growth trajectory with the financial attractiveness ofEgypt as a low-cost destination and the fact that Cairo alone produces 200,000 graduates a year (10-15% ofwhom are multilingual), all major positives

Ghana and Kenya sit at the bottom of the MEA RRI in Q4, limited by low incomes - as are the largerAfrican markets - and also having markedly smaller populations, meaning they receive low scores in theIndustry Rewards category The undeveloped nature of their economies present additional challenges for ITmarket participants; for example, electricity shortages continue to plague SSA This has a direct impact on

the IT sector through the additional cost of alternative energy solutions and an indirect impact as customersacross other industries divert spending from IT to more critical electricity solutions.

Table: MEA IT Risk/Reward Index - Q415

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

Israel 55.0 100.0 65.0 68.2 69.6 1 1 Qatar 50.8 100.0 55.0 62.5 65.5 2 3 UAE 47.5 90.0 60.0 64.0 62.4 3 2 Saudi

Arabia 52.5 75.0 55.0 60.7 59.8 4 4 Kuwait 40.8 100.0 40.0 59.2 58.5 5 5 Bahrain 31.7 85.0 57.5 55.3 52.1 6 7 South

Africa 53.3 45.0 45.0 58.2 51.2 7 6 Oman 33.3 65.0 52.5 51.9 46.7 8 9 Nigeria 50.0 30.0 45.0 44.2 43.5 9 8 Egypt 48.3 30.0 45.0 48.3 43.4 10 10 Lebanon 30.0 65.0 20.0 47.2 40.5 11 12 Ghana 35.0 35.0 40.0 51.1 38.5 12 11 Kenya 41.7 10.0 55.0 37.2 34.7 13 13

Average 43.8 63.8 48.8 54.5 51.3 -

-Scores out of 100, with 100 the highest The IT Risk/Reward Index comprises two sub-indices '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' index evaluates the size and growth potential

of an IT market in any given state and the country's broader economic/socio-demographic characteristics that affect the industry's development; the 'Risks' index evaluates industry specific dangers and those emanating from the state's political/economic profile, based on BMI's Country Risk Index, that could affect the realisation of anticipated returns Source: BMI

Market Overview

BMI View: In the Q415 update we undertook a revision of historical data for Israel's IT market to reflect

changes in underlying growth dynamics, primarily resulting in a downgrade to our estimate for PC market value and an increase to IT services sales The revised data now better reflects Israel's status as a leading innovation centre in the global IT market, with particular strengths in cybersecurity software and solutions Under our new forecast, we envisage total IT market spending will grow at a CAGR of 4.4% 2015-2019 to reach a value of almost ILS27.1bn in 2019.

Hardware

BMI estimates Israel's IT hardware market contracted 0.1% in 2014 to a value of ILS6.2bn In local

currency terms we forecast a return to growth in 2015, with spending expected to increase by 2.4% toILS6.3bn This trend is however reversed in US dollar terms, as shekel depreciation forecast by our in-house Country Risk team for Israel is expected to result in a contraction of 6.1% to USD1.6bn Depreciation

in 2015 will increase the cost of imported hardware in local currency terms, resulting in deferred purchasesand substitution of devices for lower cost alternatives, reflected in our view for PC market volume

contraction to be smaller in magnitude than the US dollar value contraction

Over the medium term we forecast positive, albeit slow growth with a compound annual growth rate(CAGR) of 1.0% over our five-year forecast from 2015 to 2019 Enterprise hardware demand for productssuch as servers and storage are expected to increase over the medium term, while the retail PC market hasgrowth potential through personal device sales, despite the limitations posed by a mature market with highlevels of household PC penetration

e/f = BMI estimate/forecast Source: BMI

Israeli government policy initiatives are also helping to underpin the hardware market The government haslaunched various initiatives to increase computer and internet penetration, such as A Computer For EveryChild, now morphing into A Tablet for Every Child, according to Israeli Prime Minister Benjamin

Netanyahu, and Digital Israel, a proposed initiative to streamline the digitisation of public sector services,such as education, healthcare and social services The level of support, however, has been criticised bysome industry insiders as too low Between its launch in 1995 and June 2013, the Computer For EveryChild initiative reportedly distributed 55,000 computers in around 2,000 localities, representing a tinyfraction of total hardware sales in Israel Industry stakeholders see Digital Israel essentially as a duplication

of its Government Computing Center The centre was established in February 2012 and operates under theauspices of the Ministry of Finance, with many of the same goals as Digital Israel However, CarmelaAvner, Israel's first chief information officer who headed the centre, announced her resignation in

December 2013 owing to the body's lack of power to implement digital initiatives

Therefore, BMI expects upgrades to new systems, Israel's vibrant local start-up and IT research and

development (R&D) markets, and purchases of personal computing devices to remain the bulk of marketsales Mobile computing devices including tablets, slimline notebooks, Ultrabooks and hybrids present akey growth opportunity for vendors as consumers increasingly complement household desktop and laptopswith more easily transportable devices

Although tablet computers took longer to reach mass popularity in Israel than other mature ICT markets,this means that unlike in markets where there was a boom in volumes, in Israel we do not forecast a steepdecline in volumes after rapid diffusion among the core user group and a lengthening of replacement cycles.Overall, PC penetration is high in Israel at 85% in 2013, comparable to the highest levels of penetration in

the Middle East and globally (see chart below), reflecting the maturity of the market and requiring vendors

to focus on personal device and upgrade/replacement sales In contrast, BMI estimates tablet penetration

reached just 16.5% of Israeli households in 2013, rising to 23% by YE2014, but still with considerablegrowth potential over our forecast period

Middle East Household PC Penetration (%)

2013

Source: National sources, ITU, BMI

Evolving Form Factors

Prior to 2012, notebooks were the fastest-growing segment of the market, although as recently as 2008desktops still took around two-thirds of unit sales In 2010-2011, however the share of desktops declinedprecipitously, and then in 2012 there was a shift from notebooks to tablets as the fastest growing segment ofthe market

This trend of preference for mobility is expected to continue over the 2015-2019 forecast period Despite itsdeclining share of sales, however, the desktop sector is still significant, largely due to business and

throughout 2013 and 2014 Data from Statcounter show that iOS, run on Apple's tablets, accounted for65.7% of all tablet browsing traffic in Israel in July 2015 This was down by 6.1 percentage points (pp) y-o-

y, though still more than four times higher than its nearest rival vendor in Samsung

Apple's dominance of Israel's tablet PC market is in line with our view of strong demand for top-end among

a relatively wealthy population In this context, despite a widening range of Android devices - including the

Kindle Fire from Amazon, the Nexus 7 and 10, LG G Pad and Samsung's Galaxy Tab range (all launched

new or upgraded models in 2014) - other device manufacturers have made only small inroads into the Israelitablet market

Statcounter data suggest that Samsung has made the most progress, with its tablets accounting for 13.3% of

browsing market share in July 2015, up by 1.4pp y-o-y ASUS claimed a 3.9% share, Google (LG Nexus) a

2.5% share and all other players claimed less than 1% share each, according to Statcounter AlthoughAndroid vendors remain a peripheral influence to tablet market volumes in 2015, the gap between thestrategies of some of the leading players is worth noting On the one hand Apple and Samsung are hardwarevendors and look to profit from the sale of devices, while on the other side Google and Amazon are servicesfirms and offer tablets almost at cost The strategies of services firms (combined with low cost originalequipment manufacturer [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 3.2% and 1.3% of total PC browsing traffic, respectively, byJuly 2015 The event with the largest impact on Israel's PC market was the launch of Windows 8 in October

2012 Windows 8/8.1 account for 17.9% of total PC browsing traffic, while Windows XP has declinedsteadily and by April accounted for just 9.5% of browsing traffic

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 enterprise

market and Microsoft's ubiquitous Office Suite There is therefore an opportunity for vendors to leverage

this strength over rival iOS and Android devices by designing tablets with strong productivity functionalityalongside the passive media consumption features Early examples were hybrid devices such as Microsoft's

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

innovation still has room to improve, prices have started to come down and the multi-use device has scope

to capture a share of the tablet market by offering a stronger value proposition to consumers while not

compromising on user experience In its earnings results for the quarter ended December 2014, Microsoftstated that the newer Surface Pro 3 outsold is predecessor the Surface Pro 2 by a ratio of 3:1, indicating thatconsumers are beginning to embrace the new form factor

200 400 600

e/f = BMI estimate/forecast Source: BMI

Vendor Developments

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

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

unit in 2005, and through increased investment into the country In 2012, Lenovo claimed that it had topspot in the commercial laptop market in the country, and that it was the second largest 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 andapplications In September 2014 Lenovo's senior vice president met with hundreds of Israeli start-ups andsuggested that the company was considering establishing a R&D centre in the country

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 Israeli research centre inRa'anana Dell set up an R&D centre in the country in 2011, Toshiba announced plans to open one in early

2014 In 2013, Samsung announced it would open of its three global innovation and strategy centres inRamat Gan, Israel (the other two are in Silicon Valley and South Korea)

Software

BMI estimates that Israeli software spending increased to ILS5.5bn in 2014, up 8.3% from 2013, with

underling enterprise software and cybersecurity solution demand growth supplemented by operating system(OS) upgrade demand in 2014 as a result of Microsoft withdrawing official support for the legacy XP OS inApril 2014 We expect growth in the software segment to decelerate in 2015 after some upgrade demandwas brought forward, while shekel depreciation against the US dollar will result in a small amount ofdeferred purchases, but demand growth will remain strong at 5.9% in local currency terms in 2015 Thiswill however translate into a contraction of 2.8% in US dollar terms in 2015 under our core scenario

We forecast a local currency CAGR of 5.3% 2015-2019, with total spending expected to reach ILS7.1bn in

2019 This is a slight deceleration from 2015 in local currency terms, but a marked improvement in USdollar terms as a result of our in-house Country Risk team for Israel's outlook for shekel appreciation from

2016 This will boost demand for systems and upgrades in the private sector, adding to public sectorinvestments form government organisations such as the Israeli Ministry of Defense and Israeli Police, and

from utilities leader Israel Electric Company

Enterprise Software

In 2014, 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-owned Matrix, which

derives most of its revenues from the Israeli market, reported 8.8% revenue growth during 2014

Opportunities for software vendors in Israel exist across a range of sectors; from government to energy,financial services, telecoms and utilities Major customers for software solutions in Israel include large andmedium enterprises such as commercial banks, loan and mortgage banks, credit card companies, insurancecompanies, telecoms service providers, hi-tech companies, and the Israeli Defense Forces, governmentministries and public agencies

In terms of verticals, the financial sector has been a mainstay of demand, with other key areas includingdefence and healthcare IT spending from the financial services vertical has been positively impacted byregulatory reform and changes affecting banking and insurance in the wake of the global financial crisis.Such changes generated demand for specific IT solutions, often in a set time period Israeli legislationpassed in 2010 and 2011 increased Israeli Securities Authority regulatory supervision over the offering ofinvestment services and administration of investment portfolios This in, turn, increased demand for

solutions for entities that became subject to such supervision

Similarly, defence spending on new systems is likely to be maintained, given increased security risksfollowing eruption of violence between Israel and Gaza in June 2014 as well as the destabilising impact ofIslamic State on the wider region In April 2014, Israeli news portal Jerusalem Post reported that the IsraelDefense Forces (IDF) is developing its own cloud computing network, which it expects to launch by the end

of 2014 The cloud computing platform will reportedly allow commanders to receive real-time intelligence

on enemy targets and friendly forces from remote locations The IDF is also implementing other IT

solutions to strengthen its operations, such as a specialised training programme for open source technologies