Israel information technology report q3 2015

... International Ltd Page 33 Israel Information Technology Report Q3 2015 Israel PC Browsing Traffic By OS (%) And y-o-y Change (pp) April 2015 Source: Statcounter Vendor Performance The Israeli PC market... However, the outlook for Israeli IT vendors and start-ups remains © Business Monitor International Ltd Page Israel Information Technology Report Q3 2015 strong, as they report strong revenue growth... on Israel' s borders © Business Monitor International Ltd Page 14 Israel Information Technology Report Q3 2015 Industry Forecast IT Market Table: IT Industry - Historical Data And Forecasts (Israel

Q3 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: April 2015

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BMI Industry View 7

SWOT 9

IT SWOT 9

Political 11

Economic 12

Operational Risk 13

Industry Forecast 15

IT Market 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 - Q315 26

Table: MEA IT Risk/Reward Index - Q315 29

Market Overview 30

Hardware 30

Software 35

Services 39

Industry Trends And Developments 42

Regulatory Development 48

Table: IT Regulatory Authorities 48

Table: Government Initiatives 50

Competitive Landscape 52

International Companies 52

Table: Intel 52

Local Companies 53

Table: Amdocs 53

Table: Check Point 54

Table: Imperva 55

Table: Mellanox 56

Company Profile 57

Matrix 57

Ness 61

Hilan 65

Table: Hilan Financial KPIs, 2008-2014 68

Regional Overview 69

Middle East & Africa 69

Demographic Forecast 72

Table: Population Headline Indicators (Israel 1990-2025) 73

Table: Key Population Ratios (Israel 1990-2025) 74

Table: Urban/Rural Population & Life Expectancy (Israel 1990-2025) 74

Table: Population By Age Group (Israel 1990-2025) 75

Table: Population By Age Group % (Israel 1990-2025) 76

Methodology 77

Industry Forecast Methodology 77

Sources 78

Risk/Reward Index Methodology 79

Table: It Risk/Reward Index Indicators 80

Table: Weighting Of Components 81

BMI Industry View

BMI View: Israel's vibrant ICT start-up community and highly skilled tech workers 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.

Nevertheless, because of the comparatively high penetration of IT products and services, as well as its small population, Israel's IT market is expected to grow more slowly than most others in the region Given its geopolitical location and the uptick in violence in the region in 2014 and 2015, we expect spending on cyber security to be a key driver of growth, contributing to software and services' increasing share of IT sales over the five years to 2019.

Headline Expenditure Projections

Computer Hardware Sales: Forecast to reach ILS9.4bn in 2015, up from ILS9.225bn in 2014 We expect

growth to accelerate in 2015, driven by the full launch of 4G mobile networks and ongoing upgrades to theWindows 8 and Windows 10 operating systems

Software Sales: ILS6.414bn in 2015, up 9.3% year-on-year (y-o-y) from ILS5.867bn in 2014 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 ILS8.793bn in 2015, up from ILS8.263bn in 2014 Cyber security services will outperform interms of growth, but it will be stable sectors such as government and defence that continue to account forthe majority of spending

Key Trends And Developments

Data from Israel's Office of the Chief Scientist (OCS) show that the high-tech sector declined as a

proportion of GDP between 2007 and 2012, a trend which we expect to continue throughout our forecastperiod, albeit at a more gradual pace However, the outlook for Israeli IT vendors and start-ups remains

strong, as they report strong revenue growth and continue to attract strategic investment from global ITfirms.

One particular area of Israel's IT market that has attracted attention in 2015 is content monetisation

Taboola and Outbrain are market leaders in embedding recommended links to articles, videos and lists

(think '10 Best Vacation Spots In Cuba', for example) into clients such as Fox News and Rolling Stone'swebsites In February, Taboola closed a USD117mn funding round, which reportedly pegs the company'svalue at nearly USD1bn In October 2013 Outbrain raised USD35mn in funding and in 2014 filed with the

US SEC for a Nasdaq IPO, which would reportedly give it a valuation of around USD1bn if it goes ahead

with its plans Meanwhile, software download and installation specialist, IronSource, recorded revenue of

USD250mn in 2014 and closed a pre-IPO funding round of USD105mn in February, which it will use tofund acquisitions and reportedly values the company at well over USD1bn

Global firms also continue their investment, with Infosys revamping its operations in Israel with a

USD100mn budget to invest in or acquire Israeli start-ups, Facebook including Israel-based Magisto's Shot app into Facebook Messenger, 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 NFV (network function virtualisation) software specialist Saguna

One of the main reasons behind these investments is to enable global firms to tap into Israel's highly skilled

IT labour force Israel's Central Bureau of Statistics estimates there were around 145,000 jobs in the ICTservices industry at end-2013 The continued entry of global IT firms will add to the number of ICT servicesjobs, but in a country with a total working age population of 4.8mn in 2014, the pool of skilled workers islimited It is therefore unlikely the level of investment will remain as high over the longer term, once themost attractive start-ups and experienced tech workers are bought up and hired by global firms

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

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

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 data centre project under way for the Israel Defense Forces

■ Outsourcing, software-as-a-service and applications management likely to growfastest out of IT services, with particular opportunities in the financial sector

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

SWOT - Continued

Threats ■ Government austerity measures will dampen consumer and business spending

■ Intensifying regional tensions could increase operational risk

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

■ Limited size of workforce could curb attractiveness as an R&D hub over the longerterm

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 Risks of a radicalisation in theWest Bank are thus prominent

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

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

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

polished diamonds could undermine demand for Israeli exports

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 Israeli and Arab areas, limiting the number of

highly skilled Arab 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 fortrading in the MENA region

■ There are plans underway to break up large business groups which enjoy a monopoly

in certain sectors, which will increase competition and investment opportunities

■ International efforts to find a resolution to the Israeli-Palestinian conflict will continue

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

disputes disrupting business activity

SWOT Analysis - Continued

■ 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

Industry Forecast

IT Market

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

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

IT market value, ILSmn 22,299.5 22,576.0 23,354.8 24,607.9 26,490.5 27,698.4 28,895.0 30,073.9 Computer hardware sales, ILSmn 9,388.1 9,143.3 9,225.2 9,400.2 9,801.5 10,082.2 10,113.2 10,104.8 Personal computer sales, ILSmn 7,895.4 7,753.5 7,869.1 8,065.4 8,517.5 8,821.9 8,909.8 8,963.0 Software sales, ILSmn 5,177.2 5,524.3 5,866.6 6,414.2 7,128.1 7,520.4 8,146.5 8,792.5 Services sales, ILSmn 7,734.2 7,908.4 8,263.1 8,793.5 9,560.9 10,095.8 10,635.2 11,176.6

e/f = BMI estimate/forecast Source: BMI

We continue to hold the view that the Israeli IT market will experience slow and steady growth over themedium term and gradually decline as a percentage of GDP This is a product of saturation of the hardwareand software/services market and price competition between vendors, which will hold down the overallvalue of the market Nevertheless, Israel remains at the forefront of development of security services andcontinues to attract investment in research and development centres from global IT firms This chimes withdata published by the Office of the Chief Scientist (OCS), which shows that although 2014 was a recordyear for exits in the technology sector, either through IPOs or being acquired, reaching USD6.9bn, hi-techhas declined as a share of total GDP from a peak of nearly 13% in 2007 to 11.5% by 2012 (latest dataavailable)

We estimate the IT market to reach a value of ILS23.355bn in 2014, equal to USD6.528bn and up fromILS22.6bn in 2013 Despite our expectations of relatively weak growth in 2013 and 2014, we maintain amore positive outlook for Israel's IT market over the long term, propelled by the country's improvingmacroeconomic outlook Israel remains a robust IT market with plenty of opportunities across industrial,government, defence, financial services and telecoms spending

Our five-year compound annual growth rate sees growth around 4.1% in Israeli new shekel terms for theperiod from 2015-2019 We expect IT software will be the fastest growing segment of the IT market,slightly ahead of services, with both growing fast relative to hardware In terms of key verticals, the

financial services and defence sectors drive growth, with rising geopolitical tensions likely to result in even

stronger demand for IT security solutions The nature of sales will change, however, as business

management, efficiency improvements and data analytics becomes increasingly important and the hardwaresegment contributes comparatively less to the market's overall growth

2015 Outlook

We project real GDP growth of 3.1% in Israel in 2015, an improvement on a slight economic downturn in

2013 BMI's Country Risk team downgraded Israel's growth forecast slightly in the wake of the violence

between Israel and Gaza, but does not expect the events to have a lasting negative impact on the economy.Over the remaining years to 2019, we expect slow but steady acceleration in the economy, with averageannual GDP growth of 3.5% This trend will pick up over the longer term as gas resources currently under

development come online from 2019 BMI also forecasts underwhelming expansion of private consumption

growth at 3.5% in 2015

The financial sector and defence continue to be the primary verticals for IT software and services, withrising geopolitical tensions in the Middle East likely to drive strong demand for cyber and informationsecurity 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 major contribution to ITspending 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

Industry Trends - IT Market

2012-2019

IT market value, ILSmn IT market value, % of GDP

2012 2013 2014e 2015f 2016f 2017f 2018f 2019f 0

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

1 1.5 2 2.5 3

e/f = BMI estimate/forecast Source: BMI

In the hardware segment, household computer penetration of more than 75% offers only 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.

Per capita IT spending is expected to reach from ILS3,107 in 2015 and rise to ILS3,585 by 2019 However,spending will fail to keep pace with GDP growth in Israel as the economy becomes less heavily weightedtowards the high-tech sector following gas exploration and growth in other sectors

Income Per Capita Breakdown

(2012-2019)

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

2012 2013e 2014e 2015f 2016f 2017f 2018f 2019f 0

100,000

25,000 50,000 75,000

e/f = BMI estimate/forecast Source: BMI, National Sources

Still, 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

Cloud computing is expected to be a source of revenue growth over the medium term as organisationslooking for efficiencies turn to more flexible and affordable Software-as-a-Service and Infrastructure-as-a-Service Particular areas of opportunity for cloud computing include banking and retail, as organisations inthose fields look to save money on hardware and improve customer services

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 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 Israel between 2005 and 2012

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 ILS9.4bn in 2015 to ILS10.1bn in 2019, with PC sales projected to rise from anestimated ILS8.1bn to ILS9.0bn 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 29.2% of Israel's IT market by 2019, up from 25.1% in 2014, while servicesare forecast to rise from 35.4% of the IT market to 37.2% over the same timeframe

Macroeconomic Forecasts

Economic Analysis

BMI View: We forecast real GDP growth of 3.1% and 3.4% in Israel in 2015 and 2016 respectively, from

2.6% in 2014 A pickup in fixed capital formation - the result of low base effects - will be the main growth driver this year as private and government consumption slow slightly Beyond 2015, a moderation of austerity policies and increasing exports underpin our relatively bullish medium-term outlook for the economy.

Economic growth in Israel will pick up marginally in 2015 and beyond but will remain below the 10-yearaverage The uptick will be mostly on the back of an increase in fixed capital formation as a result of lowbase effects and record low interest rates Economic growth rebounded to an annualised 7.2% quarter-on-quarter (q-o-q) in Q414, following 0.6% growth in Q314 when the conflict with Islamist group Hamas inthe Gaza Strip occurred We believe that the impact, and rebound, from the Gaza conflict has almost fullytaken place and thus growth will return to a more stable trajectory in the coming quarters We forecast realGDP growth of 3.1% and 3.4% in Israel in 2015 and 2016 respectively, from 2.6% in 2014

A moderation of austerity policies over the coming years, coupled with increasing exports and a subsequentacceleration in fixed investment growth, underpin our positive view for the Israeli economy over the nextfive years, and we forecast real GDP growth to average 3.6% over this period

Picking Up, But Still Below Par

Israel - Real GDP Growth (%)

2005 2006 2007 2008 2009 2010 2011 2012 2013

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

0 2 4 6 8

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

Expenditure Breakdown

Private Consumption Outlook: We expect consumer spending to hold up relatively well in the near term

and highlight three factors that will bolster household spending over the coming quarters First, inflationwill remain subdued, averaging 0.9% over 2015, particularly with global oil prices having taken a sharpdownturn in recent months Second, unemployment remains near all-time lows The joblessness rate came

in at 5.4% in December 2014, compared with an average of 6.0% over the first 11 months of the year.Finally, both fiscal and monetary policy remain in expansionary mode, with tax cuts and public sector wagehikes having been implemented last year and the Bank of Israel's benchmark interest rate down to 0.10% inFebruary We forecast private consumption growth of 3.1% and 3.4% in 2015 and 2016 respectively,compared with 2.8% last year

One-Off Jump

Israel - Real GDP, % chg q-o-q (annualised)

Source: BMI, Central Bureau of Statistics

Government Spending Outlook: The government's tight fiscal policy will lead to a slowdown in spending

on health, education and public services in 2015; however, opposition to austerity as well as the electionwill mean the decrease is relatively small We forecast government consumption to expand by 3.5% and

3.0% in 2015 and 2016, from 3.9% in 2014 (see 'Deficit To Shrink Gradually' February 20).

Our Pharmaceuticals research team believes that public spending on health will continue to increase over

the coming years Indeed, the 2015 budget will see a ILS2.8bn (USD734mn) uptick in funding for thehealthcare sector, the second largest increase after defence

No Trend Reversal

Israel - Bank Hapoalim Purchasing Managers' Index

Source: BMI, Bank Hapoalim

Fixed Investment Outlook: Gross fixed capital formation (GFCF) will rebound in 2015 on the back of low

base effects and near-zero interest rates GFCF contracted by 2.0% in 2014, mostly due to the conflict withHamas over the summer, and thus there is room for a rebound However, the uptick will be limited asconcerns remain over the state of the housing market, and with house price inflation having slowed to 0.1%year-on-year in December - down from an average of 3.5% over the past three years - residential

construction is likely to slow significantly There is also a risk that state capital spending will head lower aspressure on the government to narrow the fiscal deficit increases

The five-year outlook for gross fixed capital formation is encouraging, particularly given prospects for

increasing investment in the energy industry In the middle of November 2014, Israel-based Delek Drilling

outlined a major upgrade programme for the Tamar gas field The development plan is linked to a letter of

intent signed between Delek and Spanish gas and electricity company Union Fenosa Gas (UFG) in May

2014 for the supply of 70bn cubic metres (bcm) of gas over 15 years to Egypt's Damietta LNG terminal.The Tamar upgrade plan is estimated to cost between USD1.5bn and USD2bn, with a target of nearly

doubling production capacity to 20bcm once complete We project fixed investment to contract by 1.5% in

2014 and expand by 4.0% in 2015, and to grow by 4.5% on average over the next five years

Investment Opportunities Lie Ahead

Israel - Gas Production (bcm)

Dry natural gas production, bcm Dry natural gas net exports, bcm

2014e 2015f 2016f 2017f 2018f 2019f 2020f 2021f 2022f 2023f 2024f0

5 10 15 20 25

EIA/BMI

Net Exports: We see Israel recording net export deficits of ILS3.7bn and ILS4.5bn in 2015 and 2016

respectively, from a ILS1.2bn surplus in 2014 Exports expanded by 2.8% in Q314 due to a weakeningshekel - which lost 14.1% of its value since the beginning of August 2014 - from a sharp drop in the

previous quarter We expect total exports to expand by 2.0% in 2015, primarily as the shekel will remainweak relative to levels seen in H114 A gradual improvement in macroeconomic conditions in the UK,Belgium, the Netherlands and Germany - which accounted for 45.2% of total Israeli exports in 2013 - willalso support a return to export growth

Import growth will outpace export growth over the next few years Total imports expanded by 16.2% inQ314, from a 5.5% decline in Q214; we project this component to expand by 1.5% this year and 3.5% in thenext on the back of an uptick in domestic consumption and fixed investment

Table: Economic Activity (Israel 2010-2019)

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

Nominal GDP, USDbn 233.3 258.4 257.3 290.6 302.8 296.6 316.5 344.7 367.7 392.2

GDP per capita, USD 31,438 34,261 33,664 37,584 38,714 37,446 39,423 42,324 44,477 46,760

Industry Risk Reward Index

Middle East And Africa Risk/Reward Index - Q315

There has been some shuffling in the rankings in this quarter's update to the Middle East and Africa (MEA)

IT Risk/Reward Index (RRI), though no country has dropped out of a top five or top 10 position Israel heldits spot at the top, reflecting its mature IT software and services market, wealthy consumer base and stablepolitical environment The UAE pulled ahead of Qatar into second place, as its more diversified economycompared to other GCC peers has mitigated any impact of lower oil prices on government, enterprise andconsumer demand for services

Nigeria was the biggest loser this quarter, falling from seventh to ninth place, as BMI's Country Risk team

made a sharp downward revision to our GDP growth outlook, from 5.6% to 3.9% for 2015, given itsreliance on oil exports for around 70% of government revenue This will constrain the government's ability

to spend on IT, even though we expect the wider ICT sector to remain an important element in the

government's plan to boost economic inclusion and development over the next five years Ghana also posted

a further decline in its score this quarter, falling below Lebanon into twelfth place on our RRI table, as theCedi's depreciation again gathered speed in the run-up to an IMF agreement in early April, a trend which weexpect to continue throughout 2015 as Ghana's current account deficit widens

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 Our Country Rewards rating assesses the potentialfor consumers and businesses to spend on IT products and services based on a number of key

macroeconomic indicators, including GDP per capita and the rate of urbanisation These factors are

important gauges for the level of consumer demand for IT products and services in any given market TheIndustry Risks category reflects the strength of intellectual property (IP) protection and ICT policy in amarket, an important determinant in the rate of software piracy and counterfeiting Finally the CountryRisks category assesses external factors that could affect a country's overall investment outlook and

consequently the growth prospects for the IT sector These factors include short-term external and financialrisk, trade bureaucracy, legal frameworks and corruption perception

Macro And Political Headwinds Take Their Toll

Quarterly And Annual Change To IT RRI Scores (points), Q315

Source: BMI

A comparison on year-on-year (y-o-y) and quarter-on-quarter (q-o-q) change to each country's overall ITscore in the Q315 update shows that the IT growth outlook and wider business environment for mostmarkets have worsened over the last three to 12 months Both on a quarterly and an annual basis, there havebeen no changes to any country's Industry Risks score and only minor changes in the Country Rewardscategory

For all five African countries in our index, as well as Kuwait, Qatar and Lebanon, the Industry Rewardsscore is the prime source of the drag on their IT scores over the last year For the most part, this is owing tothe slowdown in GDP growth brought about by lower commodity prices, as mentioned above for Nigeria.Kenya, as a net oil importer, is the exception to this norm and instead benefits from lower prices, whichdrove up its Country Reward score and resulted in its strong q-o-q gains The big y-o-y drop in Kenya'sscore meanwhile reflects a downgrade to its IT growth forecast when the government abandoned its schoollaptop programme earlier in 2015

Another issue of electricity shortages continues to plague Sub-Saharan Africa (SSA), and in South Africa in

particular BMI's Country Risk team made a downward revision to our short-term GDP growth forecast

owing to the negative impact of rolling blackouts on most industries This has a direct impact on the ITsector, through the additional cost of alternative energy solutions, and an indirect one, as customers acrossother industries divert spending from IT to more critical electricity solutions Nevertheless, the maturity ofSouth Africa's IT sector and ongoing investments in fibre broadband networks in key business districtsmean it remains by far the most attractive market in SSA.

For Kuwait and Qatar, the slump is owing to slight downward revisions to our IT forecasts for the twocountries, in light of lower oil prices and some tightening of budgets across various sectors But they bothremain within our top five for the region and are important markets to IT firms aiming to establish

themselves across the GCC This is illustrated by Avaya and IBM opening new offices in Qatar and

Kuwait, respectively, in April 2015

With the exception of Qatar and Kuwait, Middle Eastern countries' scores showed an opposite pattern totheir African counterparts The UAE, Saudi Arabia, Bahrain and Israel recorded net y-o-y gains in theIndustry Rewards category, as their governments and enterprises continue to invest in modernising their IT

systems For example Saudi Arabia's Justice Ministry deployed a Symantec data recovery solution and the UAE's Al-Futtaim Group implemented the SAP Ariba solution in April 2015, while Bahrain's Ministry of Health selected Azimuth to implement a new Enterprise Asset Management solution to improve staff and

patient safety services Smart city initiatives are also beginning to gather speed in the region; since the

beginning of 2015, Msheireb Properties signed a smart city agreement with MEEZA, Etisalat and Huawei established a partnership on M2M and IoT and Cisco was selected to consult Dubai Design District

on its smart city project, where it aims to roll out 130 initiatives across at least 11 new buildings

However all six GCC countries recorded losses in the Country Risks segment, as external risks relating torising regional tensions threaten stability The proxy war unfolding between Saudi Arabia and Iran inYemen, with tensions also spreading into Bahrain and the rest of the region, too, is the main source of thedeclining scores Saudi Arabia's sharp q-o-q loss reflects further political uncertainty, as new ruler KingSalman bin Abdulaziz reshuffles the country's top leadership, in a move that strays from traditional

succession policies Nevertheless, the heavier weighting towards Industry Rewards compared to CountryRisks in our index means that the UAE, Bahrain and Saudi Arabia were able to record y-o-y gains, despiterising external risks By contrast, with losses across both categories, Qatar and Kuwait were the MiddleEast's underperformers over the last 12 months

Table: MEA IT Risk/Reward Index - Q315

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

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

Market Overview

Hardware

BMI estimates Israel's IT hardware market returned to positive growth in 2014, up 0.1% year-on-year

(y-o-y) to ILS9.225bn We forecast positive, albeit slow growth with a compound annual growth rate (CAGR) of1.5% over our five-year forecast from 2015 to 2019 In 2013 the value of hardware sales was squeezed by aweaker currency, price competition and the lower unit price of mid-range tablets hitting the market Helped

by an acceleration in private consumption growth, BMI believes that increased take-up of tablets and the end of support to older Windows operating systems boosted sales in 2014

Israel's growing attraction as an IT research and development hub to international firms and its expertise incyber security have helped to insulate the IT sector from macroeconomic headwinds, which saw the

country's GDP growth slow from 5.8% in 2010 to 2.8% in 2014 However, BMI forecasts Israel's real GDP

growth return to positive territory in 2015, reaching real growth of 3.1%, and to outperform its developedmarket peers in the eurozone and the regional outlook for the Middle East over the five years to 2019.Growth will primarily be driven by fixed investment, with net exports ticking up toward the end of theforecast period as gas resources come online

During 2015, we also expect continued modest growth in private consumption, at 3.5% Paired with loweraverage prices for devices, we forecast stronger but still modest growth in the hardware segment in 2015,continuing its recovery from a slump in 2013

The Israeli government has launched various initiatives to increase computer and internet penetration, such

as Computer for Every Child, now morphing into 'Tablet for Every Child' according to Israeli PrimeMinister Binyamin Netanyahu, and 'Digital Israel', a proposed initiative to streamline the digitisation ofpublic sector services, such as education, healthcare and social services The level of support, however, hasbeen criticised by some industry insiders as too low Between its launch in 1995 and June 2013, the

Computer for Every Child initiative reportedly distributed 55,000 computers in around 2,000 localities,representing a tiny fraction 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 the auspices of the Ministry of Finance, with many of the same goals as DigitalIsrael However, Carmela Avner, Israel's first chief information officer who headed the centre, announcedher 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 &

development markets, and purchases of personal computing devices to remain the bulk of market sales.Mobile computing devices including tablets, slimline notebooks, ultrabooks and hybrids present a keygrowth opportunity for vendors as consumers increasingly complement household desktop and laptops withmore easily transportable devices Although tablet computers took longer to reach mass popularity in Israelthan other mature ICT markets, we believe demand strengthened from 2014, further supported by animproving private consumption outlook

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 ofweakened economic growth

Hardware Market

(2012-2019)

Personal computer sales, ILSmn Servers sales, ILSmn

2012e 2013e 2014e 2015f 2016f 2017f 2018f 2019f 0

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

e/f = BMI estimate/forecast Source: BMI

Evolving Form Factors

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

total market in 2014 (excluding communications hardware) As the market continues to mature, we expectthis to drop to around 33.6% by 2019 Prior to 2012, notebooks were the fastest-growing segment of themarket, although as recently as 2008 desktops still took around two-thirds of unit sales In 2010-2011,however the share of desktops declined precipitously, and then in 2012 there was a shift from notebooks to

tablets as the fastest growing segment of the market BMI estimates that notebooks and tablets accounted

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 2015-2019 forecast period Despite itsdeclining share of sales, however, the desktop sector is still significant, largely due to business and

government end-users Meanwhile, on the opposite side of the spectrum, Israeli consumers have been slow

to embrace tablet devices, with notebooks still accounting for the largest share of PC unit sales in 2014

However, tablets have become increasingly popular since 2012 and BMI expects them to overtake

notebooks in terms of unit sales in 2015

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 maintain its dominance of Israel's tablet marketthroughout 2013 and 2014 Data from Statcounter show that iOS, run on Apple's tablets, accounted for73.3% of all tablet browsing traffic in Israel in April 2015 This was down by just 2 percentage points (pp)y-o-y, though largely unchanged since July 2014 Android accounted for most of the rest of tablet browsingtraffic, with a share of 28.6% in April 2015 (up by 4.4ppts y-o-y), but having made little gains since

mid-2014 Windows 8 had only a tiny share of tablet browsing traffic of 0.7% in April 2015

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 Household spending per capita in Israel was ILS56,571 (USD15,936) in

2014, the highest in the Middle East region according to BMI data 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 Israeli tablet market Statcounter data suggest that Samsung has

made the most progress, with its tablets accounting for 13.5% of browsing market share in April 2015, up

by around 3ppts y-o-y Asus claimed a 4.4% share, Google (LG Nexus) a 2.5% share and all other players

claimed less than 1% share each, according to Statcounter The gap between the strategies of some of the

leading players is worth noting On the one hand Apple and Samsung are hardware vendors and look toprofit from the sale of devices, while on the other side Google and Amazon are services firms and offertablets almost at cost The strategies of services firms (combined with low cost original equipment

manufacturer [OEM] tablets from China) will likely put pressure on the margins of hardware centricvendors 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, byApril 2015 (this is nevertheless up from 2.8% and 0.9% 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 Windows 8/8.1account for 17.2% of total PC browsing traffic, while Windows XP has declined steadily and by Aprilaccounted for just 10.4% of browsing traffic Although Windows will soon release Windows 10, Windows

7 still remains by far the most common OS in Israel, accounting for 61.2% of browsing traffic in April

2015, down by barely 1ppts y-o-y

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 notcompromising 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 to 1, indicatingthat consumers are beginning to embrace the new form factor

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

April 2015

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 andSamsung - 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, also overtaking HP and Dell which both had 15.2% market share in 2012

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 research and development (R&D) centre in thecountry

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 in

Ra'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 ILS5.87bn in 2014, up 6.2% y-o-y We expect

growth in the software segment to accelerate, with a CAGR forecast of around 6.5% over the five years to

2019 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 Defense 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 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 (see MatrixCompany Profile for further details)

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

Meanwhile, the small- and medium-sized enterprise (SME) segment, the mainstay of the Israeli businesssector, has emerged in recent years as an important growth area for enterprise systems The SME sector will

become more important in 2015, as the government cuts on non-essential spending in order to service debtsrelating to the June-August war with Gaza SME spending on enterprise solutions should continue to growsteadily, with reviving or emerging areas of opportunity including security, customer relationship

management (CRM) solutions and business intelligence

e/f = BMI estimate/forecast Source: BMI

Migrations to the Windows 8 operating system are believed to have had a positive impact on 2013 and 2014sales Following several upgrades to the Surface Pro, in January 2015 Microsoft announced the SurfaceHub, an 84- or 55-inch multi-touch and multi-pen 4K wall mounted screen device, aimed at business users,and which will run the newest Windows 10 OS

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

implementation and CRM The sheer volume of data that enterprises must now handle as a result of device

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

water meter technology, announced a partnership with IBM to help customers and water utilities manage

resources more efficiently through use of big data and analytics technology The analytics technology was

developed by IBM in Israel.

The security software segment is one of the fields with the greatest opportunity in Israel, potentially worthhundreds of millions of dollars over the medium term as awareness of security issues grows in tandem withthe rise of cloud computing Owing to the country's geopolitical situation, Israeli companies, organisationsand the government are highly sensitive to cyber threats, and local IT firms have responded to the

heightened demand by developing some of the world's most advanced IT security software BMI believes

research and spending is likely to continue across all software segments, although with security content andthreat management remaining the current priorities

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

to create a 'digital Iron Dome' to protect vital infrastructure from hackers and viruses (the Iron Dome isIsrael's anti-rocket defence system) This included the establishment of the National Cyber Bureau to defendthe nation against computer terrorism This policy should see vendors win public contracts, while alsoserving to focus the minds in the private sector, although at the time of writing no major contracts had beenpublicly announced In October 2014, Netanyahu announced further plans to establish a National CyberDefense Authority, which will protect civilian cyberspace as well as vital security facilities

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

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

USD950mn after proving successful among SMEs Incapsula provides high-end firewalls to assess

incoming traffic and identify possible bugs Incapsula was established in 2009, created by three Impervaemployees

The growing emphasis of many multinational IT vendors on software and services revenues has led several

of them to direct more investment into R&D at the Israeli market In June 2014, 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 start-up Hexadite announced a

USD2.5mn in seed funding for its operations

In July 2014, Microsoft, cloud services provider Akamai Technologies and Jerusalem Venture Partners

(JVP) collaborated to work on a cyber security accelerator The move is in line with Microsoft's effort toprovide start-ups with a programme and market expertise to aid them in accelerating their business and to

create milestones in cyber security At the end of the programme, one of the cyber security start-ups will beprovided with an investment of USD1mn Earlier in 2014, IBM also announced plans to open an IT security

centre in Beersheva, while Cisco and Lockheed Martin both announced plans to increase their investments

in the development of the country's IT sector

Israel's strong reputation as a hotbed for innovative software development has made Israeli companiespopular takeover targets for multinationals In September 2013, IBM completed its acquisition of Israeli-US

enterprise security firm Trusteer, for an estimated USD1bn Trusteer's customers reportedly include seven

of the top 10 US banks and nine of the top 10 UK banks More recently, in April 2014 US-based Palo Alto Networks confirmed its acquisition of Tel Aviv-based Cyvera, which has developed software to protect

computers running Windows software, including ATMs, from unknown, zero-day cyber attacks Palo Altodid not confirm the value of the transaction, but industry experts estimated it at around

USD200mn Meanwhile, European enterprise software leader SAP is also looking to leverage the skills

base of the Israeli market as it focuses on three key technology areas: mobile, in-memory computing andcloud computing SAP is developing more mobile business applications that could be deployed across avariety of devices, including tablets In-memory computing, a technology which SAP is developing throughits HANA solution, is expected to revolutionise the way companies handle big-data SAP Labs Israel hasbeen at the forefront of SAP's work in this area, with more than 100 local developers participating in thedevelopment of the HANA in-memory solution Israeli developers were also responsible for the creation ofthe company's Real Time Offer Management solution, which is currently being tested by French

supermarket chain Casino

Given the current focus of many businesses on controlling costs, the pay-on-demand software-as-a-service(SaaS) model has grown in popularity and spread beyond the initial core application area of CRM Newcloud computing offerings and increased competition in this segment should fuel further demand fromusers As well as cost savings, businesses will look to boost efficiency and increase flexibility of response tocustomer needs Large businesses are most likely to put IT applications such as mail, phone systems anddocument management into the cloud However, enterprise applications that require a high level of

customisation, or which are subject to regulatory or data-sensitivity constraints, are more likely to stay onpremise

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 legislation

passed 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 technologiesPython and Ruby on Rails In August 2013, the IDF also launched an internal platform called Yohanan,which allows soldiers to use open-source software components created within the military organisation

Services

The IT services segment is estimated to have reached a value of ILS8.26bn in 2014 BMI forecasts this to

continue expanding at a CAGR of 4.9% over the next five years to reach ILS11.18bn in 2019 In 2014 andQ115 vendors reported a continued flow of new projects in sectors such as government, financial services,homeland security and utilities

Matrix's chief rivals in its domestic IT services market include fellow Israeli IT services giant Ness

Technologies (whose local segment Ness Israel was acquired by Hilan in June 2014) as well as Malam, One-1, Taldor Computer Systems, the Elad Group and Yael These local firms also compete

Team-with international players such as HP and IBM International vendors in the Israeli market often work Team-withlocal subcontractors

The IT services market is affected by regulatory reform, which influences and drives demand in sectorssuch as; government, with much spending related to e-government targets; financial services, where anincrease in regulatory supervision has necessitated new IT investments; and telecoms, where spending isdriven by the roll-out of new platforms and services In August 2012, Ness was awarded a 10-year contractfrom Israel's Ministry of Finance to establish and operate the country's new National Long-Term Savingsand Insurance Exchange The new exchange is expected to streamline work processes, and provide thepublic with information about the retirement savings and insurance plans on offer So important is theproject to Ness that the company established a dedicated subsidiary to develop and operate the NationalExchange, including a service and support centre

5 10 15

0 20

e/f = BMI estimate/forecast Source: BMI

Defence and government spending represent a significant component of Israeli IT demand and have someimmunity to economic vicissitudes The Ministry of Defence has awarded a number of multimillion-dollar

IT contracts, including a USD10mn tender for a new command and control system and a data centre

contract awarded to VMware in December 2013, which Jewish Business News valued around USD27mn.

One potential demand driver will be organisations looking for help to utilise efficiencies from cloud

computing, such as SaaS and infrastructure-as-a-service (IaaS) In 2011, vendors such as Alcatel-Lucent

have continued to invest in new cloud computing facilities in Israel, leveraging the country's expertise

While large organisations still dominate demand for services, SMEs have also been investing more,

representing a growth opportunity Many SMEs are waking up to the need to compete through more directinvestment in support and service infrastructures These factors are driving an increase in demand formanaged services among SMEs, which are keen to leverage the operational efficiencies offered by SaaS andIaaS solutions