Israel information technology report q4 2013

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

Q4 2013 www.businessmonitor.com ISRAEL INFORMATION TECHNOLOGY REPORT INCLUDES 5-YEAR FORECASTS TO 2017 ISSN 1752-4245 Published by:Business Monitor International Israel Information Technology Report Q4 2013 INCLUDES 5-YEAR FORECASTS TO 2017 Part of BMI’s Industry Report & Forecasts Series Published by: Business Monitor International Copy deadline: August 2013 Business Monitor International Senator House 85 Queen Victoria Street London EC4V 4AB United Kingdom Tel: +44 (0) 20 7248 0468 Fax: +44 (0) 20 7248 0467 Email: subs@businessmonitor.com Web: http://www.businessmonitor.com © 2013 Business Monitor International All rights reserved. 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All information is provided without warranty, and Business Monitor International makes no representation of warranty of any kind as to the accuracy or completeness of any information hereto contained. Israel Information Technology Report Q4 2013 CONTENTS BMI Industry View ............................................................................................................... 7 SWOT .................................................................................................................................... 9 IT SWOT .................................................................................................................................................. 9 Political ................................................................................................................................................. 11 Economic ............................................................................................................................................... 12 Business Environment .............................................................................................................................. 13 Industry Forecast .............................................................................................................. 14 IT Market ............................................................................................................................................... 14 Table: Israel IT Industry - Historical Data And Forecasts (ILSmn) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Internet .................................................................................................................................................. 20 Table: Table: Internet Data And Forecasts, 2010-2017 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Macroeconomic Forecasts ............................................................................................... 22 Macroeconomic Forecast .......................................................................................................................... 22 Industry Risk Reward Ratings .......................................................................................... 28 Table: Middle East And Africa Risk/Reward Ratings Q413 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Market Overview ............................................................................................................... 31 Hardware ............................................................................................................................................. 31 Software ............................................................................................................................................... 36 Services ................................................................................................................................................ 40 Industry Trends And Developments ................................................................................ 45 Regulatory Development .................................................................................................. 49 Table: IT Regulatory Authorities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 Table: Government Initiatives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 Company Profile ................................................................................................................ 53 Ness ...................................................................................................................................................... 53 Matrix ................................................................................................................................................... 58 Regional Overview ............................................................................................................ 62 PC Market Feels The Squeeze .................................................................................................................. 64 Demographic Forecast ..................................................................................................... 66 Table: Israel's Population By Age Group, 1990-2020 ('000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 Table: Israel's Population By Age Group, 1990-2020 (% of total) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 Table: Israel's Key Population Ratios, 1990-2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 Table: Israel's Rural/Urban Population Split, 1990-2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69 © Business Monitor International Page 4 Israel Information Technology Report Q4 2013 Methodology ...................................................................................................................... 70 Methodology ........................................................................................................................................... 70 IT Industry Forecasts .............................................................................................................................. 70 IT Risk/Reward Ratings - Methodology ...................................................................................................... 71 Table: IT Business Environment Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 Weighting ............................................................................................................................................. 73 Table: Weighting Of Components . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 Sources ................................................................................................................................................ 73 © Business Monitor International Page 5 Israel Information Technology Report Q4 2013 BMI Industry View BMI View: IT spending is expected to reach ILS22.6bn in 2013, with relatively stronger growth in software and services, compared to hardware as the market matures. Although vendors reported a seasonal dip in new projects in Q113, BMI believes IT spending will remain on a positive trajectory this year. The market will increasingly be driven by software and services in key sectors such as government, defence and financial services - resulting in IT services accounting for 36.4% of the overall market spending by 2017. Headline Expenditure Projections Computer Hardware Sales: ILS9.56bn in 2012 to ILS9.55bn in 2013, down 0.1% in local currency terms. The slowdown is primarily the result of macroeconomic factors, but Israeli businesses are investing more to facilitate expansion and development and sales growth should strengthen from 2014. Software Sales: ILS5.0bn in 2012 to ILS5.1bn in 2013, an increase of 2.3% y-o-y. Device and data proliferation will drive spending on customer relationship management (CRM), databases and business intelligence. IT Services Sales: We expect IT services sales will outperform the rest of the IT market, increasing from ILS7.73bn in 2012 to ILS7.90bnin 2013. Stable sectors such as government and defence offer continued revenue opportunities, while growth will be derived from cyber and data security, cloud computing and outsourcing. Key Trends & Developments ■ The IT market in Israel continues to be held back by the wider economic environment, underpinning our view of weak IT market sales growth in 2013. Despite a domestic slowdown and global economic headwinds, a significant number of opportunities remain. The launch of Windows 8 operating system and an expected increase in tablet sales will offset some of the economic slowdown in the retail hardware market, as will the development of multi-use hybrid notebooks by Windows vendors in 2013 and 2014. ■ The IT services market will also fare better than either software or hardware, with sales driven by cloud computing, outsourcing and security. As a wider range of cloud computing products are released, and increased competition between vendors lowers prices, uptake will increase among enterprises and government. Particular areas of opportunity for cloud computing include banking and retailing as organisations in those fields looking to save money on hardware investments. Businesses will not only seek to make cost savings, but will look to boost efficiency and increase flexibility of response to customer needs. ■ BMI also highlights the potential for of continued financial sector spending in Israel as a result of a number regulatory changes introduced in the wake of the economic crisis of 2008-2009.Israeli financial services regulatory body the Israeli Security Authority has increased supervision of companies offering © Business Monitor International Page 7 Israel Information Technology Report Q4 2013 advice with respect to pensions, insurance and other financial products. This, in turn, has generated additional IT spending, with banks and other organisations often needing to implement solutions to ensure compliance within a set time. © Business Monitor International Page 8 Israel Information Technology Report Q4 2013 SWOT IT SWOT SWOT Analysis Strengths ■ One of the most modern economies in the region, with a highly educated, linguistically skilled workforce, and relatively low labour costs compared with most developed countries. ■ Strong defence and government spending provides base for IT demand. ■ Relatively mature IT market, with services accounting for an estimated 34.7% of spending in 2012. Despite this, the market for basic IT hardware and software is far from saturated. ■ Strong political support, with the government having implemented many policies to aid in the development, success and expansion of the IT sector. ■ Investment in FTTH and wireless data networks provide basis for cloud computing growth and internet of things expansion. Weaknesses ■ The recession at the beginning of the 2000s created a client mentality of focusing on the bottom line, with enhanced services and customer market power adding to pressure on pricing and margins. Opportunities ■ Digital divide, with just 3% of bottom-income group having home internet access. ■ Cyber security is a growing concern for government and enterprises, with potential for sales growth in data security as well. ■ Growing demand for tablets and other mobile computing devices such as hybrids and ultrabooks. ■ Despite the financial crisis, the financial services sector, which accounts for around 15% of spending, will have to spend on compliance with new Israeli Securites Authority regulations, introduced in the wake of hth economic crisis. © Business Monitor International Page 9 Israel Information Technology Report Q4 2013 SWOT Analysis - Continued ■ Defence and government projects should be less sensitive to fiscal retrenchment, with a major Savings and Insurance Exchange project rolled out by the Ministry of Finance in 2013. ■ Outsourcing, Software-as-a-Service (SaaS) and applications management likely to grow fastest out of IT services, with particular opportunities in financial sector. Threats ■ Opportunities for partnership/investment in Israel's lively local IT company sector. ■ Healthcare IT will be a growing source of opportunity. ■ Economic downturn and unemployment will lead to weaker consumer and business sentiment. ■ Other factors may affect business confidence, notably the security situation. ■ The weaker local currency, and aggressive pricing, may continue to constrain growth and put pressure on margins. © Business Monitor International Page 10 Israel Information Technology Report Q4 2013 Political 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 tensions between Israel and Hamas set to remain elevated. ■ Frequent change to the composition of the coalition government often leads to policies becoming fragmented or significantly diluted. Opportunities ■ With the civil war in Syria intensifying, risks of a spill over into Israel are increasing. ■ A warming of relations with Greece has given Israel the ability to engage in military exercises over a larger geographic area Threats ■ The victory of Hamas in the 2006 Palestinian elections, its subsequent takeover of the Gaza Strip and Israel's military incursion into the territory in December 2008/January 2009 have added to uncertainty. Despite the ongoing truce between Jerusalem and Gaza city, finding a lasting solution continues to pose a dilemma for Israel. ■ The construction of the West Bank barrier and the continued home-building in some West Bank settlements antagonises the Palestinians and stands in the way of the peace process. ■ Iranian President Mahmoud Ahmadinejad's refusal to give up his country's nuclear programme raises concerns that an open military conflict between Israel and the Islamic republic could erupt in the second half of 2013. © Business Monitor International Page 11 Israel Information Technology Report Q4 2013 Economic SWOT Analysis Strengths ■ The policy framework has stabilised in recent years, and recent austerity measures will help to keep the fiscal deficit under control. ■ The workforce is highly educated and skilled. ■ The country's close ties with the US provide it with substantial financial assistance for economic and military ends. Weaknesses ■ The main downside risk to the economy is the security situation. A sharp deterioration can have an immediate impact on domestic confidence, tourism receipts, the exchange rate and foreign investment. ■ The economy is highly exposed to that of the US and Europe in terms of exports and investment. Opportunities ■ In the long term, high levels of employment will underpin private consumption growth. ■ Israel produces more technology start-up companies than any other country in the world except the US. ■ The discovery of large offshore gas deposit will bring an influx in foreign investment and is expected to serve the country's energy needs for decades. Threats ■ Israel's energy supplies are not stable at the moment - the Egypt-Israel gas pipeline has been targeted frequently in 2011, forcing the country to buy more expensive fuels from alternative sources. That said, risks will abate as production in the recently discovered Tamar gas field begins in June 2013. ■ Competition from emerging Chinese and Indian producers of high-tech goods and polished diamonds, as well as sluggish growth in the eurozone, could undermine demand for Israeli exports. © Business Monitor International Page 12 Israel Information Technology Report Q4 2013 Business Environment SWOT Analysis Strengths ■ The business environment is supported by sound infrastructure and communication networks, as well as transparent legislation. ■ The banking system is one of the most sophisticated in the region, and offers a wide range of both consumer and commercial credit products. Weaknesses ■ Historic political instability increases the risk premium of investment in Israel. ■ Some limits on repatriation of capital exist and there are constraints on foreign investment in the high-tech sector. Opportunities ■ The Qualified Industrial Zone agreements with Jordan and Egypt boost the potential for trade. Threats ■ Strike action has proved extremely disruptive to the business environment in 2011, and could regain strength in 2013. ■ The parliament approved a plan to increase the country's oil and gas royalties, which could reduce energy profits in the future. © Business Monitor International Page 13 Israel Information Technology Report Q4 2013 Industry Forecast IT Market Table: Israel IT Industry - Historical Data And Forecasts (ILSmn) 2010 2011 2012e 2013f 2014f 2015f 2016f 2017f 19,204 20,436 22,299 22,576 23,355 24,608 26,490 27,698 o/w Hardware 8,450 8,877 9,561 9,550 9,745 10,125 10,743 11,233 - PC 6,844 7,208 7,840 7,908 8,069 8,383 8,895 9,301 760 799 860 860 877 911 967 1,011 o/w Software 4,225 4,541 5,004 5,117 5,347 5,690 6,186 6,370 o/w Services 6,529 7,018 7,734 7,908 8,263 8,793 9,561 10,096 2.3 2.3 2.5 2.4 2.4 2.3 2.3 2.2 IT Market Value - Servers IT Market, % of GDP e/f = estimate/forecast. Source: BMI We have made a minor adjustment to our forecast in the Q413 update on the basis of the macroeconomic environment, but our assessment of the underlying trends in the market is unchanged. We continue to hold the view that the Israeli IT market will experience only limited growth over the medium term and decline as a percentage of GDP. This is a product of uncertainty in the domestic and global economy, saturation of the hardware and software/services market and price competition between vendors, which will hold down the overall value of the market. We believe the IT market reached a value of ILS22.3bn in 2012, equal to around US$5.7bn. Our lower expectations of growth in 2012 and 2013 have caused the decrease in our forecasts, although the latter years see little change to overall growth expectations. Israel remains a robust IT market with plenty of development across industrial, government, defence and financial services spending. Our five-year CAGR sees growth around 5.2% in Israeli new shekel terms for the period from 2013-2017. We expect IT services will be the fastest growing segment of the IT market, narrowly ahead of software, with both growing fast relative to hardware. In terms of key verticals, financial services remains an important vertical, boosted compliance with new regulations introduced in the wake of the economic crisis in 2008-2009. Defence and government will remain key in the market's sustained importance to the overall economy, with security an important source of growth. The nature of sales will change however as business becomes increasingly important and the hardware segment contributes comparatively less to the market's © Business Monitor International Page 14 Israel Information Technology Report Q4 2013 overall growth. Given Israel's relatively rich tech skills resource base, many organisations prefer to conduct software development in-house. 2013 Outlook Despite a slight improvement in the rate of real GDP growth from 2012 to 2013, BMI forecasts a slowdown in spending growth in 2013 to 1.1%. The downward revision to the Israeli market forecast is in part due to the risk of a further escalation of hostilities between Israel and Gaza. Meanwhile, the Israeli economy continues to cool and sluggish external demand and weaker consumer spending are likely to weigh on headline growth throughout the year. The government is set to rein in spending, while leading indicator data paint a relatively negative picture for private consumption and fixed investment. Although we expect the overall growth rate for the Israeli market to slow in 2013 there will nonetheless be opportunities for vendors. One such opportunity is in the provision of cyber and information security products and services. This is a growth area in IT markets globally, but there is a particularly large opportunity in Israel where regional political tensions and the uptick in cyber attacks in 2012, affecting Israel, UAE and Saudi Arabia, have concentrated the minds of government and enterprise decision makers on investments to protect their IT systems. Other areas we expect to see growth include business intelligence and cloud computing, with the latter likely to gain traction among SMEs as a lower cost alternative to bespoke systems. Meanwhile sales of hardware and software will receive a boost from Windows-8 driven upgrades and computer purchases previously delayed as a result of the economic situation. The move to mobility and new form factors such as tablets, hybrids and ultrabooks will help to drive demand in the consumer segment, while to some extent undermining demand for traditional notebooks. Meanwhile, despite the challenging trading conditions, vendors have reported a continued flow of IT projects, with large tenders from the Israeli Ministries of Finance and Defence and the Israel Electric Company. Following the global financial crisis, vendors reported demand had revived in the key financial services vertical, with new projects including an US$11mn IT outsourcing tender by the First International Bank of Israel. Healthcare, the public sector and utilities were also generating new projects or significant contract extensions. Migrations to Microsoft's Windows 8 operating system could trigger a new cycle of hardware upgrades in 2013, although much will depend on business and consumer confidence. A substantial share of Israeli computer users are estimated to still be using the Windows XP operating system. Windows 8 could also fuel © Business Monitor International Page 15 Israel Information Technology Report Q4 2013 the ultrabook market as tablet makers leverage its capabilities to offer devices with touch screens and convertible designs. © Business Monitor International Page 16 Israel Information Technology Report Q4 2013 Market Drivers The Israeli IT market has several positive fundamentals that should keep it in positive territory during BMI's five-year forecast period to 2017. Although household computer penetration of around 75% offers only limited potential for growth derived from first time buyers, there are several factors pushing multiple device ownership. Innovation in form factors, including tablets and hybrids will push sales of personal devices. Meanwhile, investments by telecoms operators to expand the reach of high capacity wireless and wireline broadband services will catalyse demand for personal devices. Spending will continue to move away from desktops as more consumers acquire personal devices such as tablets - which may also cut into spending on notebooks. Per capita IT spending is expected to rise from ILS2,965 in 2013 to ILS3,459 by 2017. However, spending will fail to keep pace with GDP growth in Israel as the economy becomes less heavily weighted towards the high-tech sector following gas exploration and growth in other sectors. Some key IT spending verticals will however keep pace, for instance defence and financial services, which are somewhat insulated from economic vicissitudes. Vendors will target projects across a range of sectors from government to financial services, telecoms and utilities. Regulatory compliance will continue to necessitate IT spending by banks and the financial services sector, which accounts for about 15% of Israeli IT spending. Another 50% of IT spending is accounted for by government and military projects, which will have a relatively low sensitivity to economic downturn compared with the commercial sector. Government IT and digital-divide initiatives are important sources of opportunity for vendors, with recent projects ranging from government e-services portals to healthcare. The government remains determined to preserve the country's status as a high-tech powerhouse and drive development of the knowledge economy. While the defence sector is, and is expected to remain, the single most important vertical, investments by financial sector organisations should mean more large outsourcing deals. Other sectors of opportunity will include healthcare and telecoms, as well as infrastructure, transport and the small office and home office sector. © Business Monitor International Page 17 Israel Information Technology Report Q4 2013 Opportunities Industry Trends - IT Market BMI expects IT services will display the highest 2010-2017 growth over the forecast period to 2017, due to growth in key verticals and the opportunities presented by cloud computing, big data analytics and real-time enterprise services based on the internet of things. In addition, growing enthusiasm for outsourcing is putting Israel on the map, with some recent large tenders such as HP's contract for outsourced management of the Israeli navy's IT infrastructure. The economic slowdown may reinforce this trend. Israel is also emerging as a location for some business process outsourcing (BPO) functions e/f = BMI estimate/forecast. Source: BMI helped by government incentives. However, much depends on there being a sustained improvement in the economy, as well as the overall political environment. As noted, cloud computing is expected to be a source of revenue growth over the medium term as organisations looking for efficiencies turn to Software-as-a-Service and Infrastructure-as-a-Service. Particular areas of opportunity for cloud computing include banking and retailing, as organisations in those fields look to save money on hardware. While large organisations still dominate, SMEs have been investing more and represent a growth opportunity. Many SMEs are waking up to the need to compete through more direct investment in support and service infrastructures. Cloud computing is a field which could gain traction with SMEs as the ondemand model fits well with their smaller budgets and lack of demand for bespoke in-house solutions and software. Summary The Israeli economy remains vulnerable to global economic headwinds, with an escalation of risk particularly around events in the eurozone. Despite these storm clouds BMI believes IT spending has © Business Monitor International Page 18 Israel Information Technology Report Q4 2013 sufficient strength in key demand verticals to maintain a positive trajectory over the medium term. However, we do not expect growth to keep pace with GDP as market saturation and price competition between vendors limit increases in the total value of the market. The hardware market is forecast to grow from ILS9.6bn in 2013 to ILS11.2bn in 2017, with PC sales projected to rise from an estimated ILS7.9bn to ILS9.3bn. While growth will remain strong, the market will be increasingly dominated by IT service sales and software sales, indicating the maturity of the market. © Business Monitor International Page 19 Israel Information Technology Report Q4 2013 Internet Internet Table: Table: Internet Data And Forecasts, 2010-2017 No of internet users, '000 2010 2011 2012e 2013f 2014f 2015f 2016f 2017f 4,982 5,115 5,405 5,656 5,889 6,089 6,246 6,356 67.2 67.6 70.2 72.3 74.2 75.5 76.3 77.7 1,762 1,800 1,860 1,917 1,971 2,023 2,071 2,119 23.8 23.8 24.2 24.5 24.8 25.1 25.3 25.9 No of internet users/100 inhabitants No of broadband internet subscribers, '000 No of broadband internet subscribers/100 inhabitants e/f = BMI estimate/forecast. Source: BMI As with our fixed-line and mobile telephony forecasts, we have revised and extended our forecast for the development of Israel's internet user and Industry Trends - Internet Sector 2010-2017 broadband subscriber markets. Our new set of forecast figures runs to the end of 2017. There were approximately 5.115mn users as of 2011, giving Israel a penetration rate of 67.6%. We expect steady, but slowing, growth in the number of internet users to continue for the duration of our forecast, resulting in 6.356mn internet users in 2017, equivalent to a penetration rate of 77.7%. Meanwhile, owing to a lack of reliable data on the number of mobile broadband subscribers (specifically those subscribers who use USB dongles and data cards to access the internet via laptops, PCs e/f = forecast. Source: BMI and smartphones), our forecast for the Israeli broadband sector is currently based on fixed broadband connections only. Data published by incumbent telco Bezeq suggests that the number of fixed broadband subscribers had increased to around 1.800mn at the end of 2011, up by 2.2% y-o-y. BMI believes that, by the end of 2012, Israel's broadband subscriber base will have risen to 1.860mn; this is equivalent to a penetration rate of 24.2% and reflects full year growth of 3.3%. © Business Monitor International Page 20 Israel Information Technology Report Q4 2013 Over the next five years ending 2017 we envisage average annual growth of 3.9% for the Israeli broadband sector. This will see the subscriber base reach 2.112mn subscribers, equivalent to a penetration rate of 25.9%. We expect the growing popularity of mobile broadband services to result in slowing demand growth in the fixed broadband sector. Nevertheless, we identify several developments which will sustain fixed broadband growth for the duration of our forecast and beyond. These include Bezeq's ongoing deployment of its fibre-to-the-cabinet (FTTC), a development which is helping to drive capacity for its residential and corporate customers' broadband access. Meanwhile, recent months have seen considerable reductions in the price of broadband tariffs being offered by the major operators. Another development likely to stimulate growth is the introduction of LLU, which will give alternative operators access to Bezeq's network and will stimulate much greater competition. © Business Monitor International Page 21 Israel Information Technology Report Q4 2013 Macroeconomic Forecasts Macroeconomic Forecast BMI View: We project real GDP growth in Israel to come in at 3.7% and 3.8% in 2013 and 2014. Although the beginning of natural gas production in the Tamar gas field will ensure that growth accelerates compared to 2012, the domestic economy will remain in a soft patch, with austerity measures hitting private consumption hard. We forecast real GDP in Israel expanding by 3.7% and 3.8% in 2012 and 2013, respectively, compared to growth of 3.2% in 2012. Much of the acceleration in growth will be triggered by the beginning of natural gas production in the recently discovered Tamar gas field, which will significantly reduce the country's import bill, while base effects will underpin an, albeit modest, acceleration in export growth this year. That said, the domestic economy will remain in a soft patch, with austerity fiscal measures set to hit private consumption in H213 and 2014. Accelerating Despite Weak Domestic Economy Israel - Components Of GDP (ILSbn) & Real GDP Growth, % chg y-o-y Source: BMI, Central Bureau of Statistics Israel. F= BMI Forecasts. © Business Monitor International Page 22 Israel Information Technology Report Q4 2013 Private Consumption Outlook Private consumption grew 2.9% y-o-y in seasonally adjusted terms in Q113, after increasing 3.1% y-o-y in Q412. The inflationary outlook will certainly prove conducive to supporting household spending, with our baseline scenario seeing headline CPI averaging 1.9% this year, slightly higher than 1.7% in 2012. Moreover, the Bank of Israel (BoI) cut benchmark interest rates by 25 basis points to 1.25% on May 26, a move which follows a 25 basis points cut which took place on May 13. We believe that the BoI's dovish monetary policy stance will continue, and we forecast the benchmark interest rates coming in at 1.00% and 0.75% in 2013 and 2014, respectively, a trend which will support private consumption growth over the coming quarters (see 'Chart of Day: Further Rate Cuts On The Cards'). Increasing In April Israel - Unemployment Rate Source: BMI, Central Bureau of Statistics That said, Israel's Finance Ministry released on May 7 the draft 2013-2014 budget, which includes several tax hikes and cuts to expenditure in a view to bring the budget deficit to below 4.65% of GDP in 2013 and 3.0% in 2014, respectively, from a 4.2% deficit in 2012. Although drastic cuts are unlikely, we believe that consumer demand will be hit in H213 (see 'Austerity Measures Hitting Domestic Consumption', May 14). © Business Monitor International Page 23 Israel Information Technology Report Q4 2013 For instance, Finance Minister Yair Lapid won a concession from union leaders to delay until 2015 a 1.0% scheduled pay increase for public employees, which was originally due in July 2013. Moreover, According to latest data released by Israel's Central Bureau of Statistics, the unemployment rate came in at 6.9% in April, from 6.6% in March. Given relatively weak consumption patterns, while fiscal cuts could hit public sector job creation in H213, we project the unemployment rate coming in at 6.7% this year, the same level as 2012. We forecast private consumption increasing 3.1% in 2013 and 2.5% in 2014, when we expect the majority of spending cuts to take place. Dovish Monetary Policy Supporting Private Consumption Israel - CPI Vs Policy Rate Source: BMI, Bank of Israel Government Spending Outlook Government consumption growth declined 0.7% y-o-y in Q113, compared to quarterly average growth of 2.9% in 2012. Given the aforementioned cuts to expenditure, we believe that government consumption will remain relatively subdued over the coming quarters. For instance, the government is planning significant cuts for the Education Ministry's budget, which will likely lead to a freeze of several programs which aim to reduce the financial burden on middle-class parents on their children's education, as well as cuts to funding © Business Monitor International Page 24 Israel Information Technology Report Q4 2013 for ultra-Orthodox religious students. We forecast government consumption expanding 2.0% and 1.4% in 2013 and 2014, respectively. Imports and Fixed Investment Declining Steadily Israel - Components Of Real GDP, % chg y-o-y Source: BMI, Central Bureau of Statistics Israel Fixed Investment Outlook Fixed capital formation declined 8.3% y-o-y in Q113, compared to quarterly average growth of 4.0% in 2012 and 17.5% in 2013. That said, while fixed investment will increase at a slow pace this year, base effects will ensure that growth returns to positive territory over the coming quarters. Moreover, BMI's Infrastructure research team sees significant prospects in the energy sector. The discovery of the Leviathan and Tamar gas fields, which comprise some of the Mediterranean's largest gas finds, has attracted interest from oil majors such as Russian outfit Gazprom, and we see investment in the segment picking up in H213. Finally, the Israeli government approved in April the construction of 500 new homes in the West Bank, which will form part of a proposed new city on the site of the Gush Ezion settlement, a move which reaffirms Jerusalem's commitment to lowering house prices. We forecast gross fixed capital formation expanding 4.0% in 2013 and 6.0% in 2014. © Business Monitor International Page 25 Israel Information Technology Report Q4 2013 Net Exports We see Israel's net export position coming in surplus to the tune of 0.7% and 0.8% of GDP in 2013 and 2014, respectively, up from a deficit of 0.8% of GDP in 2012. Total exports increased 2.5% y-o-y in Q113, compared to average quarterly growth of 0.1% in 2012 and 5.2% in 2011. Base effects will ensure that exports expand at a faster pace this year compared to 2012. Moreover, recent cuts to interest rates (see above) have significantly slowed the appreciation of the shekel, which gained 11.4% as of June 8, 2013 since hitting multi-year lows in July 2012. We see the unit trading sideways over the coming quarters, which will benefit Israeli exporters. That said, we do not expect exports to increase dramatically, mainly due to slow growth in the US economy and the eurozone - which together account for approximately 60% of the country's exports. Indeed, we project the economy in the eurozone contracting 0.3% this year, from a 0.6% contraction in 2012, while we see real GDP growth in the US increasing 2.1% in 2013 from 2.2% in 2012 (see April 29, 'Global Assumptions - Q3 2013 - Update'). We forecast total exports increasing 2.4% in 2013 and 3.0% in 2014 in Israel. Export Growth Outpacing Import Growth Israel - Exports & Imports, % chg y-o-y Source: BMI, Central Bureau of Statistics Israel. F=BMI Forecasts © Business Monitor International Page 26 Israel Information Technology Report Q4 2013 Imports have been declining steadily over the past quarters, mainly as a result of slow expansion in private consumption and fixed investment. As we see growth in those components unlikely to pick up significantly this year, imports will continue to grow at a modest pace. In addition, Israel will start pumping gas from the Tamar field by June, which will enable the country to reduce its dependence on imported gas for much of its electricity generation and allow for a significant improvement in the country's balance of payments position. We forecast total imports increasing 1.0% in 2013 and 1.2% in 2014. © Business Monitor International Page 27 Israel Information Technology Report Q4 2013 Industry Risk Reward Ratings There are minor changes in the scores of some countries in BMI's IT Risk/Rewards Ratings (RRRs) for the Middle East and Africa (MEA). The regional average score across all four categories of our ratings has changed this quarter, with decreases in the industry rewards, country rewards and country risks average scores and an increase in the industry risks score. As a result, the overall aggregate score has fallen marginally to 54.3, from 54.9 in the previous. However, the only change in the country rankings on our table is a swap between Saudi Arabia and South Africa for the fifth and sixth positions. The former has moved up one place into fifth, while the latter has dropped one place into sixth. BMI has a positive outlook for the IT sector across the entire MEA region based on key macroeconomic and industry-specific growth factors. These include strong economic growth and, consequently, real private consumption growth, increasing disposable among a rapidly expanding middle class, increasing access to next generation broadband technologies and high public spending on IT-related projects. Although these factors create significant growth opportunities for IT vendors and their channel partners, there are some risks that threaten to prevent the region's IT market from reaching its full potential. The most notable risks are a weak regulatory environment, evidenced by poor IP and piracy, low income levels and lack of connectivity among the majority of the population in less affluent countries. Qatar's reign at the top of our ratings has continued this quarter with an aggregate score of 68.4, unchanged from the quarter. The country sits above Israel, which is in a close second position with an aggregate score of 68.2. Qatar's best score is in the country rewards category where, along with Kuwait, it registers the maximum score of 100 to reflect its high GDP per capita and relatively low unemployment rate, especially among locals. The country also benefits from a rate of urbanisation and access to power. Qatar's industry rewards score is the third highest in the region. Although it will continue to be held back by the country's relatively small population, we highlight the potential for an upgrade in the future to reflect the planned public spending on infrastructure and IT projects in preparation for the hosting of the 2022 FIFA World Cup tournament. Israel remains in second place with strong scores in the country rewards, industry risks and country risks categories. The Israeli IT market is ahead of all other countries in the region in many regards, PC literacy and penetration rate, e-governance and domestic production of IT products and services. Israel also hosts a large number of IT research and development facilities while consumer spending on IT products in the country is the highest in the region. © Business Monitor International Page 28 Israel Information Technology Report Q4 2013 The UAE and Kuwait retain third and fourth places this quarter. The UAE has the highest score in the country risks category in the region, reflecting a combination of political stability, economic growth and strong private consumption. We have reined in Kuwait's industry rewards score this quarter to reflect a cautious outlook for capital expenditure (capex), which has tended to miss government targets by wide margins in recent years. The average implementation rate of the CAPEX budget has been approximately 75% over the last five years, weighed down by recurrent disputes between the government and the legislature, red tape and an inefficient bureaucracy, as well as chronic dissolutions of parliament. Saudi Arabia has moved up to fifth position this quarter, although there was no change to its score in any of our four categories. The country has benefited instead from changes to South Africa's score in three out of four categories, resulting in the decrease of its aggregate score from 58.3 to 57.6. The country's industry risks score increased by 10pts to 55.0 to reflect improvements in the regulatory environment. However, this was offset by a 16.7pt decrease in its country risks score over continued economic uncertainty and its impact on private consumption growth. Oman and Bahrain's smaller markets offer more limited potential for growth with smaller populations and economies. While there are still growth opportunities and growing interest in new technologies such as cloud computing, the smaller market size prevents these markets from moving up our ratings. The government will continue to drive growth in the IT sector in the markets through public spending and investments in various e-governance projects. Nigeria and Ghana, two of the new countries in our expanded coverage, remain in ninth and 11th positions with no changes to their scores in any of our four categories. Nigeria has the joint highest score in the industry rewards score, with South Africa, owing to its large population and strong government IT procurement. Nigeria and the four countries ranked below it on our table all score below the regional average in the industry risks category, highlighting low scores for IP protection with the counterfeit software segment still quite high. Lebanon has the lowest score in this category, with software piracy in that country among the highest in the region. Efforts at taming this trend are undermined by the country's political and security instability. Lebanon remains a key logistics and distribution centre for IT products within the region considering the country's geographic location, which puts it in close proximity to major markets in Europe, Middle East and North Africa. Egypt and Kenya occupy the two last positions on our table, both of them held back by weak country rewards scores despite relatively high scores in the industry rewards category. Egypt's industry rewards score is boosted by the size of its population, the second biggest in the region after Nigeria, while Kenya © Business Monitor International Page 29 Israel Information Technology Report Q4 2013 benefits from strong public spending in ICT as reflected by the government's multibillion dollar school computerisation project and various other e-governance initiatives. However, Egypt is hamstrung by its economic woes and high unemployment rate. Although its country risks score is unchanged this quarter, there is potential for a downgrade in subsequent updates on the back of uncertainties surrounding the recent change of government in the country. For its part, Kenya's low rate of urbanisation and GDP per capita are two key downsides risks to the country's ambitious vision 2030 plan of integrating IT into every aspect of national development. The company is progressing with plans to be a sub-regional hub in East Africa by attracting major global ICT players. Global IT services giant IBM established an innovation centre in Kenya, the third in Africa after Morocco and South Africa and in Kenya in May 2013, while Vodafone Global Enterprises announced plans in July 2013 to establish two new regional hubs in Nairobi, Kenya, and Accra, Ghana. Table: Middle East And Africa Risk/Reward Ratings Q413 Rewards Country Industry Rewards Country Rewards Risks Industry Risks Country Risks IT Rating Rank Previous Rank Qatar 55.8 100.0 55.0 66.3 68.4 1 1 Israel 55.0 95.0 65.0 67.0 68.2 2 2 UAE 52.5 90.0 60.0 68.3 65.4 3 3 Kuwait 42.5 100.0 40.0 66.0 60.5 4 4 Saudi Arabia 45.8 75.0 55.0 67.7 58.0 5 6 South Africa 63.3 50.0 55.0 45.0 57.6 6 5 Oman 31.7 80.0 52.5 60.5 51.2 7 7 Bahrain 28.3 80.0 57.5 61.8 50.5 8 8 Nigeria 63.3 30.0 45.0 44.7 49.6 9 9 Lebanon 46.7 65.0 20.0 42.2 47.2 10 10 Ghana 51.7 35.0 40.0 50.8 46.0 11 11 Egypt 53.3 25.0 45.0 43.4 43.6 12 12 Kenya 53.3 10.0 55.0 33.6 39.4 13 13 Average 49.5 64.2 49.6 55.2 54.3 Scores out of 100, with 100 highest. The IT Risk/Reward Rating comprises two sub-ratings 'Rewards' and 'Risks'. Scores are weighted as follows: 'Rewards': 70%, of which Industry Rewards 65% and Country Rewards 35%; 'Risks': 30%, of which Industry Risks 40% and Country Risks 60%. The 'Rewards' rating evaluates the size and growth potential of an IT market in any given state, and country's broader economic/socio-demographic characteristics that impact the industry's development; the 'Risks' rating evaluates industry specific dangers and those emanating from the state's political/ economic profile, based on BMI's proprietary Country Risk Ratings that could affect the realisation of anticipated returns. Source: BMI © Business Monitor International Page 30 Israel Information Technology Report Q4 2013 Market Overview Hardware Israel's IT hardware market is forecast to decline by 0.12% in 2013 to ILS9.55bn. However the mediumterm growth outlook is stronger with CAGR of 4.1% over our forecast period 2013-2017. In 2013 the value of hardware sales will be squeezed by a weaker currency, price competition and the lower unit price of midrange tablets hitting the market. While there are factors limiting the increase in the total value of sales, there will be a boost from the release of Microsoft's Window 8 operating system, launched in October 2012, which set off greater competition and innovation in tablets, notebooks and hybrids. As well as economic and IT market trends, another Hardware Demand factor behind our pessimistic outlook for 2013 is the risk of a further escalation of hostilities between 2010-2017 Israel and Gaza. This uncertainty will drag on confidence and curtail investments in some areas. Wider economic uncertainty means businesses are now investing more to increase flexibility and realise cost efficiencies rather than expand IT hardware capabilities, but nonetheless there should be growth areas. However, as noted, lower average prices have meant that revenue growth in most segments has lagged shipments. BMI forecasts real GDP growth of 3.5% in Israel in 2013, a slight improvement from 3.1% real growth e/f = BMI estimate/forecast. Source: BMI in 2012. However, the more relevant figures for the hardware market are the slower rate of real private final consumption growth, at 2.5% in 2013 compared to 3.2% in 212, and the slowdown on real government spending from 4% in 2012 to 2.5% in 2013. The government's policies are less supportive of private consumption in 2013. The 1% rise in VAT that was part of the government's package of austerity laws, approved by parliament in August 2012, will have an impact on discretionary spending on items such as PCs and notebooks. This has an obvious impact on the growth potential of the IT market, as consumers consider reigning in their spending and government faces fiscal constraints on new investments. © Business Monitor International Page 31 Israel Information Technology Report Q4 2013 Despite the weak consumer outlook in Israel there are several factors which present an optimistic medium term outlook for continued hardware sales. Current PC penetration, while high for the region, shows potential for organic growth. Household penetration is estimated at around 75%, meaning there is some potential for sales to first-time buyers. However these new sales will be concentrated in lower income segments, which will mean low margins for vendors in this sub-segment. Digital divide issues mean Israel currently has 600,000 children living below the poverty line, only 3% of whom have internet or home PC access, compared with 90% in the top-income group. The Israeli government has launched various initiatives to increase computer and internet penetration, including Computer for Every Child, Window to Tomorrow's World, Tapuah (the Israeli Society for the Advancement of the Information Age) and others. The level of support, however, has been criticised by some industry insiders as too low. Upgrades to new systems and purchases of personal computing devices will remain the bulk of market sales. Mobile computing devices including tablets, slimline notebooks, ultrabooks and hybrids present a growth opportunity for vendors as consumers buy personal products to complement the household desktop or laptop. This segment will be held back by a weak consumer outlook in 2013, but strengthen from 2014. It is significant for medium term hardware sales that telecoms networking infrastructure in Israel continues to receive investment. This generates use cases for IT hardware, including desktops and mobile computing devices and helps to increase demand. Meanwhile, the release of Windows 8 is expected to result in higher sales in the retail and enterprise markets. In the retail market Windows 8 will deepen the tablet market, as well as introducing hybrids, while in the enterprise market the new OS should trigger computer hardware tenders previously delayed because of the economic situation. In 2012, retailers claimed that many businesses and consumers were waiting for the October 2012 release of Microsoft's new operating system before investing in an upgrade. The launch of Windows 8 in Israel coincided with the launch of the Surface tablet and a new suite of mobile handsets using Windows Mobile. Microsoft CEO, Steve Ballmer, began an international promotional tour for the new operating system in Israel in November 2012. An upgrade to Windows 8 was available to Israeli consumers for US$40 to download or ILS280 installed in store. Evolving Form Factors The Israeli IT market is relatively mature, but hardware still accounted for 42.9% of the total market in 2012 (excluding communications hardware). Prior to 2012, notebooks were the fastest-growing segment of © Business Monitor International Page 32 Israel Information Technology Report Q4 2013 the market, although as recently as 2008 desktops still took around two-thirds of unit sales. However in 2010-2011 the share of desktops declined precipitously, and then in 2012 there was a shift from notebooks to tablets as the fastest growing segment of the market. This trend of preference for mobility is expected to continue over the 2013-2017 forecast period. Despite its declining share of sales, however, the desktop sector is still significant, largely due to business and government end-users. One device category we believe to be on the way to becoming obsolete is the netbook, which had been a driver of PC market growth in 2010, but have plateaued in the face of competition from tablets and smartphones. In particular, smartphones from Samsung, RIM, Apple and other vendors are being offered as alternative connectivity solutions and often include a Wi-Fi option. The competition from tablets and smartphones is also driving innovation in notebook design, as slim-line and hybrid devices are increasingly the centre-piece of Windows vendors product ranges. The tablet market in Israel has been dominated by Apple. However, its relative position did weaken in Israel PC Browsing Traffic By OS (%) And Y-o-Y Change 2012 and it faces much stronger competition in March 2013 2013. Data from Statcounter show Apple's iOS, run on its tablets, accounted for 2.1% of Israeli PC browsing traffic in March 2013 - a figure that was up by 1.2pps y-o-y. Meanwhile, Google's Android OS, which is used on Samsung, Asus and Google's own Nexus range accounted for less than 1% of PC browsing traffic in March 2013. This recent data reinforces Apple's dominance. However, with the widening range of Android devices - including the Kindle Fire from Amazon, the Nexus 7 and 10 and Samsung's Galaxy Tab range - competition will Source: Statcounter continue to intensify. A key feature of the threat posed to Apple by Android vendors came only after the release of lower cost tablets and were predominantly the smaller 7" form factor. This contrasted with Apple's larger and more expensive iPad - and the popularity of these smaller, cheaper devices, catalysed the development of Apple's own iPad Mini. Apple is set to face competition throughout 2013 from rival Android vendors that will offer consumers a wider choice in terms of price and size, as well as specifications and features. © Business Monitor International Page 33 Israel Information Technology Report Q4 2013 The gap between the strategies of some of the leading players is also worth noting. On the one hand Apple and Samsung are hardware vendors and look to profit from the sale of devices, while on the other side Google and Amazon are services firms and offer tablets almost at cost. The strategies of services firms (combined with low cost OEM tablets from China) will likely put pressure on the margins of hardware centric vendors in the medium term. The tablet market in Israel remains relatively undeveloped, with low penetration, and heavily dominated by Windows machines. BMI forecasts Israeli market PC tablet sales at 279,000 units in 2013 and projects that sales could pass 500,000 in 2017. As such a significant development that will affect both the tablet market and the notebook market is the arrival of Windows 8. In October 2012, with the launch of the new OS, Windows vendors were able to introduce touch devices - with a number of tablets released in Q412 and Q113. The addition of more vendors and another touch OS will add to competition in the market - putting further pressure on prices. However the more significant development is the medium term impact on innovation and form factors. Windows has a traditional strength in productivity use cases and software, with the OS being central to the enterprise market and Microsoft's Office Suite ubiquitous. There is therefore an opportunity for vendors to leverage this strength over rival iOS and Android devices by designing tablets with strong productivity functionality alongside the passive media consumption features. Early examples have been hybrid devices such as Microsoft's own Surface (RT & Pro), Hewlett-Packard's Envy and Lenovo's Yoga and Helix. Although design innovation has some way to go, and prices of hybrids will need to decline, the multi-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. Another device category that should receive a boost from the launch of Windows 8 is the ultrabook. They are higher-performance notebooks designed as a response to Apple's increasingly popular MacBooks, and are an emerging product category that Intel and certain vendors backed heavily. Due to initially high prices, these devices failed to enjoy the hoped-for success, at least initially. Vendors appear to have realised this and are moving ahead with plans to supply low-end ultrabooks. Vendor Performance The Israeli PC market has undergone significant changes in terms of market shares. In the PC market, the top three vendors, HP, Lenovo and Dell, had enjoyed a combined market share approaching 50%, but while Lenovo has gone from strength to strength, HP and Dell have been hit by competition from Asus and Samsung - as well as the shift to tablets. Most PC market growth in 2012 was driven by growth in the © Business Monitor International Page 34 Israel Information Technology Report Q4 2013 mobile PC segment, and in fact notebook sales declined and growth was solely driven by tablets according to research from IDC. IDC's data for 2012 show that laptop sales declined 16.4% from 2011 to 2012, falling to 426,526, in contrast to a 20.2% increase in tablet sales to 225,767. In the laptop market Lenovo leaped to top spot with a market share of 21.2%, overtaking HP and Dell. In second position was Asus with 16% market share, up from 12.2% in 2011, also overtaking HP and Dell which both had 15.2% market share in 2012. Based on these figures BMI estimates that Lenovo and Asus achieved 8.8% and 9.7% growth in laptop unit sales respectively, in stark contrast to the 25.6% and 40.3% respective declines in laptop unit sales for HP and Dell. Meanwhile, the tablet market continues to be dominated by Apple, according to IDC data for 2012. Apple took a 49.8% share of tablet sales, more than double the share of second placed Samsung which had 20.1% share. However, as impressive as this dominance is Apple's share of the tablet market declined 6.4pps y-o-y and units sold only increased 6.6% in 2012, versus 20.2% increase for the market as a whole. The other vendors chasing Apple include Samsung and Asus, which we calculate from IDC data to have achieved 27.9% and 138.5% unit growth in 2012. Asus is believed to have benefited from the manufacture of Google's Nexus 7 alongside its own products. Chinese giant Lenovo has built its strong position atop the Israeli market following its purchase of IBM's PC unit back in 2005 and in 2012 the company continued to increase its investment in Israel. In 2012, Lenovo claimed that it had top spot in the commercial laptop market in the country, and that it was 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 and applications. Lenovo is far from the only multinational PC vendor to be increasing its R&D investment in Israel. In early 2012, it was reported that iPad and Mac producer Apple was looking to open a research centre in Haifa. The new facility is located at the Matam technology district, which also houses facilities of Intel, Microsoft and Philips among others, and was due to become operational by March 2012. Apple's new investment followed on the vendor's recent acquisitions of Israeli NAND flash technology manufacturer Anobit for a reported US$390mn. In 2011, US PC leader Dell inaugurated a new Israeli R&D centre, which is part of the company's Enterprise Storage Business. The new centre is based on Exanet, which Dell acquired in 2010. The centre © Business Monitor International Page 35 Israel Information Technology Report Q4 2013 will focus on developing storage technologies and cloud computing solutions. Meanwhile, Acer's inventory problems resulted in the vendor losing ground in the regional market. Software BMI forecasts Israeli software spending will increase to ILS5.25bn in 2013, up 2.3% y-o-y. The packaged software segment is expected to grow at a CAGR of around 3.7% over BMI's forecast period to 2017. In the past few years, there has been pick-up in demand for systems and upgrades in public and private sectors, with investments by government organisations such as the Israeli Ministry of Defence and Israeli Police, and from utilities leader Israel Electric Company. In H113, leading software vendors in the Israeli market reported steady, single-figure growth, much in line with our forecast. Leading Israeli software and services group Formula Systems announced that its revenues were up by 6% in Q113, compared with the same period of the previous year. However group company Matrix, which derives most of its revenues from the Israel market, experienced a decline in its operations, due largely to seasonal factors. In Israel, the first quarter usually reflects a decline following an active fourth quarter, during which companies seek to utilise budgets before the end of the fiscal year. The third quarter is also generally a slower quarter, reflecting reduced activities during the summer months. Despite the uncertain global economic outlook for Israel's export-based economy, opportunities for software vendors continue to exist across a range of sectors from government to energy, financial services, telecoms and utilities. Major customers for software solutions in Israel include large and medium enterprises such as commercial banks, loan and mortage banks, credit card companies, insurance companies, telecoms service providers, hi-tech companies, and the Israeli Defence Force and government ministries and public agencies. Large organisations investing in SAP-based systems included the Meitav Regional Water and Sewage Corporation and Israel Direct Insurance (IDI). Local IT leader Ness was among those vendors reporting a rebound in Israeli market revenue growth, with the company's annualised revenue growth increasing in each quarter. Meanwhile, the SME segment, the mainstay of the Israeli business sector, has emerged in recent years as an important growth area for enterprise systems. Spending on enterprise solutions should continue to grow steadily, with reviving or emerging areas of opportunity including security, CRM solutions and business intelligence. However, in the current economic climate, vendors will continue to pitch the efficiency gains potentially offered by these applications. © Business Monitor International Page 36 Israel Information Technology Report Q4 2013 Microsoft Israel has an annual turnover of around Software Sales (ILSmn) US$1bn. It hopes its Windows 8 operating system, launched in October 2012, will continue to boost 2010-2017 sales throughout 2013, with support for the Windows XP operating system due to be withdrawn in 2014. Israel also hosts an important research and development centre for Microsoft, one of its 3 largest global facilities. As of Q111, the centre, which employs 600 workers, was reported to be developing 13 new products in various areas. In 2010, the centre launched Microsoft's new unified access gateway (UAG) product for the Windows 2008 Server R2. The UAG product is already used in the Windows 7 operating system to provide PCs with online access to enterprise servers. The product e/f = BMI estimate/forecast. Source: BMI. positions Microsoft to make a play for the Softwareas-a-Service (SaaS) market opportunity. About 70% of the centre's work is now focused on cloud computing, with Microsoft Israel expecting to hire up to 100 new workers for cloud computing projects. Migrations to the Windows 8 operating system should have a positive impact on 2013 sales despite business caution and the fact that the pre-launch publicity for Windows 8 was more low-key than for its predecessor Windows 7. Microsoft is touting the touchscreen capabilities of Windows 8 and Q412 saw the release of a new wave of Windows 8 tablets and notebooks. A large portion of Israeli computer users are estimated to still be using the Windows XP operating system, accounting for over 25% of PC browsing traffic in March 2013, and this represents a significant potential market, as support for XP will be withdrawn by 2014. Current areas of enterprise demand include management of Microsoft systems and servers, as well as systems management, basic data management, firewalls, enterprise resource planning (ERP) implementation and CRM. CRM is a particularly buoyant area, while in 2012 vendors continued to sign up new business intelligence customers. The sheer volume of data that enterprises must now handle as a result of device proliferation is fuelling investments in business analytics. In May 2013, Arad Group, a world leader in water meter technology, announced a partnership with IBM to help customers and water utilities © Business Monitor International Page 37 Israel Information Technology Report Q4 2013 manage resources more efficiently through use of Big data and analytics technology. The analytics was developed by IBM in Israel. The security software segment is an important opportunity, potentially worth hundreds of millions of dollars over the medium term, and awareness of security issues has grown with the rise of cloud computing. Israel has also become more aware of the growing threat and sophistication of cyber attacks and has been encouraging government and private sector organisations to take action. Spending is likely to continue across all segments, with security content and threat management the current priorities. The market will be catalysed by the October 2012 announcement from Israel's Prime Minister Benjamin Netanyahu that the government was working to create a 'digital Iron Dome' to protect vital infrastructure from hackers and viruses (the Iron Dome is Israel's anti-rocket defence system). This includes the establishment of the National Cyber Bureau to defend the nation against computer terrorism. This policy should see vendors win public contracts, while also serving to focus the minds in the private sector. Local companies have appeared that will serve the local and international market. Check Point and Imperva are listed companies, while in March 2013 Israeli security services company Incapsula, an Imperva subsidiary, was valued at around US$950mn after proving successful among small- and mediumsized businesses. Incapsula provides high-end firewalls to assess incoming traffic and identify possible bugs. Incapsula was established in 2009 and was created by three Imperva employees. The growing emphasis of many multinational IT vendors on software and services revenues, has led several of them to direct more investment in R&D at the Israeli market. Israel's strong reputation as a hotbed for innovative software development has made Israeli companies popular takeover targets for multinationals. US vendor Dell, a traditional manufacturer of PCs and related hardware, is one vendor aiming to make a transition to being a comprehensive provider of IT and computer solutions. The company has launched a plan to expand its presence in Israel, with the establishment of a new R&D centre in the country. Dell spent just 1.7% of sales on R&D in the first quarter, well below the level reported by many of its industry peers. The company's software business is currently a small component of its overall product mix, but is targeted to quintuple by 2015. Dell's strategy for the Israeli market is being managed by Dell Europe, and includes passive investments in early-stage companies with the objective of obtaining access to technology developments. 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 and cloud © Business Monitor International Page 38 Israel Information Technology Report Q4 2013 computing. SAP is looking to develop more mobile business applications that could be deployed across a variety of devices, including tablets. In-memory computing, a technology which SAP is developing through its HANA solution, is expected to revolutionise the way companies handle big-data. SAP Labs Israel has been at the forefront of SAP's work in this area, with more than 100 local developers participating in the development of the HANA in-memory solution. Israeli developers were also responsible for the creation of the company's Real Time Offer Management solution, which is currently being tested by French supermarket chain, Casino. SAP Israel has been voted one of SAP's top-performing units and the company has a strong local client base. In September 2010, Ness won a US$3.7mn, five-year contract from Israel's Meitav Regional Water and Sewage Corporation to provide development, improvement and maintenance services for the company's SAP-based ERP and billing system. The contract also included an optional three-year extension, valued at US$2.2mn. In 2008, SAP reached an agreement with Ness to purchase the latter's SAP Sales and Distribution division in Israel. The acquisition was in line with SAP's focus on enhancing direct operations in Israel and other high-growth Middle Eastern markets. SAP implementations are a major IT services category in Israel, and SAP aims to be closer to its customers and partners. However, SAP continue to work with Ness as a systems integrator and the latter will also retain its SAP Academy training centre. Another enterprise software player, US vendor CA Technologies, is extending its Israeli university relationship programme, with plans announced in 2012 to roll-out a new Innovation Centre in partnership with Tel Aviv University. The new centre is expected to focus on areas such as IT management and cyber security. Israeli storage companies appear a hot segment for multinational investors currently. Dell's sole acquisition to date of an Israeli company was its US$12mn acquisition of storage solutions developer, Exanet, in early 2010. Dell established its R&D centre on the basis of Exanet's team. Meanwhile, in mid-2012, shares in Israeli storage business company, Mellanox Technologies, surged on rumours that either IBM or Oracle might buy the firm Given the current focus on many businesses of 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. The economic crisis may have provided a lasting boost to the SaaS model, particularly as broadband penetration grows. More vendors are looking for channel partners to help them offer cloud computing and rented software services to local organisations. © Business Monitor International Page 39 Israel Information Technology Report Q4 2013 New cloud computing offerings and increased competition in this segment should fuel further demand from users. As well as cost savings, businesses will look to boost efficiency and increase flexibility of response to customer needs. Large businesses are most likely to put IT applications such as mail, phone systems and document management into the cloud. However, enterprise applications that require a high level of customisation, or which are subject to regulatory or data-sensitivity constraints, are more likely to stay on premise. In terms of verticals, the financial sector has been a mainstay of demand, with other key areas including defence and healthcare. Despite the recent financial crisis, regulatory compliance and demand for new services will continue to drive IT spending by banks. IT spending from this vertical has been positively impacted by regulatory reform and changes affecting banking and insurance in the wake of the global financial crisis. Such changes generate demand for specific IT solutions, often in a set time period. Following the economic crisis of late 2008 and 2009, vendors reported that the key financial services segment actually saw demand increase. Israeli legislation passed in 2010 and 2011 increased Israeli Securities Authority regulatory supervision over the offering of investment 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 the current security situation. Software comprises an important part of Israel's industrial production and exports, with software exports of US$3bn representing around two-thirds of the value of the entire domestic IT sector. Almost all global vendors are active in the domestic market, selling licences alongside integration and applications services. Global vendors control more than three-quarters of the market, with SAP in first place. In the past, the Israeli SME segment was dominated by local software companies. Now international players, including market leaders such as SAP and Oracle, are entering with appropriate software packages. Microsoft is also designing a software package for this market segment. Services The IT services segment is forecast to reach a value of ILS7.91bn in 2013 and this is expected to grow at a CAGR of 6.3% over the forecast period to reach ILS10.11bn in 2017. In H113 vendors reported a continued flow of new projects in sectors such as government, financial services, homeland security and utilities. Key sectors such as government and financial services had driven a pick-up in growth in 2010 after demand was hit by a slowdown in 2009. Regulatory reforms in the wake of the economic crisis of late 2008 and 2009 proved a driver of IT spending in these sectors. © Business Monitor International Page 40 Israel Information Technology Report Q4 2013 A slowing economy is posing a challenge to Israeli market IT services vendors in 2013, with the downtrend in business investment expected to continue into H213. However, demand for IT services has generally continued to be healthy, according to leading vendors, with new projects across public sector, industrial and financial verticals. The defence and homeland security sector has also been solid. In 2012, leading software vendor Matrix, which is part of the Formula Systems group and employs 6,500 people, reported revenues of US$515,000. Matrix, which offers custom software development services and also sells solutions from international vendors, derives most of its revenues from the Israeli market. Matrix's chief rivals in its domestic market include fellow Israeli IT services giant Ness Technologies, as well as Team-Malam, One-1, Taldor Computer Systems, the Elad Group and Yael, as well as international competitors like HP and IBM. International vendors in the Israeli market often work with local subcontractors. All vendors in the Israeli market have had to adapt to an environment where some projects are commissioned more in response to immediate needs, with a focus on cost reduction. Given there is no shortage of technical skills in Israel, internal IT departments often prefer to develop solutions in-house. Major client sectors for market leaders like Matrix and Ness include the financial services and government sectors as well as other segments like utilities. The IT services market is influenced by regulatory reform which influences and drives demand in sectors like government, with much spending related to e-government targets, financial services, where an increase in regulatory supervision has necessitated new IT investments, and telecoms, where spending is driven by the roll-out of new platforms and services. In August 2012, Ness was awarded a 10-year contract from Israel's Ministry of Finance to establish and operate the country's new National Long-Term Savings and Insurance Exchange. The new exchange is expected to streamline work processes, and provide the public with information about the retirement savings and insurance plans on offer. So important is the project to Ness that the company will establish a dedicated subsidiary to develop and operate the National Exchange, including a service and support centre. © Business Monitor International Page 41 Israel Information Technology Report Q4 2013 Cloud computing is a major vendor focus and will continue to attract investment from all sections of Services Market the industry chain. In April 2011, telecoms 2010-2017 equipment vendor, Alcatel-Lucent, unveiled a new cloud computing centre in Israel. The centre will develop cloud-based and open architectures for communications carriers. While US companies often have a long history in Israel, the major Indian vendors such as Satyam Computer Services and Tata Consultancy Services have built their presence in the Middle East over the past few years. Tata opened an Israeli office in 2006, while Satyam has experienced strong growth in the Middle East region and is looking to grow its consulting and outsourcing businesses by e/f = BMI estimate/forecast. Source: BMI. 100% over the next few years. Defence and government spending represent a significant component of Israeli IT demand and have some immunity to economic vicissitudes. The Ministry of Defence has awarded a number of multimillion-dollar IT contracts, including a US$10mn tender for a new command and control system. Among other smaller recent government projects, the Israeli Police awarded a US$6mn contract. Meanwhile, the healthcare and utilities sectors have also been generating outsourcing projects, such as the award of a US$17mn deal by Israel Electric Company. The development of a natural gas sector should be one driver of opportunities in the utilities vertical. Following a recovery in 2010 from the economic slowdown, vendors reported that demand had revived in the key financial services vertical, where recently projects have included an US$11mn IT outsourcing tender by the First International Bank of Israel. Government agencies were also commissioning or extending IT contracts, including a US$2.6mn outsourcing contract extension awarded by Israel's Ministry of Environmental Protection. Growth is expected to reach a higher trajectory in the second half of our five-year forecast period. Key Israeli IT services spending verticals include the financial sector, where international regulatory compliance and structural and market reforms have driven substantial IT investment. The sector accounts for around 25% of total IT services spending, while the government accounts for another quarter. © Business Monitor International Page 42 Israel Information Technology Report Q4 2013 Along with defence, these two key sectors are likely to be a continued source of opportunity because the factors driving spending in each case are not particularly sensitive to the economic downturn. The new administration will likely feel pressure to ramp up government spending to combat lower private consumption and rising unemployment. Another key area of opportunity is healthcare IT. One potential demand driver will be organisations looking for help to utilise efficiencies from cloud computing, such as SaaS and Infrastructure-as-a-Service (IaaS). Particular areas of opportunity for cloud computing include banking and retailing as organisations in those fields look to save money on hardware investments. In 2011, vendors such as Alcatel-Lucent have continued to invest in new cloud computing facilities in Israel, leveraging the country's expertise. While large organisations still dominate, SMEs have also been investing more and represent a growth opportunity. Many SMEs are waking up to the need to compete through more direct investment in support and service infrastructures. Similar factors are driving an increase in demand for managed services, with businesses reluctant to invest in internal IT capabilities, or deterred from doing so by a lack of available skills. Outsourcing Outsourcing has become a bigger factor and was forecast to account for about 20% of IT services spending, or at least US$424mn, in 2012. Key sectors for IT outsourcing include: The military, with outsourcing deals such as that awarded to HP by the Israeli Navy for management of its IT infrastructure highlighting the opportunities there. While the value of the HP deal was not made public, it is estimated to be worth several million shekels. The financial sector is another leading vertical for outsourcing. In 2006, a deal between First International Bank of Israel and EDS Israel was the largest outsourcing contract in the Israeli banking industry and a milestone at the time. Tata Consultancy Services' decision to open a local branch also underlines the potential attraction of the financial sector, now benefiting from economic recovery and greater security. The retail sector offers further opportunities, with IBM Israel having a 10-year outsourcing contract with Clubmarket Marketing Chains. The contract includes computer systems for the supermarket chain's branches and point-of-sale terminals. © Business Monitor International Page 43 Israel Information Technology Report Q4 2013 Although Israel seemingly possesses many advantages as an outsourcing destination (in particular a technologically literate, linguistically skilled workforce and low labour costs relative to most developed countries), the country has failed to capitalise on these strengths in the past. Aside from Israel's small size, another issue is security. However, the government is now actively promoting Israel to multinationals, and there has been a spate of call-centre construction. The work seems to be paying off, with Israel starting to emerge as a desirable location for packaged applications and localisation services. In 2013 HP's IT services operations in Israel suffered a setback as communications equipment vendor ECI sued HP Israel for ILS38mn in April 2013, claiming HP did not meet the terms of an agreement to upgrade its computer systems. In 2010 ECI contracted HP to provide its computing requirements including maintenance, support and upgrades in a deal worth US$120mn over 10 years. This made it one of the largest such contracts in Israel, as well as ECI being one of the first Israeli companies to switch to cloud computing and utilise a server farm in France. However, HP cancelled the contract in February 2013, claiming ECI had breached the contract and was in arrears. ECI claimed HP had failed to provide services promised, meeting none of the eight milestones it had set for April 2011 and the cloud computing element was only supporting 900 users, rather than ECI's 3,000 employees, as required. © Business Monitor International Page 44 Israel Information Technology Report Q4 2013 Industry Trends And Developments IT is an important element of the Israeli government's socio-economic policy framework. The National Economic Council submitted a policy agenda to the government that specified two main policy tracks to reduce poverty and achieve balanced growth. The first track is expected to emerge as the main priority for the government. The digital divide is a symptom and an aggravator of relative poverty. In May 2010, the Israeli Ministry of Finance launched a programme called 'Relative Advantage' to provide a boost to Israel's high-tech sector. IT will be harnessed to the second goal of achieving balanced, long-term economic growth. Israel's software sector has long been one of the country's economic pillars and a magnet for inward investment. The Israeli Association of Electronics and Software Industries has projected that the software sector will generate US $3.2bn annually by the end of the decade. The government hoped the high-tech sector would generate US $3.0bn for the nation's economy by 2010. Offshoring Israel is working hard to ensure it benefits from the global offshoring trend, which it sees as an area of potential. Despite an often unstable political and security situation, Israel has marketed its IT skills with some success and attracted outsourcing operations from major IT corporations such as Intel, IBM and Microsoft, as well as Motorola. One factor in this, of course, has been incentives that the Israeli government started to offer back in 2006, with subsidies of up to ILS1,000 per employee per month. Several major public and private sector outsourcing deals have also highlighted the growing importance of outsourcing. However, there are fears of a skills bottleneck. In 2007, the government said Israel hoped to produce 10,000 engineers a year by 2010, up from the present graduation rate of 4,900, a small number by the standards of China, India and the US, but a big challenge for Israel.. Engineering salaries in Israel are about half those in the US but double those in India. E-Services As part of its modernisation agenda, the government is also pressing ahead with various other strands of its e-government project. Among other initiatives, there has also been spending on computers in healthcare and the nationwide paperless court initiative. The e-government programme is leading to increased demand for © Business Monitor International Page 45 Israel Information Technology Report Q4 2013 computers, with the Israeli government reaching a supply agreement with Dell and HP. The government chose Microsoft search technology to power its government services portal, gov.il. In 2012, Israel's Ministry of Finance launched a major new project to establish and operate the country's new National Long Term Savings and Insurance Exchange. The new exchange is expected to streamline work processes, and provide the public with information about the retirement savings and insurance plans on offer, including pension plans. The project was awarded to local company Ness Technologies, which will establish a dedicated subsidiary to develop and operate the National Exchange, including a service and support centre. When the system comes online, officials expect it to provide a boost to the economy, when as many as hundreds of millions of shekles are freed up as pensions holders claim what is theirs. The Israeli government was progressing with its plans to roll-out smart ID card systems intended to cover the entire population. With an urgent need for the government to update technology and strengthen authentication systems, the original target was to introduce 2.5mn smart ID cards. In December 2008, HP was awarded a contract to produce 5mn ID cards; however, it is yet to receive the go-ahead from the Knesset, which is deliberating over the passing of the biometric database bill. The ID cards, set to cost Israel US$67.49mn, would use 'smart' identification methods involving fingerprints and digital photography. The 2005-2007 masterplan of the government's ERP project called for implementation in around 90 government units by the end of 2007. The project leveraged mySAP ERP (content delivery software) and had a focus on financial, logistics and human resource components. Dubbed Merkava, the project cost an estimated ILS800mn since its launch in 1999. Intel Israel Reports Strong Figures Bucking Industry Trend In February 2013 Intel Israel reported its exports more than doubled to US$4.6bn in 2012, from US$2.2bn in 2011. Over the same period Intel's Israeli workforce increased 10% to 8,500, as over the course of 2012 it invested US$1.1bn in Israel. Intel Israel says Intel Corporation has invested $10.5bn in Israel over the past decade, and received $1.3bn in Israeli government grants. It is estimated Intel accounts for 10% of Israel's total industrial exports, and one- third of exports to China. Without the contribution of Intel, high-tech exports would have declined by 10% in 2012, according to Intel estimates. Meanwhile, the Manufacturers Association of Israel stated that high-tech exports totalled US$25.6bn in 2012, up 3% from 2011, and the industry provided employment for 210,000 people. The Israel Association of Electronics and Software Industries (IAESI) highlighted the risk of declining exports from high-tech, a traditional bastion of the Israeli economy, as cutbacks could result in a loss of technological leadership and © Business Monitor International Page 46 Israel Information Technology Report Q4 2013 a subsequent negative spiral. The IAESI is concerned the public and media debate has become so centred on government budget cuts, financial institutions and gas exploration that high-tech has become less of a priority for government. A stronger currency could also result from the potential for gas exports, hurting the competitiveness of high-tech exporters. ECI sues HP for ILS38mn Communications equipment vendor ECI sued Hewlett-Packard Israel for ILS38mn in April 2013, claiming HP did not meet the terms of an agreement to upgrade its computer systems. In 2010 ECI contracted HP to provide its computing requirements including maintenance, support and upgrades in a deal worth US$120mn over 10 years. This made it one of the largest such contracts in Israel, as well as ECI being one of the first Israeli companies to switch to cloud computing and utilise a server farm in France. However, HP cancelled the contract in February 2013, claiming ECI had breached the contract and was in arrears. ECI claimed HP had failed to provide services promised, meeting none of the eight milestones it had set for April 2011 and that the cloud computing element was only supporting 900 users, rather than ECI's 3,000 employees, as required. Israel's Digital Divide It has been estimated that Israel currently has around 600,000 children living below the poverty line, and the Gini co-efficient has been estimated as among the highest of any Organisation for Economic Cooperation and Development (OECD) country. A 2007 survey found only 30% of children living in poverty have internet or home PC access, compared with 90% in the top-income group. Alarm at such statistics has helped to make tackling the digital divide central to the government's key policy goal of reducing poverty. There is also an ethnic dimension to digital inequalities. Recent research by the University of Haifa showed a consistent gap in internet access between the Jewish and Arab populations, with 72.5% of the former using the internet in Israel compared with 52.5% of the latter. In order to deal with the digital divide problem, the following measures have been proposed: ■ A senior minister for the high-tech sector should be appointed to coordinate activities currently carried out by various ministries. The minister should prepare a master plan for government policy in the information industry. ■ Regulations should be amended to facilitate rapid investments in communications, technological infrastructure, bandwidth and fast internet backbone. ■ Massive investment should be made in the educational system for training information workers. ■ Aid to be given to the less wealthy to make them part of Israel's information industry. © Business Monitor International Page 47 Israel Information Technology Report Q4 2013 Latest Developments In March 2013 CA Technologies agreed to purchase Israeli app deployment and management company Nolio for US$40-42mn. Nolio provides software that automates application deployment and allows IT staff to maintain, manage and recover these enterprise applications. In March 2013 Israeli security services company Incapsula, an Imperva subsidiary, was valued at around US$950mn after proving successful among small- and medium-sized businesses. Incapsula provides highend firewalls to assess incoming traffic and identify possible bugs. Incapsula was established in 2009 and was created by three Imperva employees. In February 2013 JethroData closed a US$4.5mn investment round. JethroData is an analytics database company based on Hadoop. It claims to combine the storage scalability of Hadoop with query performance of a fully indexed, columnar analytic database. In February 2013 Israeli mobile optimisation vendor Intucell was acquired by US software firm Cisco Systems. Intucell specialises in software that can make automatic modifications to a mobile network, responding in real-time to the network's relative performance, enhancing average network throughput by around 12%. The acquisition was worth a reported US$475mn. Spanish telecoms company Telefónica Digital has announced plans in November 2012 to invest US$25mn in Israeli smartphone platform provider Everything.me. US web services firm Mozilla and Israeli investor BRM Group also pledged to support the development of the company. Everything.me hopes the additional funding will enable it to continue to grow and add to its workforce. Members of the Anonymous hacking circle have targeted websites in Israel in response to violence and military bombings in the Gaza. Distributed denial of service (DDoS) attacks had affected 40 websites linked to the government by November 15 2012, reports the Register. In particular, the group is understood to object to government threats to block access to the internet in the Gaza Strip. IBM announced in October 2012 that it was in discussions to purchase Israeli software management firm Red Bend Software. The acquisition is worth up to US$250mn and would enable IBM to increase its presence in the mobile operating systems market. Red Bend's existing customers include US computer hardware firm Intel, and South Korean electronics company Samsung. © Business Monitor International Page 48 Israel Information Technology Report Q4 2013 Regulatory Development Table: IT Regulatory Authorities Government Authority Ministry of Science and Technology Minister Daniel Hershkowitz Source: BMI The Ministry of Science and Technology has undergone numerous name changes and received its current name following the election of Binyamin Netanyahu's government in March 2009. The ministry's responsibilities include forming a national science and technology policy, coordinating research areas and technological analysis and organisation. The main priorities for the ministry are as follows: ■ Establishing a national policy and priorities for R&D; ■ Developing scientific and technological infrastructure; ■ Establishing and strengthening foreign scientific relations; ■ Participating in the establishment of research centres, including regional R&D centres; ■ Participating in the development of scientific and technological human resources; ■ Increasing awareness of science within the public, especially the youth of Israel; ■ Developing digital infrastructure (facilitating access to information); ■ Consulting the government and its offices in the area of science and technology. Cyber Security In October 2012 Israel's Prime Minister Benjamin Netanyahu announced the government was working to create a 'digital Iron Dome' to protect vital infrastructure from hackers and viruses (the Iron Dome is Israel's anti-rocket defence system). This includes the establishment of the National Cyber Bureau to defend the nation against computer terrorism. The announcement follows a series of cyber attacks linked to political tensions in the Middle East, including attacks on Israeli institutions, as well as Saudi oil companies and banks in the UAE. © Business Monitor International Page 49 Israel Information Technology Report Q4 2013 In January 2013 Netanyahu opened a national programme to train teenagers in the skills of cyber security. The programme accepts high achieving students for a three-year training program to intercept malicious attacks. The government is hoping the programme will deliver the skilled professionals to meet the escalating cyber threats in the region and globally. Regulatory Changes Drive Financial Sector IT Spend Israeli financial sector spending actually increased following the economic crisis of late 2008 and 2009, as it was positively impacted by regulatory reform and changes affecting banking and insurance in the wake of the crisis. Israeli legislation passed in 2010 and 2011 increased Israeli Securities Authority regulatory supervision over the offering of investment services and administration of investment portfolios. This in turn increased demand for solutions for entities that became subject to such supervision. The entry of banks entry into new areas such as offering advice with respect to pension, insurance and other financial products has also triggered increased supervision by the Israeli Securities Authority. Again, this has driven demand for IT solutions to help compliance with enhanced compliance requirements for banks and financial institutions, with the regulatory changes generating demand for specific IT solutions, often in a set time period. Government Approves FTTH Build In January 2013 Israel's government agreed to allow a consortium of privately owned companies to join forces with the state electricity utility to begin building the country's first alternative next-generation fibreoptic backbone. The roll-out should increase competition in high-speed internet access and lower prices opening up new opportunities for IT vendors in terms of devices sales and services to consumers. Reportedly, a group led by Sweden's Viaeuropa has been offered a 60% stake in a joint venture to be established with Israel Electric Corporation (IEC) that will build, operate and manage the new 25,000km fibre-to-the-home (FTTH) network. The aim is for construction on the multi-billion shekel network to begin before the end of 2013, and for coverage to reach two-thirds of the population by 2020. Viaeuropa will own 50% of the consortium, with four other investors - understood to include local firms BATM Advanced Communications and Rapac Communications - each owning 12.5%. Government To Invest In Dual-Use R&D In January 2013 the Ministry of Finance, Ministry of Defence and Ministry of Industry, Trade and Labour announced a joint budget of ILS30mn available for R&D for technologies with civilian and military © Business Monitor International Page 50 Israel Information Technology Report Q4 2013 applications. Each ministry contributes one-third of the funds to the programme. The programme has already identified 17 projects of potential dual-use, including some software research. Background All major vendors have a direct presence in Israel, employing substantial numbers of staff. For example, IBM has its only IBM Global Services regional subsidiary in Petach Tikva and employs around 2,000 staff at its Haifa Labs and various IBM facilities in Rehovot and Jerusalem. HP has as many as 4,000 employees and offers services and support through its subsidiary HP-OMS. Other vendors such as Oracle and EDS also have a sizeable presence. Foreign direct investment (FDI) first started to play a key role in Israel's economy in the mid-1990s as the country's high-tech sector underwent a rapid expansion. As well as the opening up of the financial and telecoms sectors, the high-tech sector succeeded in attracting large FDI inflows. The government's policy made foreign high-tech companies eligible for government grants covering 38% of the cost of new research and development facilities. Today, Israel has more offshore R&D centres of US high-tech companies than any other country. Local companies also have a significant presence in the Israeli IT market, with seven of the top 10 IT services firms being Israeli. Major players include Matrix, Ness Technologies and Malam Group, with Israel typically accounting for 40-50% of their revenue. © Business Monitor International Page 51 Israel Information Technology Report Q4 2013 Table: Government Initiatives Initiative Details Gov@Net Government intranet A cross-government intranet planned to connect more than 80 governmental networks and hundreds of institutes. The implementation will create the largest Israeli IP-VPN. The project will allow efficient internal communication and resource sharing. Mercava Government ERP Mercava is the largest ever IT project implemented in Israel. It will gradually replace the assortment of unique legacy systems currently operating in governmental bodies with a central, unified enterprise resource planning (ERP) system running on SAP system software. This project will create a unified language for cross-government activities. Government EIP This project is intended to promote enterprise portals within the government. Since a cross-government portal will be based on information received from the different bodies, the first step involves the construction of a ministry-level portal. This portal will draw information from Merkava, ministry-specific operational systems and intra-government shared resources. Tehila Government ISP The Government ISP project has been operational since 1998, providing essential infrastructure for publicgovernment communication. To date, 60% of the governmental bodies have voluntarily joined the project. Shoham - Ecommerce infrastructure and service A central e-commerce service allowing citizens and companies to access a uniform interface to carry out a variety of payments and purchases, including the payment of taxes, fees, fines (VAT, vehicle and driving licence fees, traffic fines), and the purchase of tangible goods (government publications). The service processed more than ILS250mn in its first year. Lehava project Group of initiatives to help close digital divide. Source: BMI © Business Monitor International Page 52 Israel Information Technology Report Q4 2013 Company Profile Ness SWOT Analysis Strengths Weaknesses ■ Acquisition by CVCI will see new investment into operations. ■ Large international presence offering wide client base. ■ Several technology centres in India, one of the fastest growing IT markets. ■ Acquisition by private equity rather than technology company misses opportunity to take advantage of scale or expertise. Opportunities ■ Slow revenue growth. ■ Divestment of non-core assets will allow greater focus on core businesses. ■ Major deals with banks and governments provide growth. ■ Acquisition of Imano offers strong potential for moving into the mobile app segment. ■ Onshore presence in the US opens doors to high value mobility and analytics software development opportunities for corporates. Threats ■ Israel's IT market is competitive with several players. ■ Software development and offshoring both areas of intensifying competition as vendors in emerging markets attempt to move up the value chain. Company Overview Ness is an Israeli company and global provider of end-to-end IT services and solutions. The company was founded in 1999. On June 10 2011, Ness announced it would be acquired by an affiliate of Citi Venture Capital International (CVCI) in an all-cash transaction valued at approximately US$307mn. Ness announced on October 11 2011 that the acquisition was finalised. The company subsequently delisted and ceased trading on the Nasdaq Global Select Market and the Tel Aviv Stock Exchange. Ness specialises in outsourcing, systems integration and application development, software and consulting as well as quality assurance and training. In August 2012, Ness was awarded a 10-year contract from Israel's Ministry of Finance to establish and operate the country's new National Long Term Savings and Insurance © Business Monitor International Page 53 Israel Information Technology Report Q4 2013 Exchange. So important is the project to Ness that the company established a dedicated subsidiary called SwiftNess to develop and operate the National Exchange, including a service and support centre. The new exchange is expected to streamline work processes and provide the public with information about the retirement savings and insurance plans on offer. Ness acquired Gilon Business Insight, a business intelligence provider, in H110. During 2010, the company also announced plans to sell its software distribution business in Europe. The company had already signed an agreement to sell its Asia Pacific integration and application development operations. Ness announced it would continue to provide outsourcing services from its development centres in India, Bangalore, Mumbai and Hyderabad, and from its centres in Israel, Eastern Europe and Asia Pacific. With 7,800 employees, Ness maintains operations in 16 countries and partners with more than 100 software and hardware vendors worldwide. In 2010, Israel accounted for 37% of the company's quarterly revenue, with North America at 33%, Europe at 28% and the rest of the world at just 2%. Strategy Ness' plans include a focus on improving margins in its Israeli business and reducing non-core staff, with the aim of creating profitability at the company. Having already divested stakes in non-core operations such as in Asia Pacific and Europe, the company's operations are more focused. Ness forecasted top line growth and operating margin expansion in 2011 with a trend of sequentially increasing quarterly revenue, except for the second quarter. The acquisition of Imano in 2012 show's Ness' ability to respond to global trends, increasing its ability to cater to mobile device growth and the demand for products that work on wireless devices. As well as expanding its presence in mobility and analytics, Ness is also opening new offices to offer a range of onshore, nearshore and offshore services. Financial Results Following its acquisition by CVCI Ness no longer reports separate financial results. These data are provided for reference only. Ness reported revenue of US$141mn in Q211, with just 1% annualised growth. Revenue from the Israeli market accounted for 42% of the total, and Ness reported that demand in its market was solid across key verticals such as industrial, government, financial services and defence. Ness Israel reported modest annualised revenue growth of 1% in Q211, to US$141bn. This was up 3% from Q111. Improved results in 2010 followed a 17% decline in fullyear 2009 revenue compared with 2008, although around one-third of this was due to foreign currency effects. Annual revenues for 2009 were reported at US$547mn. Israel accounts for around 42% of Ness' revenue. Among major developments in H111 was a US$75mn five-year agreement that Ness signed with global finance leader Barclays Capital to develop a high-tech research and © Business Monitor International Page 54 Israel Information Technology Report Q4 2013 development centre in Israel. The outsourced software engineering model was hailed by Ness as pioneering. The company's top 20 customers accounted for only 37% of the company's Q211 revenue, with the largest customer accounting for about 5%. Ness Israel reported full-year 2010 revenue of US$571.8mn, up 12% year-on-year (y-oy). Among major projects in 2010, the company revealed it had completed the successful roll-out of a next generation court system for the Israeli Courts Administration and announced a large military intelligence system contract with the Ministry of Defence. Ness also revealed in June 2010 that its outsourcing contract with Israel's Ministry of Environmental Protection had been extended for three years in a deal valued at around US$2.6mn. The company also won a US$4mn healthcare sector outsourcing contract with Israel's Clalit Health Services in June. Company Developments In March 2013 Ness Technologies announced the opening of a new development centre in Pittsburgh in the US. The launch of the Pittsburgh Development Centre is part of Ness' strategy of building a strong onshore presence to compliment its offshore and nearshore development centres in India, Eastern Europe, Singapore and Israel. The Pittsburgh centre will specialise in mobility and business analytics, as well as providing a full spectrum of engineering services. The location was selected to provide proximity to US corporate locations, for better collaboration and flexibility of resources, as well as being close to major universities for hiring purposes. In December 2012, Ness announced its intended acquisition of UK based Imano, a company that specialises in mobile strategy, design and development. The deal is aimed at improving Ness' ability to meet the mobility demand of its customers. Imano designs web applications and created mobile apps for a number of major brands in the UK. Ness opened a new software development centre in Iaşi, Romania. The new unit will form part of the company's Software Engineering Services unit. The expansion forms part of a wider strategy to give Ness a global footprint. On September 14 2009, Ness Technologies launched its stock on the Tel Aviv Stock Exchange (TASE), having received approval for the listing from TASE authorities. Ness Technologies common stock will continue to be listed on the NASDAQ exchange in the US and will remain subject to the rules and regulations of NASDAQ and the US Securities and Exchange Commission. Ness hoped the dual listing would increase its visibility and status in the Israeli market, with almost a third of the company's business aimed at Israeli customers or delivered by an Israeli workforce. The listing came despite a series of disappointing quarterly results in 2009, which added up to a 17% decline in revenue compared with the previous year. The company witnessed a 19% decline in revenue in Q309, following from a 20% decline in Q209, although more than half of this headline decline was due to currency translation from non-dollar revenue. The steepest declines in H109 were experienced by the company's © Business Monitor International Page 55 Israel Information Technology Report Q4 2013 Systems Integration and Application Development division, while Software Product Engineering continued to perform well. Contracts In August 2012 Ness announced a 10-year contract with the Israeli Ministry of Finance to create a new national long term savings and insurance exchange. Ness is to create a new subsidiary to develop and operate the national exchange. The first phase of the project is scheduled to begin in Q213 offering funds transfers and information transmission to insurance brokers and banks. Future developments will allow individuals and enterprises to access information in the exchange. In January 2011, Ness' software engineering unit became a partner for Pegasus Solutions. The two companies established an extended software development centre in Mumbai. Ness' Software Product Engineering division continued to be a strong performer in Q111, with a major boost from the software engineering outsourcing contract signed with Barclays Capital. In the same quarter, Ness' Commercial and Civilian business unit reported 4% annualised organic growth, with the biggest win being the US$17mn contract with Israel Electric Corporation. The Defence and Homeland Security unit was described as slightly behind plan with revenue, but reported strong operating margins, boosted by a big deal with the Israel Ministry of Defence. In Q111 one big win reported by Ness in the Israeli market in H111 was a US$17mn deal with Israel Electric Corporation, for which Ness will implement a range of SAP solutions and provide support over a five-year period. Other successes included a US$10mn deal with the Israel Ministry of Defence and a US$5mn deal with Derect Eretz, the operator of the Trans-Israel toll road. In September 2010, Ness won a US$3.7mn, five-year contract from Israel's Meitav Regional Water and Sewage Corporation to provide development, improvement and maintenance services for the company's SAP-based ERP and billing system. The contract also included an optional three-year extension, valued at US$2.2mn. The company continued to be strong in the financial services sector, with a US$1.1mn contract win in October 2010 from Israel Direct Insurance (IDI) to implement a companywide, SAP-based ERP system. The new system will comprise financial, logistics and HR modules. At the end of 2009, Ness won a five-year ILS42mn (US$11.2mn) outsourcing deal from Israel's Ministry of Immigration Absorption. Under the contract, Ness will operate and maintain the ministry's IT systems, which support 600 users. The company also won an US$11mn outsourcing contract from the First International Bank of Israel and a US $4mn contract from the Israeli ministry of the interior. Ness had been on the rise with several landmark deals in the past two years. These included an eight-year US$120mn outsourcing contract, including hardware, with the First International Bank of Israel, in which Ness is serving as lead sub-contractor to EDS. Ness also made the headlines for a 10-year multimillion outsourcing contract with © Business Monitor International Page 56 Israel Information Technology Report Q4 2013 Israel's Yellow Pages, which, although far smaller at approximately US$8.5mn, was one of the largest projects in Israel at that time. The project was subsequently extended. Financial Data ■ ■ ■ Company Details ■ ■ Revenues (Global, 2010): US$571.8mn Revenues (Global, Q111): US$137.3mn Revenues (Global, Q211): US$141.3mn Ness Israel Ness Tower Atidim Industrial Park P O Box 58152 Tel Aviv 61580 Israel ■ Tel: +972/3 766 6800 ■ Fax: 3 766 6809 ■ www.ness.com © Business Monitor International Page 57 Israel Information Technology Report Q4 2013 Matrix SWOT Analysis Strengths Weaknesses Opportunities ■ Global client base in more than 50 countries. ■ Working with different industries. ■ Partnerships with major international IT companies. ■ Reliance on government projects, which can waver with economic outlook. ■ Lacks scale to compete with global leaders. ■ Increased presence in the US opens avenues to higher value software development and testing deals. ■ Broad range of capabilities and expertise creates potential for larger contract deployments. Threats ■ International outlook allows for expansion of services. ■ Contracts with telecoms companies offer potential. ■ Israel is emerging as an IT hub, bringing attention to local companies. ■ Israel's IT Market is highly competitive with several players. ■ Increasing competition from emerging market providers of IT software and services providers as they look to move up the value chain. Company Overview Matrix is a leading IT company in Israel that develops and implements technologies, software solutions and products, as well as providing infrastructure and consulting services, outsourcing, offshore, training and assimilation. It also represents and markets for the world's leading software vendors in Israel, including IBM, Microsoft, Oracle, RedHat, EMC, SAP, HP and Apple. Matrix is part of the Israeli-owned Formula Systems group, which also includes Magic Software and Sapiens. Unlike those two companies however, which focus more on their global client base, Matrix derives most of its revenues from the Israeli market. In Q113, Matrix reported revenues of US$413mn from the Israel market, from total reported © Business Monitor International Page 58 Israel Information Technology Report Q4 2013 quarterly revenues of US$515mn. Revenues were down slightly in Q113, due largely to seasonal factors and timing of Jewish holidays. Matrix, which employs 65,000 people, also owns a large number of subsidiaries including information security provider 2bsecure, Matrix BI (business intelligence), Matrix Global (offshore and nearshore services in Israel and Eastern Europe), Tact Software (software testing company), Tangram Soft (IT services), Exzac (US subsidiary helping financial services institutions meet regulatory compliance requirements and defend against fraud) and Xtivia (US subsidiary offering database support, data warehouse and business intelligence products). Strategy Services include implementing integration projects, developing and marketing software technologies and products for business systems, providing infrastructure and consulting services, outsourcing contracts, training and assimilation, and acting as a distributor for global leading software products, hardware solutions, and IT infrastructures. In 2012 Matrix increased its focus on information and cyber security solutions through 2BSecure, which were consolidated with solutions targeting the cyber world at Matrix including fraud and money laundering prevention and the financial regulation of EXZAC. Financial Results Matrix reported total revenues of ILS1.984bn in 2012, a 12.8% increase from 2011. Gross profit increased by 5.5% to ILS332.6mn, while operating profit increased 2% to ILS140.4mn in 2012. This provided a gross margin of 16.8% (down 0.9pps y-o-y) and an operating margin of 7.1% (down 0.7pps y-o-y). Finally, net income declined 3% y-oy to ILS90.7mn, giving a profit margin of 4.6% for 2012. Matrix's financial performance in 2012 was driven by growth in software services sales, which increased 19.4% to ILS1.405bn - equal to 70.8% of total revenue (up 0.9pps y-oy). Operating profit from software services failed to keep pace with sales growth, affecting margins at group level, with operating profit from software services increasing 5.4% to ILS103mn in 2012, equal to an operating margin of 7.3%. Marketing of software, integration and computer infrastructure and training and deployment are the other three reporting divisions at Matrix. Of these only integration and computer infrastructure reported increased revenue in 2012, up by 10.1%, while training and deployment sales were virtually flat and marketing of software revenues declined by 8.6%. In 2011, Matrix reported a 15% year-on-year (y-o-y) increase in revenues to ILS1.758bn, driven by organic growth and acquisitions. Software sales grew 15.5% to ILS1.177bn. The company won several new contracts across its business areas including public, financial and pharmaceutical. The company highlighted increasing customer interest in areas such as nearshore and offshore for a number of industry verticals as many clients are interested in increasing efficiency and flexible business models. The market of software products generated ILS194.4mn, up 14%, while © Business Monitor International Page 59 Israel Information Technology Report Q4 2013 integration and computer infrastructure grew 19% to ILS261mn. Training and deployment gave the company ILS164mn, a 4.5% increase. Net profit in 2011 was a record ILS96.1mn, up 8.4%, having gained 30% in the final quarter of the year. Company Developments In H112 results, Matrix announced it had acquired US company Exzac, which specialises in risk management and regulation in the finance sector. The new acquisition offers clients in 'leading financial institutions' in the US and Israel. Matrix also acquired Netwise, which offers solutions for the digital world and management of effective, continuous, and valuable customer experience. In 2010, Matrix reported growth in revenue and profits thanks to momentum in key sectors and services. The company won new projects in the public sector and the insurance sector, with mobile/cellular projects a growth area. Telecoms was another growth vertical in summer 2010. Major projects included a new interface and integration for a high-tech organisation, a core financial system in the field of taxation for a leading bank and a multi-channel project for a pharmaceutical company. Despite the challenging economic climate, Matrix reported continuing successes in 2009, with wins in key sectors including healthcare, financial services, defence and government. Among tender wins in the Israeli market were a project to implement a core system in three hospitals, a software and hardware upgrade for a leading credit card company and a large-scale testing project for a government organisation. The company also reported several new projects in Q109, including several financial sector implementations. The company credited its continued profitability in the face of the global economic slowdown to preparatory measures taken at the end of 2008. It cut operational expenses, including senior management salaries, and exercised what it described as 'extreme caution' in tenders. In 2008, Matrix reported tender wins in sectors including defence, communication and industrial. Specific successes included winning a ILS20mn project to implement a CRM system at long-time customer Bezeq, as well as a number of public sector CRM projects. In 2007, Matrix undertook the implementation of a pension consulting system for the Mizrahi Tefahot Bank, contracts based on the Matrix CRM system for three capital market companies and a large-scale integration project for the Airport Authority. Matrix also won a tender from the Ministry of Finance to make government forms available online. The project, which focused particularly on tax forms, cost around ILS2mn spread over two years, with the option of further expansion. Matrix is also focusing on the growing outsourcing market with government as well as corporate IT departments and has recently appointed a new sales and marketing © Business Monitor International Page 60 Israel Information Technology Report Q4 2013 manager for its Talpiot division. The division has a dedicated software development centre, with around 25 projects currently claimed to be under way. In 2011, Matrix won projects in several areas. In the financial market Matrix deals included a loan system for a leading bank, core financial system in the field of taxes for a leading financial institution, operation sites for two banking institutions in Israel and abroad, channel infrastructure for a bank and significant interface and integration project for the capital market, establishment of back office and an interface project for two leading customers in the financial field and software for the central computer of a large financial institution. In the pharmaceutical industry, there were multi-channel projects in the field of pharmaceuticals and finances, complete computerisation of yet another hospital abroad as well as public sector projects such as conversion of dozens of knowledge management sites for a government organisation, warehousing projects for large industrial companies and for the public sector and winning significant bids for training and deployment projects at the Ministry of Finance, in the public sector, financial institutions and the police. Financial Data ■ ■ ■ ■ ■ ■ Company Details ■ ■ Revenues (2010): ILS1.528bn Revenues (2011): ILS1.758bn Revenues (2012): ILS1.984bn Net Income (2010): ILS88.6mn Net Income (2011): ILS93.4mn Net Income (2012): ILS90.7mn Matrix 3 Abba Eban Boulevard P O Box 2062 Herzlia Pituach 46120 Israel ■ Tel: +972/(0) 9 959 8840 ■ Fax: (0) 9 959 8844 ■ www.matrix.co.il © Business Monitor International Page 61 Israel Information Technology Report Q4 2013 Regional Overview The eurozone crisis has continued to weigh on the performance of IT markets across Europe. However, this should not overshadow positive developments in certain segments of the market. While on the one hand the PC market has been hit hard, tablet sales are booming and the release of Windows 8 has ushered in a period of device innovation from vendors. Some enterprises are delaying tenders, while real-time enterprise software, cloud computing and data analytics are growing fast. BMI expects this pattern of mixed performance to continue over the medium term as older technologies reach maturity while others grow quickly. While technology trends will impact all markets in the region, over the medium term, there will be differences across Europe. One differentiator in this IT Market Size As % Of National GDP respect is the level of development of countries and IT markets. There is a wide range of IT market development across Europe, from high-income markets such as Sweden and the UK that also have large IT markets relative to their size, right through to lower income markets, such as Turkey and Romania, with small IT sectors. Generally, BMI is forecasting the IT market will increase as a percentage of GDP faster in emerging European markets where PC penetration is still rising, and where enterprises and government have lower levels of IT utilisation. Meanwhile, in the f = BMI forecast. Source: BMI more developed markets such as Germany and the UK, a combination of market saturation and macroeconomic conditions will combine to limit IT market growth. France and Sweden are the exception to this trend, with separate developments in each market responsible for IT continuing to increase as a share of GDP through to 2017. In Sweden we consider there to be further growth potential from the location of large datacentres in the Arctic north of the country. Facebook located its datacentre in Lulea, 60 miles south of the Arctic Circle, and it is estimated that utilising innovative cooling systems that capitalise on the cold climate can increase efficiency by 40%. The Facebook datacentre © Business Monitor International Page 62 Israel Information Technology Report Q4 2013 began supporting traffic in H113, following the Google datacentre in Finland. We expect further datacentre investment in Nordic markets to capitalise on cold conditions, strong telecoms infrastructure, proximity to large markets and political stability. The location of large datacentres has also resulted in firms such as EMC and Fusion-io setting up local offices, creating a positive cycle. Meanwhile, in France BMI has taken a positive view of the cloud computing market, and we believe the national cloud computing project (Andromede) could be positioned to capture strong growth in the medium term as the European market integrates. In September 2012 the French sovereign wealth fund Caisse des Dépóts announced its investment of EUR75mn in each of two competing cloud computing providers as part of the Andromede project - Numergy (SFR and services and server vendor Bull) and Cloudwatt (France Télécom-Thales) - in return for a 33% minority stake in each. Numergy started with two datacentres in France, but plans to build 40 more in France by 2020. It will initially target only the French market, but plans to expand across Europe. Cloudwatt has broader ambitions of expanding across Europe, using France Télécom's presence in the UK, Spain, Poland and elsewhere as a starting point. We believe there is growth potential for Numergy and Cloudwatt domestically and in serving other European markets. There is concern in Europe about the exposure to the US Patriot Act's provisions for government access to data if stored with a US company, which, combined with the harmonisation of data protection regulation across the EU, could see the French vendors in a strong position to expand regionally and serve customers from French datacentres. © Business Monitor International Page 63 Israel Information Technology Report Q4 2013 PC Market Feels The Squeeze A trend affecting the whole region is the decline of the traditional PC market - the result of a combination of high levels of PC ownership, EMEA PC Shipments* (mn) Q112 & Q113 competition from tablets and the weakness of consumer spending. Gartner estimates a 25% decline in PC shipments for the EMEA region as a whole y-o-y to Q113. This includes desktops and notebooks, but excludes tablets, which have exhibited strong growth in sales. The vendors most exposed to the downturn in traditional PC sales are HP, Dell and Acer, which all have heavy European exposure but also lack a strong presence in tablets or smartphones. However, diversification across products is not the only route to success, as demonstrated by Lenovo, the only EMEA vendor in the top five to report a y-o-y increase in sales. *excludes tablets. Source: Gartner The decline in PC shipments has occurred faster than was expected, as it was expected the launch of Microsoft's new Windows 8 operating system, released in October 2012, would provide a bump to volumes. It is dangerous to draw far-reaching conclusions about prospects for traditional PC sales in Europe based on data for the first quarter, where economic conditions cannot be discounted, but it is clear there is a rapid shift towards tablet sales. Apple has dominated the tablet markets across Europe since the release of the first iPad, but the deepening of the tablet market in H212 is seeing that situation change. Cheaper 7-inch tablets running Google's Android OS saw success in H212, most notably Google's Nexus 7 and Amazon's Kindle Fire. These were important in that they undercut Apple's price points while offering strong specifications, increasing consumer choice and driving sales higher. The presence of Google and Amazon devices will be important for the market, with neither firm prioritising margins on the devices themselves, helping to lower prices in the wider market. The increase in competition has already contributed in a shift to Apple's strategy, which saw the release of the iPad Mini in Q4 2012. BMI does not consider the rise of tablet sales to be a one-way street with traditional PC form factor sales cannibalised. Rather, we consider there to be innovation under way that is blurring device categories. The © Business Monitor International Page 64 Israel Information Technology Report Q4 2013 October 2012 launch of Windows 8 introduced touch functionality to Microsoft partner vendors and has seen a wave of innovation in hybrid models that combine the mobility of tablets with the productivity functionality of notebooks. Early examples have been hybrid devices such as Microsoft's own Surface (RT & Pro), HP's Envy and Lenovo's Yoga and Helix. Initial reports are for subdued sales of these hybrid models, most of which are new to the market and priced as premium devices, but we consider them to be a forerunner for devices that will capture a larger share of sales. Windows has a traditional strength in productivity use cases and software, with the OS being central to the enterprise market and Microsoft's Office Suite ubiquitous. There is therefore an opportunity for vendors to leverage this strength over rival iOS and Android devices by designing tablets with strong productivity functionality alongside the passive media consumption features. Design innovation has some way to go, and prices of hybrids will need to decline, but we believe the multi-use device has scope to capture a share of the tablet/notebooks market. OS Share Of Browsing Traffic (%) And Y-O-Y Change March 2013 Source: Statcounter © Business Monitor International Page 65 Israel Information Technology Report Q4 2013 Demographic Forecast Demographic analysis is a key pillar of BMI's macroeconomic and industry forecasting model. Not only is the total population of a country a key variable in consumer demand, but an understanding of the demographic profile is key to understanding issues ranging from future population trends to productivity growth and government spending requirements. Source: World Bank, UN, BMI © Business Monitor International Page 66 Israel Information Technology Report Q4 2013 The accompanying charts show Israel's population pyramid for 2011, the change in the structure of the population between 2011 and 2050 and the total population between 1990 and 2050, as well as life expectancy. The tables show key data points from these charts, in addition to important metrics such as the dependency ratio and the urban/rural split. Table: Israel's Population By Age Group, 1990-2020 ('000) 1990 1995 2000 2005 2010 2012e 2015f 2020f 4,500 5,332 6,015 6,605 7,418 7,695 8,061 8,666 0-4 years 483 528 614 666 735 769 792 794 5-9 years 461 511 548 619 666 695 740 794 10-14 years 462 508 527 554 620 642 671 742 15-19 years 430 495 528 536 564 587 623 672 20-24 years 355 451 514 538 556 558 567 624 25-29 years 328 383 463 523 557 560 558 568 30-34 years 315 360 392 470 546 557 560 560 35-39 years 325 346 370 397 500 527 550 562 40-44 years 271 357 359 375 424 454 503 551 45-49 years 188 304 371 362 390 401 425 502 50-54 years 171 204 316 373 372 375 389 422 55-59 years 160 185 215 315 388 384 368 385 60-64 years 150 182 195 213 329 360 381 362 65-69 years 136 165 184 188 217 253 318 368 70-74 years 98 145 160 170 183 184 204 299 166 208 259 305 373 389 412 461 Total 75+ years f = BMI forecast. Source: World Bank, UN, BMI © Business Monitor International Page 67 Israel Information Technology Report Q4 2013 Table: Israel's Population By Age Group, 1990-2020 (% of total) 1990 1995 2000 2005 2010 2012e 2015f 2020f 0-4 years 10.74 9.91 10.21 10.09 9.91 10.00 9.83 9.16 5-9 years 10.26 9.58 9.10 9.38 8.98 9.03 9.18 9.16 10-14 years 10.27 9.52 8.77 8.38 8.35 8.35 8.32 8.56 15-19 years 9.55 9.29 8.77 8.12 7.61 7.62 7.73 7.76 20-24 years 7.90 8.45 8.54 8.15 7.49 7.26 7.04 7.20 25-29 years 7.29 7.18 7.70 7.92 7.50 7.27 6.93 6.56 30-34 years 7.00 6.75 6.51 7.12 7.37 7.24 6.95 6.46 35-39 years 7.22 6.50 6.16 6.00 6.74 6.84 6.82 6.48 40-44 years 6.03 6.69 5.96 5.68 5.71 5.90 6.24 6.35 45-49 years 4.18 5.71 6.17 5.49 5.26 5.21 5.27 5.79 50-54 years 3.80 3.82 5.25 5.65 5.01 4.87 4.83 4.87 55-59 years 3.55 3.47 3.57 4.77 5.22 4.99 4.57 4.45 60-64 years 3.34 3.41 3.24 3.22 4.43 4.67 4.72 4.18 65-69 years 3.02 3.10 3.06 2.85 2.92 3.29 3.94 4.25 70-74 years 2.17 2.72 2.67 2.57 2.46 2.39 2.53 3.45 75+ years 3.70 3.91 4.31 4.62 5.03 5.06 5.11 5.32 f = BMI forecast. Source: World Bank, UN, BMI © Business Monitor International Page 68 Israel Information Technology Report Q4 2013 Table: Israel's Key Population Ratios, 1990-2020 Dependent ratio, % of total working age 1 Dependent population, total, '000 2 Active population, % of total 3 Active population, total, '000 4 Youth population, % of total working age 5 Youth population, total, '000 6 Pensionable population, % of total working age 7 Pensionable population, '000 8 1990 1995 2000 2005 2010 2012e 2015f 2020f 67.1 63.2 61.6 61.0 60.4 61.6 63.7 66.4 1,807 2,066 2,293 2,502 2,794 2,933 3,136 3,458 59.9 61.3 61.9 62.1 62.3 61.9 61.1 60.1 2,693 3,267 3,722 4,102 4,625 4,761 4,925 5,209 52.2 47.4 45.4 44.8 43.7 44.2 44.7 44.7 1,407 1,547 1,689 1,839 2,021 2,107 2,203 2,330 14.8 15.9 16.2 16.2 16.7 17.4 19.0 21.7 400 519 604 663 773 827 934 1,128 f = BMI forecast; 1 0>15 plus 65+, as % of total working age population; 2 0>15 plus 65+; 3 15-64, as % of total population; 4 15-64; 5 0>15, % of total working age population; 6 0>15; 7 65+, % of total working age population; 8 65+. Source: World Bank, UN, BMI Table: Israel's Rural/Urban Population Split, 1990-2020 1990 1995 2000 2005 2010 2012e 2015f 2020f Urban population, % of total 90.4 90.9 91.4 91.6 91.8 91.9 92.0 92.2 Rural population, % of total 9.6 9.1 8.6 8.4 8.2 8.1 8.0 7.8 4,212.6 5,040.4 5,748.1 6,348.0 6,810.1 7,069.9 7,416.1 7,990.5 447.4 504.6 540.9 582.1 608.3 624.8 644.9 676.0 Urban population, '000 Rural population, '000 f = BMI forecast. Source: World Bank, UN, BMI © Business Monitor International Page 69 Israel Information Technology Report Q4 2013 Methodology Methodology BMI's industry forecasts are generated using the best-practice techniques of time-series modelling. The precise form of time-series model we use varies from industry to industry, in each case being determined, as per standard practice, by the prevailing features of the industry data being examined. For example, data for some industries may be particularly prone to seasonality, ie, seasonal trends. In other industries, there may be pronounced non-linearity, whereby large recessions, for example, may occur more frequently than cyclical booms. Our approach varies from industry to industry. Common to our analysis of every industry, however, is the use of vector autoregressions. Vector autoregressions allow us to forecast a variable using more than the variable's own history as explanatory information. For example, when forecasting oil prices, we can include information about oil consumption, supply and capacity. When forecasting for some of our industry sub-component variables, however, using a variable's own history is often the most desirable method of analysis. Such single-variable analysis is called univariate modelling. We use the most common and versatile form of univariate models: the autoregressive moving average model (ARMA). In some cases, ARMA techniques are inappropriate because there is insufficient historic data or data quality is poor. In such cases, we use either traditional decomposition methods or smoothing methods as a basis for analysis and forecasting. Human intervention plays a necessary and desirable part in all of our industry forecasting techniques. Intimate knowledge of the data and industry ensures we spot structural breaks, anomalous data, turning points and seasonal features where a purely mechanical forecasting process would not. IT Industry Forecasts A number of criteria drive our forecasts for each IT variable. IT forecasting is complicated due to the fragmented nature of the market, with little transparency of vendor data and low apparent agreement between many sets of figures in terms of market definition, base and methodology. In addition, forecasts are affected by consideration of a variety of internal and external political and economic factors. © Business Monitor International Page 70 Israel Information Technology Report Q4 2013 Within best-practice techniques of time-series modelling, BMI's quarterly updated forecasts are improved substantially by intimate knowledge of the prevailing features of each local market. Individual variables taken into account in creating each forecast include: ■ Overall economic context, and GDP and demographic trends; ■ Underlying 'information society' trends; ■ Projected GDP share of industry; ■ Maturity of market structure; ■ Regulatory developments and government policies; ■ Developments in key client sectors such as telecommunications, banking and e-government; ■ Technological developments and diffusion rates; ■ Exogenous events. Estimates are calculated using BMI's own macroeconomic and demographic forecasts. IT Risk/Reward Ratings - Methodology Our approach in BMI's IT Risk/Reward Ratings is threefold. First, we seek accurately to capture the operational dangers to companies operating in this industry globally. Second, we attempt, where possible, to identify objective indicators that may serve as proxies for indicators that were traditionally evaluated on a subjective basis. Finally, we include aspects of BMI's proprietary Country Risk Ratings (CRR) that are relevant to the IT industry. Overall, the ratings system, which integrates with those of all industries covered by BMI, offers an industry-leading insight into the prospects and risks for companies across the globe. Ratings System Conceptually, the ratings system divides into two distinct areas:Rewards: Evaluation of sector's size and growth potential in each state, and also broader industry/state characteristics that may inhibit its development. Risks: Evaluation of industry-specific dangers and those emanating from the state's political/ economic profile that call into question the likelihood of anticipated returns being realised over the assessed time period. © Business Monitor International Page 71 Israel Information Technology Report Q4 2013 Indicators The following indicators have been used. Overall, the rating uses three subjectively measured indicators, and 41 separate indicators/datasets. Table: IT Business Environment Indicators Indicator Rationale Rewards Industry IT market value, US$bn Denotes breadth of IT market. Large markets score higher than smaller ones. Sector value growth, % year-on-year Denotes sector dynamism. Scores based on annual average growth over five-year (y-o-y) forecast period. Government initiatives and spending Hardware, % of total sales Denotes spending boost provided by public sector, which can be a crucial determinant of sector development. Denotes maturity of market. A high proportion of hardware sales, compared to services/software, indicates that the overall IT market is immature. Country Urban-rural split GDP per capita, US$ Urbanisation is used as a proxy for development. Predominantly rural states therefore score lower. A high GDP per capita supports long-term industry prospects. Overall score for country rewards is also affected by the coverage of the power transmission network across the state. Risks Industry Intellectual property (IP) laws ICT policy Markets with fair and enforced IP regulations score higher than those with endemic counterfeiting. Subjective evaluation of official policy towards IT development, as enshrined in statute and tax code. Country Short-term external risk Rating from CRR evaluates the vulnerability to external shock, which is the principal cause of economic crises. Such a crisis would cut investment. Short-term financial risk Rating from BMI's CRR, to denote risk of currency crisis and stability of banking sector. The former would hit revenues in hard currency, while the latter would curtail investment funding. Trade bureaucracy Legal framework Bureaucracy © Business Monitor International Rating from CRR to denote ease of trading with the state. Rating from CRR denotes the strength of legal institutions in each state - security of investment can be a key risk in some emerging markets. Rating from CRR denotes ease of conducting business in the state. Page 72 Israel Information Technology Report Q4 2013 IT Business Environment Indicators - Continued Indicator Rationale Rating from CRR denotes the risk of additional illegal costs/possibility of opacity in tendering/business operations affecting companies' ability to compete. Corruption Source: BMI Weighting Given the number of indicators/datasets used, it would be wholly inappropriate to give all sub-components equal weight. The following weight has been adopted. Table: Weighting Of Components Component Weighting Rewards 70% - Industry 65% - Country 35% Risks to 30% - Industry 40% - Country 60% Source: BMI Sources Additional sources used in IT reports include national ministries and ICT regulatory bodies, national industry associations, and international industry organisations such as the International Telecommunication Union (ITU), officially released company results and figures, and international and national industry news agencies. © Business Monitor International Page 73 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. [...]... increasing 2.1% in 2013 from 2.2% in 2012 (see April 29, 'Global Assumptions - Q3 2013 - Update') We forecast total exports increasing 2.4% in 2013 and 3.0% in 2014 in Israel Export Growth Outpacing Import Growth Israel - Exports & Imports, % chg y-o-y Source: BMI, Central Bureau of Statistics Israel F=BMI Forecasts © Business Monitor International Page 26 Israel Information Technology Report Q4 2013 Imports... International Page 14 Israel Information Technology Report Q4 2013 overall growth Given Israel' s relatively rich tech skills resource base, many organisations prefer to conduct software development in-house 2013 Outlook Despite a slight improvement in the rate of real GDP growth from 2012 to 2013, BMI forecasts a slowdown in spending growth in 2013 to 1.1% The downward revision to the Israeli market forecast... anticipated returns Source: BMI © Business Monitor International Page 30 Israel Information Technology Report Q4 2013 Market Overview Hardware Israel' s IT hardware market is forecast to decline by 0.12% in 2013 to ILS9.55bn However the mediumterm growth outlook is stronger with CAGR of 4.1% over our forecast period 2013- 2017 In 2013 the value of hardware sales will be squeezed by a weaker currency,... vendor's recent acquisitions of Israeli NAND flash technology manufacturer Anobit for a reported US$390mn In 2011, US PC leader Dell inaugurated a new Israeli R&D centre, which is part of the company's Enterprise Storage Business The new centre is based on Exanet, which Dell acquired in 2010 The centre © Business Monitor International Page 35 Israel Information Technology Report Q4 2013 will focus on developing... funding © Business Monitor International Page 24 Israel Information Technology Report Q4 2013 for ultra-Orthodox religious students We forecast government consumption expanding 2.0% and 1.4% in 2013 and 2014, respectively Imports and Fixed Investment Declining Steadily Israel - Components Of Real GDP, % chg y-o-y Source: BMI, Central Bureau of Statistics Israel Fixed Investment Outlook Fixed capital formation... Despite Weak Domestic Economy Israel - Components Of GDP (ILSbn) & Real GDP Growth, % chg y-o-y Source: BMI, Central Bureau of Statistics Israel F= BMI Forecasts © Business Monitor International Page 22 Israel Information Technology Report Q4 2013 Private Consumption Outlook Private consumption grew 2.9% y-o-y in seasonally adjusted terms in Q113, after increasing 3.1% y-o-y in Q41 2 The inflationary outlook... production in the recently discovered Tamar gas field begins in June 2013 ■ Competition from emerging Chinese and Indian producers of high-tech goods and polished diamonds, as well as sluggish growth in the eurozone, could undermine demand for Israeli exports © Business Monitor International Page 12 Israel Information Technology Report Q4 2013 Business Environment SWOT Analysis Strengths ■ The business... Consumption', May 14) © Business Monitor International Page 23 Israel Information Technology Report Q4 2013 For instance, Finance Minister Yair Lapid won a concession from union leaders to delay until 2015 a 1.0% scheduled pay increase for public employees, which was originally due in July 2013 Moreover, According to latest data released by Israel' s Central Bureau of Statistics, the unemployment rate... the country's oil and gas royalties, which could reduce energy profits in the future © Business Monitor International Page 13 Israel Information Technology Report Q4 2013 Industry Forecast IT Market Table: Israel IT Industry - Historical Data And Forecasts (ILSmn) 2010 2011 2012e 2013f 2014f 2015f 2016f 2017f 19,204 20,436 22,299 22,576 23,355 24,608 26,490 27,698 o/w Hardware 8,450 8,877 9,561 9,550... Mahmoud Ahmadinejad's refusal to give up his country's nuclear programme raises concerns that an open military conflict between Israel and the Islamic republic could erupt in the second half of 2013 © Business Monitor International Page 11 Israel Information Technology Report Q4 2013 Economic SWOT Analysis Strengths ■ The policy framework has stabilised in recent years, and recent austerity measures will