October 1999

Israel Update Memo

The following report outlines new developments in the past three months and the state of on-going developments.

1. General Background

The internal telecommunications market has been opened and liberalized following the implementation of the Rosenne Report beginning June 1,1999. The tariffs of the historical operator have been revised following the Gronau Committee and are down by 21% (since April, 1999) in preparation to the liberalization; cross subsidy among the services of the historical operator are being abolished. The implementation of the decision opening the telecommunications market for competition since June 1^st, 1999 resulted in an intense confrontation among the main players through different means: investments and buy outs; the press; political pressures; appeals to the courts.

The developments since July until middle October are the following:

• Cable TV as an alternative Infrastructure for Telecommunications

The main playes are the regulator - the Ministry of Communication that is allocating new licenses for additional services and providers; the Ministry of Finances and specially the Division for Budgeting; the Cable TV companies; the new DBS television company (YES); the historical operator, the Bezeq. The issues are the conditions for the extension of the licenses for the Cable TV companies due to expire between 2002 and 2005 - whether they should pay or not for the extension of their licenses; whether should be separation between the provision of content and ownership of the infrastructure; which additional services should they be allowed to provide and under which conditions: Internet access, telephony and so on.

Cable TV present the main alternative infrastructure for telecommunication services with a local loop in place covering more than 65% of the households in the country (There are currently three cable television operators, each with a monopoly in specific geographic regions, and covering over 90% of the country. About 70% of homes have subscribed to cable television.) It should be noted that the main newspapers chains in the country (Yedioth Aharonot group and Maariv) have a significant presence in the ownership of the Cable TV companies with the consequent leverage this provides them.

Latest developments: The Ministry of Finances (MOF) announced that the value of the extension of the present licenses for the Cable TV companies until the year 2013 are in the order of 950 million to 1.4 billion dollars. Several methods have been employed to calculate - the depreciated value of the Cable TV infrastructure as it appears in the company's books and the value of the latest transaction for the acquisition of one of the regional cable companie when the value set for the indivitudal Cable TV customer was 1,600 dollars. The Ministry of Finances prefers that a new open tender should be published for new cable TV operators allowed also to provid Internet access and telephony. Alternatively, the cable TV companies should be required to pay for the extension of their license. The Minister of Communications in contraposition intend to extend the licenses without payment; the rational is to compensate the Cable TV companies for the introduction of the DBS (multi channel direct broadcasting by satellite) TV services.

The legal counsel of the Ministry of Communications, Dr. Izhar Tal, points out that the economic value of the extension of the license for the Cable TV companies and for the new telecommunication services is much larger than the "damage" (apostrophes in the original) caused by the introduction of DBS services.

Content : The Cable TV companies ask for immediate licenses for the provision of broadband Internet services and telephony over their infrastructure. They oppose the government request for separation between content provision and infrastructure ownership. Meanwhile the ICP arrangement through which the Cable TV companies were allowed to join forces for broadcasting and the acquisition of content was prorrogated for another two months. This until a decision is reached regarding content and intrastructure separation and the issues related to the introduction of the DBS broadcast.

Internet: The small ISP Aquanet announced its intention to lead the small ISP in an appeal to the Supremet Court of Justice in case that the separation between content provision and infrastructures for Cable TV, Internet access and Telephony over cables is not effectivated. They argue that this kind separation has been enforced in the case of the historical telecom operator. The separation enabled a lively market for ISP and content providers to evolve. If no such separation is enforced in the case of the Cable TV companies the investments made by the ISPs so far will be jeopardized.

It should be noticed that Cable TV companies have heavily invested in the latest months in the acquisition of the largest ISP.

Competition between Cable TV and the DBS

The DBS company (multi-channel direct broadcast by satellite) YES is already installing antennas in collective buildings. The antennas are installed freely with a total investment of about 45 million dollars - the antenna costs for the company 400 dollars and the decoder about 200 dollars. Full services should be offered in early 2000.
The latest three months testimonied a continuous confrotantion between the cable TV companies and the DBS.

One of the issues regard content; Cable TV tried to close deals with most international content providers so as to create barriers for the DBS acquisitions in this area. They invested tens of millions of dollars for the rights of broadcasting the main sports leagues, the national selection and both the Warner and Columbia companies. One of the reactions of the DBS company so far has been the acquisition of the most popular soccer team in the country, the Betar Yerushalaim team.

Another issue regards tiering. Cable TV companies didn't offer their customers the alternative of choosing packages of channels at different prices; this although their licenses required them to do so. With the establishment of the DBS company which will offer tiering packages the Cable TV asked to do the same and were forbidden by the Ministry of Communications for at least one to two years. The rational of the Ministry is to provide some advantages to the DBS company (which will offer tiering) until it reaches an adequate customers base that garantees its viability.

• Competition between the Cellular Telephony Companies

The competition between the Cellular Telephony Companies has intensified in the last three months. The third company, Orange-Partner started offering its services at the end of 1998 and has steadily expanded its customer base; this occurred in a large measure at the expense of the historical Cellular operator Pelephone. As a reacion, for the first time, the Pelephone company decided in August in view of the loss of customers to lower its tariffs by 25% and to expand the kind of services offered to the public. The Pelephone CEO, Igal Bar-Iossef, stated that their intention is not to become the cheapest cellular company (like Cellcom) but to be the one which provides most value in relation to the price. Among their marketing strategies: the establishment of a brand for their digital network - Pelephone Next; the Coca-Cola logo in their telephones; special information services for automobiles based on GPS; a special youth campaign to compete with similar campaigns by Orange-Partner and Cellcom.

Historical analysis of the competition in the cellular market: Sever Plotzker, economics editor of the Yedioth Aharonot newspaper defines 4 main causes for the successful competitive environment established in the cellular market in Israel (26.8.1999 , Economy, page 2):

1. Abolition of the monopoly held by Pelephone without payment of any compensation against the opposition of a very strong company, Motorola that was the owner together with the historical operator, the Bezeq.
2. The price was set as the unique criteria in the tender for the second cellular operator. Instead of seeking to maximize the payment for the license the Ministry of Finance and the Ministry of Communications choose the company that showed herself to be able to offer the lowest tariffs and still be profitable, Cellcom.
3. Avoidance of the government from transforming the cellular market into a source of taxes. In parallel to the publication of tenders for the second and third operators the customs and taxes for importation of cellular telephones were abolished. The government also avoided getting income taxes from the use of the cellular telephone by employees received them from their work places.
4. The enactment of legislation establishing that the payment for the connection with a cellular telephone should be paid by the initiator of the conversation and not by the owner of the cellular phone. These four decisions established a competitive system that is efficient and fair and provided the high rate of penetration in a very short interval of time. He concludes saying that competition is not enough; the maximun welfare for consumers is obtained by competition and the intervention of a sage public hand.

Environmental issues regarding cellular telephony: Following a public campaign regarding the danger of radiation from cellular telephony antennas and the decision of the Major of Beer Sheva to demolish all antennas established in populous quarters without a license from the municipality a special forum was established by the cellular telephony companies. They announced their commitment to: (1) Complete the licensing process for all the antennas (2) To unifiy the location of the antennas of the different companies in every place where this is possible so as to diminish their number (3) To open information centers where the public may be able to receive any information they need concerning the antennas and cellular telephony (4) To obey the most stringent standards of the World Health Organization.

• Competition in International Telephony

The intensive competition between the International Telephony companies focused in the last months in the allocation of the customers between the different companies. The historical operator subsidiary Bezeq Beinleumi (Bezeq International) continued to operate the historical access code for international calls 00 and 188. Each of the international operator have been allocated the 012, 013 and 014 codes of access. However the continuing operation of 00 by one of the three internationaloperator garanteed him an unfair advantage as most users automatically used this way of access. The Ministry of Communication decided in middle June 99 to arbitrarily allocate customers who have not so far chosen an specific international operator among the different operators. As a reaction, Bezeq Beinleumi, appealed to the Supreme Court of Justice. In the SCJ (July 18, 1999) the companies reached a compromise that establish that a survey will be carried out among the customers asking them for their preferred company for international calls. The survey will encompass all customers of the fixed and cellular telephony. Beginning May 1^st 2000 the customers allocated by the survey will automatically access their chosen company using the 00 interntaional code; they still will be able to access an alternative company if they occasionally prefer by using their special prefix 012, 013 and 014. The Ministry of Communications signed the new general licenses for the companies with a paragraph enacting the obligation for all telecommunications companies to carry out the survey among their customers.

• Internet Users Strike - Tariffs for Internet Access

For some time it has been possible to carry out telephone calls between 22:00 p.m. to 8:00 a.m. by paying one unit for every 15 minutes for call over all the country; this arrangement facilitated Internet access by users but was abolished. Internet user got organized and put pressure on the historical operator and the Ministry of Communication to provide lower tariffs for Internet access. A initial date for a strike was set up for and then postponed for the 13^th of August. The postponement was the result of intense pressures and consultations held out in the framework of the Sciences Committee of the Parliament that invited all the main players for consultations; these included the Bezeq, the Ministry of Communications, the organizers of the strike, the Israel Internet Association (ISOC-IL) and more. The Bezeq proposed a substantial reduction of tariffs but there was no guarantee of agreement for such tariffs by the Ministry of Communications due to its policy against cross-subsidies. The postponed strike did not succeed to involve a majority of the Internet users. However, lately the Bezeq has come with an special tariff reduction proposal aimed at the Internet users.If accepted they may be able to freely use the telephone unlimitedly after 18:00 p.m. until 8:00 a.m. for a payment of less than 50 NIS a month ( about 10 dollars). An additional arrangement to be offered will provide cheaper local access (.24 NIS for half an hour) to three fixed phone numbers after 22:00 p.m. against a monthly fixed payment of 10 NIS. The Bezeq marketing vice-manager Herzl Ozer said he expects the Ministry of Communication to accept the reduction although the General-Director opposed such arrangements in the past.

• 750,000 Internet Users in Israel

The GeoCartography Institute published the results of a survey carried out by Profs. Rina and Avi Degani. The survey, carried out in October 1999, over a sample of 1,500 persons of age 8 and more representing the Jewish population, shows that almost 1 among each 5 Israelis surf the Internet at least one hour each week.

The inference from the sample is that the number of Internet users in Israel is 750,000, that is 19.5%. A third of the surfers are children and youngsters aged 8-17 and two-thirds older than 18 ; two thirds of them are male. The average age of the Israeli surfer is 26 and most of them come from well to do, well educated, secular families with an average to good knowledge of English.

Three out of four youngsters aged 12-14 experimented at least once to surf the Internet, that is 75%. In general children and youngsters experiment more, even if they do not stay as permanent users. The rate of experimentation among youngsters and adults alike is 38%. (Yedioth Aharonot, 24 hours, page 11, 3.11.1999).

2. Bi-lateral Agreements

• Morocco: The Minister of Communications, Binyamin Ben-Eliezer and the Minister of Communications and Technology of Morocco, Mr. Larbi Ajoul conducted a working discussion for the first time in four years. The Moroccan Mininister suggested that a delegation of experts and businesspeople will visit Morocco in the coming months to discuss technological cooperation between the two countries as soon as possible. He reported that Morocco is at the beginning of a privatization process and is interested in an exchange of knowledge with Israel in the field of hi-tech and telecommunications.

• Palestinian Authority: Israel and the Palestinian Authority signed agreements (dated 19.8.99) that regulate the aspects of operation, settling of accounts and security of the postal exchange between the Autonomy's territories, Israel and overseas. The agreements enable the Autonomy to forward mail directly to Jordan and Egypt.

• Jordan: following the visit of the Minister of Communications to Jordan and agreement was reached between the the directors of the JTC (Jordan Telecom Corporation) and the director of the Ministry of Communications, Daniel Rosenne regarding the establishment of a new communications cable between the two countries. Bezeq Beinleumi (Bezeq International) and the JTC will set the cable with an investment of 1.5 million dollars. In the same occasion was settled a conflict between the two companies; Bezeq Beinleumi will pay compensations to JCT of 4.3 million dollars; 3 million in 30 days and the remaining in a later date. JCT argued that the debt was the result of changes in the tariffs in Israel and changes in rules for settlement between the two companies.

3. Liberalisation

Postal Services: The committee for the review of the postal sector, headed by David Brodet, former Director General of the Ministry of Finance, has turned his recommendations to the Minister of Communications, Benyamin (Fuad) Ben-Eliezer and the Minister of Finance, Avraham (Beiga) Shohat. The main recommendation is fully opening of the postal sector to competition immediately, turning the Postal Authority into a government holding company that will encopass two different companies: one for postal services, and the other for counter and banking services, with the guarantee that the prices to the consumer will remain unchanges. Another recommendation is to decrease the rates of the Postal Authority by 11%: an immediate 6% decrease and the other 5% to be spread over the next 5 years (1% a year) . This is aimed at reducing the existing cross subsidizing among the postal services.
The Postal Authority is well advanced in the planning and implementation of advanced electronic based services including access to the government and electronic/paper alternative delivery interfaces.

4. Copyright and intellectual property rights

The Constitution and Law Committee of the Parliament approved a new law that reinforces protection of intellectual property right is Israel and abroad. The amendments are intended to adapt Isaeli legislation in this area to the World Trade Organization convention, which Israel signed four years ago.

The Ministry of Justice, Yossi Beilin, stated on the same occasion the need that the European Union and the United States put pressure on the Palestinian Authority to wipe out the counterfeit video and compact disc industry. The PA serves as a distribution center for the whole region, including Israel. The dmand was made against a backdrop of the threat of US and European sanctions against Israel for selling counterfeit products.

Moshe Alon, head of the software Calanit group of companies stated (9.8.99) that the situation in Israel has greatly improved. He pointed out as an example the agreement reached lately by Microsoft with the IDF for increased surveillance of the IDFon the use of software packages. He stated that changes in the policy for software licensing are responsible for the confusion; once, when you bought 100 licenses this meaned that even if you had 1,000 employees you could use at the same time up to 100 copies of the software and didn't need a license for each one of your employees. The new policy demand a license for each one of your 1,000 users.

The Minister of Trade and Industry, Ran Cohen, allocated 8 million NIS for a campaign of education, information and publicity regarding the fight on counterfeited software and CD products. The campaign aims at involving the public as an active associate in the fight. One of the tools of the campaign is a video being broadcasted at the main TV channels showing a director of a firm being taken to priso who wonders who among his employees reported to the authorities the fact that he uses counterfeit software.

5. On-going changes in the regulatory framework

• Sectorial Radio Broadcasting: The Cabinet decided to establish a Minister's Committee headed by Justice Minister Yossi Beilin regarding the matter of Sectorial Radio Broadcastings. This follows the pressure of different sectors and communities in Israel for self expression through broadcasts. The growth of cable, satellite and local broadcasting calls for policies that will allow legal and regulated broadcastings to specific sectors in the Israeli society. The Committee will discuss concurrently the appropriate legal solution for the complicated matter of regulation of sectorial radio broadcasting, and the issue of enforcement with regard to pirate broadcastings. (5.8.99)

• Licensing for experiments in the area of telephony; multimedia; and Internet based on access to the wireless network: The Minister of Communications published the rules regarding the conduct of such experiments. The main stress of the regulations is on the transitory character of the licensing which will be limited to the operational and technical aspects; will be limited in scope and time; did not convey any intention by the Ministry to enlarge the experiment into the regular provision of commercial services.

6. Media and telecommunication markets

• Intel buy the DSPC Israeli Company for 1.6 billion dollars in cash: the deal has been announced by Intel last Thursday, 14 October. Each share holder will receive 36 dollars for his shares; the value market of the share in the day previous to the deal was 28 dollars.. This is the largest deal that happened in Israel ever and one of the largest in cash by Intel. The DSPC company was established 14 years ago by Davidi Gilo and it focuses in the development, production and marketing of silicon chips for cellular telephony. Among its 300 employees, 250 work at the development center in Givat Shmuel, near Tel-Aviv. The employees and directors of DSPC have a 17% share of the company and each of them will receive an average of 900 thousand dollars.

• Microsoft invest in the start-up company AKAMAI : Microsoft invested 15 million dollars for 1% of the shares of the company reflecting a value of 1.5 billion dollars for the company that been established in September 98 by Daniel Levin. AKAMAI focuses on the development of a software package called FreeFlow for the rapid transmission of Web pages in the Internet. As part of a cooperation agreement between the companies AKAMAI will develop technologies to be integrated in future versions of the Microsoft Windows operating system.

• Motorola invests in 50 start-up companies related to Internet technologies: nThe vice president of Motorola Fred Kuzkick announced they were investing in 50 start up Israeli companies that operate in the area of Internet technologies. Motorola defined the Internet as one of its central areas of operation in the coming years. He stated that companies that companies that do not integrate the Internet in their routine operations will disappear in 10 years. Motorola that produces communications and electronics equipment and computers employs 150 thousand persons; has had revenues in the last 12 months of 30.2 billion dollars and profits of 563 million dollars. Its value market is 56.5 billion dollars.

• NDS provides equipment for Direct-TV : NDS is a company whose center of operations is in Israel and offers solutions for secure access to cable television (Video Guard). This is the second contract with Direct-TV. NDS is the provider of the communication infrastructure for leading digital broadcasters like BskyB in England and StarTV in Hong Kong.

• The IPEX Fund will participate in the tenders for internal communications in Israel: John McMonnigal head of the area of telecommunications in the IPEX fund stated their interest in the upcoming tenders for LDMS frequency allocation in Israel. He stressed that the main developments in the area of teleommunications are to be expected in the wireless domain. This statements follows several investments initiatives in Israel: a first fund of 50 million dollar immediately succeede by a second one of 150 million dollars.

• ECI announces contract of 165 million dollar with the N.T.L. British company for the development of the N.T.L. digital telecommunications network.

• Gallery Telecom (Israel) and Microsoft are developing a call center to be integrated in the Window 2000 Operating system. The Gallery call center enables the provision of support to users throough the Internet instead than by telephone. The user calling the center can receive the necessary information browsing different windows; in case that he need direct contact with a person an additional window will open enabling him to interact with the support person which will be able to see the customer computer and the open windows and to provide the necessary help. Michelle Spector, vice [presiden for Business Development the call center market in the world reaches figures of billions of dollars.

• British Telecom and AT&T negotiate partnership in Bezeq Beinleumi: John Polombo, president for international markets of the Convert corporation, a partnership between British Telecom and AT&T met in Telecom 98 with Moshe Haba the Bezeq Beinleumi CEO and discussed the acquisition of 26%-50% of the company by Convert.

• Bezeq proposes to buy Motorola share in the Pelephone cellular company: the two companies have equal shares in their partnership in the Pelephone company. The chairman of the Board of Directors of the Bezeq, Izi Tapuhi announced that he has offered to Motorola to buy her part in the Pelephone company. The value of the company is estimated at 2 to 2.5 billion dollars. If they wish Motorola could get Bezeq shares when the control shares are sold. In case the deal is effectivated Bezeq intends to market 24% of the Pelephone shares and continue to keep 76%. Tapuhi stressed that control should be transferred only with the completion of the privatization of the Bezeq; there is no intention to have a company like Pelephone under governmental ownership that can only be detrimental for its activities.Pelephone has suffered lately due to the entry in the market of the Orange-Partner cellular company. The worsening of the results derived from massive investments it made in infrastructures while upgrading from a fully analog to a digital network; also heavy subsidies provided for new customers acquisition of telephone sets contributed to the bad business results in the last year.

• Good results for Orange-Partner before the marketing of its shares to the public: A month before the marketing of its shares in the american stock exchange market the Orange-Partner company published its business results. For the second quarter the losses were 166 million NIS against a loss of 252 in the first quarter; the income has increased in the second quarter by 17% and reached 179 million NIS against 92 million in the first quarter. Partner also announced that it reached in August 230,000 subscribers in comparison to only 100,000 in the first quarter.

• Tevel and Aruzei Zahav shareholders acquire control of the Netvision ISP: The Cable TV companies Tevel and Aruzei Zahav are negotiating their merge; the shareholders of Tevel are expected to buy the shares in Aruzei Zahav from their holders. At the same time the share holders of Aruzei Zahav, Aureq, the Fishman group and Yedioth Aharonot negotiation regarding changes in the ownership of Netvision. Netvision is owned by 34% by Tevel and 32% by Elron. The remaining 34%bouth by Aureq and Fishma are presently in the hands of a trustee due to the opposition of the Anti-Trust Authority head David Tadmor, to the deal. If the shares of Aruzei Zahav holders are transferred to Tevel they will be able to receive the shares from the trustee.

• Reshet buys 25% of the NetKing Portal: Reshet, one of the concessionnaires of the Second Commercial TV Channel bought 25% percent of the NetKing Internet portal for 1.5 million dollars. Discount Investments are expected to buy 30% of the portal at a market value of 6.5 million dollars for the company. Yohanan Zengen, the CEO of Reshet announced that the future lays in the concatenation between television and Internet. From the beginning of 2000 the classic TV broadcast is expect to change radically and Reshet is preparing itself for this change.