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1

Jim,thankyouforinvitingmeback.ThoughIhavebeenapaidupsubscriberfordecades,I
amnowquiteworriedaboutyourfranchise.Yousee,anumberofyearsago,Iheardyou
quipthatbondsconstitutereturnfreerisk,butbackthentheystillhadsomeyield.
Today,inpartsoftheworld,ratesarezeroorevennegative,whichmakesthetitleGrants
InterestRateObserveraparadox.Howdoyouobserveinterestrateswhentheyhave
ceasedtoexist?Youmayhavetorethinkyourbrand.

IlastspokeherethreeyearsagoandtalkedaboutwhatIdubbedtheFedsJellyDonut
monetarypolicy.Iobservedthataccommodativepolicyhasdiminishingreturnsthathad
longsincepassedthepointofbeingproductiveandwasnowactuallyslowingtherecovery.
Icomparedittoeatinga36thJellyDonut.
Bykeepingratestoolow,theFedsoughttocreateastockmarketwealtheffect.Isuggested
thatwhilethiswouldincreaseincomeinequality,thewealtheffectwouldnotlikely
translatetoenoughadditionalconsumptiontooffsettheevenbiggerdrainfromlost
incometosavers.

PolicymakersandmainstreameconomistsarestuckinGroupThinkthateasymoneyalways
helpstheeconomy,despitebasiceconomicprinciplesthatsuggestdiminishingornegative
marginalreturns.

Inarecentblogpost,Mr.Bernankewrote:thebestwaytoimprovethereturnsattainable
bysaverswastodowhattheFedactuallydid:keeprateslow,sothattheeconomycould
recoverandmorequicklyreachthepointofproducinghealthierinvestmentreturns.
Thisiscircularreasoning:Heisassumingthatwhichheseekstoprove,namelythatultra
lowratesactuallyhelptheeconomy.But,thatistheopenquestion.
_____________
Source:http://www.brookings.edu/blogs/benbernanke/posts/2015/03/30whyinterestratessolow

Aquicklookatthehouseholdbalancesheetshowsabout$10trillionheldinshortterm
ratesensitiveinstrumentslikesavingsaccountsandmoneymarkets.
Mosthouseholdliabilitiesarefixedratemortgages,wherepaymentsareunaffectedbyrate
changes.Consumercreditis$3trillion,someofwhichisalsofixed.Iestimatehouseholds
haveabout$7trillioninexposuretoshortterminterestrates,soa1%changeinratesadds
about$70billiontoannualincome.
_____________
Source:http://federalreserve.gov/releases/z1/current/z1r5.pdf

SwissRerecentlycalculatedthatfrom20082013,U.S.householdslost$470billionof
incomeduetoexcessivelylowinterestrates.
Becausesaversperceiveinterestincomeasmorerecurringthanvolatilestockmarketgains,
andbecauseinterestincomeisspreadmorebroadlythanequitygains,itsfairtoassume
thatamuchgreaterproportionofinterestincomewouldbespent.
_____________
Source:http://media.swissre.com/documents/Financial_Repression_pub_web.pdf

TheFedexpectedthewealtheffectwoulddrivegrowthto34%.Despitethestockmarket
risingabout50%overthelastthreeyearsandtriplingoverthelastsix,GDPgrowthhas
stagnatedataround2%.
_____________
Source:BloombergL.P.
http://www.businessinsider.com/fedgdpforecast20129
https://research.stlouisfed.org/fred2/series/A191RO1Q156NBEA

10

IfpeoplewerespendingthepapergainsfromrisingassetpricesastheFedhoped,the
savingsratewouldhaveplummetedasitdidduringthehousingbubble,whencashout
refinancingsagainstrisinghomevaluesdrovespending.
Instead,thesavingsratehasremainedatorabovetheprehousingbubblelevels,even
thoughhouseholdnetworthhasreachednewhighs.AsSwissReputit,Overall,thereis
noclearevidenceofequityrelatedgainshavingtranslatedintoadditionalconsumptionand
thusnorealeconomicgrowth.
_____________
Source:BloombergL.P.
https://research.stlouisfed.org/fred2/series/PSAVERT/
http://media.swissre.com/documents/Financial_Repression_pub_web.pdf

11

Lowinterestratesmakeworkerssavemore,astheycantanticipateearningsafeincomeon
savings.Theyalsomakeretireesspendless,astheyhavelesscurrentandfutureincome
andneedtostretchsavingsovertheirremaininglives.Bothdynamicscreatelessspending
andaslowerrecovery.
_____________
Source:http://www.bis.org/events/agm2013/sp130623.htm

12

IremainoftheviewthathigherrateswillsurprisebyimprovingtheeconomyonMain
StreeteventhoughitisquitepossibletheywouldcreatesometurbulenceonWallStreet,
asmostequitiesarenowhighlypricedandaselectgroupareinabubble.

13

WhenIspokethreeyearsago,IwasalsoworriedabouthowJellyDonutpolicywasdriving
commoditypriceinflation.Therecentfallinmanycommoditieshassurprisedme.Ithas
turnedoutthatoverseveralyears,sharplyrisingcommoditypricesandlowinterestrates
createdaboomininvestment,andexcesssupplyineverythingfromironoretooil.
Lacklusterdemandhasfailedtokeepupwiththisgrowingsupplyand,ironically,itturns
outthattheloosemonetarypolicyputinplacebycentralbankerstofightdeflationhasin
factcontributedtoit.

14

Thequestioniswhobenefitsfromtheharmtosavers?Ofcourse,itisgovernmentswho
areabletoborrowmorecheaply.

15

ItshouldntbesurprisingthatJapanandEurope,whichhaveworsefiscalsituationsthanwe
do,haveimplementedevenmoreaggressivemonetarypolicy.
_____________
Source:http://www.imf.org/external/data.htm

16

Japanhashadnearzerointerestratesformanyyears.
SinceJapanrampedupitsQEinthefallof2012,itscurrencyhasweakenedbyabout50%
anditsstockmarkethasralliedover115%.However,GDPhasbarelybudged,asstock
marketgainshaventtranslatedintoeconomicgrowththere,either.
_____________
Source:BloombergL.P.

17

InEurope,wecanseeGreecebeingtaughtthat"HonestyisNOTthebestpolicy.
LetsplayagameCananyonenameaEuropeancountryexpectedtorunsurpluses
sufficientforittopayitsdebtoutofitstaxrevenues?
TheonlythingthatseparatesGreecefromFrance,Ireland,Italy,PortugalandSpainisthat
theGreeksopenlyadmitthattheycantrepaytheirdebts,whiletherestremainsilent.
Greek10yeardebtyieldsmorethan10%,whilealltheseothercountrieshavelowerrates
thantheU.S.
Notoneofthemplanstorepayitsdebtoutoftaxcollections.Greeceslossofaccesstothe
capitalmarketsisaheavypricetopayforitscandor.

18

TheECBhadmanagedtolowersovereignyieldswithforwardguidance,targetedbank
lendingprograms,andthethreatofQE.ItsthereforepuzzlingthattheECBisactuallygoing
throughwithbuyingbillionsofEurosworthofbondsatnegativeyields,whenitcould
declarevictorysimplybythreateningtobuythem,ifneeded,toenforceinterestratepolicy.
IwonderwhetherECBPresidentMarioDraghispentsomuchpoliticalcapitalfightingthe
GermanBundesbankfortheabilitytodoQE,thatnowthathehasemergedvictorious,he
willfollowthroughwhetheritsneededornot.

19

Whichbringsustothecuriousexistenceofnegativeyieldingbonds.
Logically,interestratesshouldalwaysbepositive.Peopleshouldpreferadollartodayto
somethinglessthanadollarinthefuture.Ifyouhaveadollar,youcanliterallyavoid
negativeratesbystickingitunderthemattress.TempurSealymaybealong.
Negativeinterestratesarelikethesquarerootofnegativeone:theyexistintheory,butno
oneissupposedtobeabletoseethem.

20

Yet$3trillionofsovereigndebtfromsevenEuropeannationsandJapanhasnegative
yields.Germanysextendto7years,andSwitzerlandsto10years.
_____________
Source:http://www.projectsyndicate.org/commentary/negativenominalinterestratesbynourielroubini
201502

21

TheECBsaysitwillbuybondswithyieldsaslowasitsdepositrate nowatnegative0.2%
toimplementQE.So,itseasytoimaginethatsomeshorttermtradersarebuying
negativeyieldingbondswiththeintentofflippingthemtotheECBatamarkup.

22

Ithinkthemoreinterestingquestioniswhydolongterminvestorswhoboughtsovereign
bondsfortheincomecontinuetoholdthematnegativeyields?Whynotsellandcapture
allthefutureincomeandthensometoday?Whycontinuetotakedurationrisk,liquidity
riskandevencreditriskwithoutanycompensation?
Wethinktheanswerliesinthenewregulatoryregimesthatareshapingthebehaviorof
largefinancialinstitutionstoday.

23

Postcrisis,BaselIIIregulationsforbanksandSolvencyIIregulationsforinsurerswere
designedtoimprovetheirfinancialstability.However,itsnotclearthatthedesigners
contemplatednegativebondyields.
Requiringfinancialinstitutionstoholdbondsthatareguaranteedtolosemoneydestroys
valueandaddssignificantandunderappreciatedsystemicrisk.

24

Letsstartwithbanking.Attheirmostbasicpurpose,banksexisttotakedepositsfrom
thosewithmoneythatisntneededtodaytolendtothosewhocanuseitforproductive
endeavors.Depositsusedtobevaluedasastablefundingsource,andbankscompeted
hardtogatherthemfromindividualsandbusinesses.
Zerointerestratepolicyiscombiningwithnewliquidityrequirementstomakecommercial
depositsunattractive,leadingbankstoabandontheircorepurposeofacceptingdeposits.

25

UnderthenewBaselIIIregulations,thereissomethingcalledtheLiquidityCoverageRatio,
whichrequiresbankstomaintainlotsofverysafeliquidassetslikegovernmentbondsto
coverfundingstress.
Thisratioalsocategorizescertaindepositsasnonoperatingandassignsthempunitive
haircuts.
Inresponse,banksarehoardingsovereigndebt,whilelookingforloopholesenablingthem
tomoreprofitablycarrythesenonoperatingdeposits.Insomecases,theyreshunning
themaltogether.
Gonearethedayswhenabankwillgiveyouafreetoasterforopeninganaccount;these
daystheyaregivingbackthedough.IthasgottensobadthatinFebruary,JPMorgan
announceditplannedtoreturn$100billiontocustomers.

26

Someeffortstoimproveregulatoryratiosinclude:
Askingcustomerstoswitchunwanteddepositsintosecuritiesthebankcanhold
incustody;
Askingcustomerstotakeoutloanstobuytreasuries;
Askingcustomerstotransactthroughoffbalancesheetderivativessuchas
swaps;and
Askingcustomerstoreplacephysicalpositionswithsyntheticlookalikes,
collateralizedwithU.S.treasuries.
Noneofthesechangesmakebankssaferorbenefitthecustomers.Theyraisecosts,reduce
liquidity,andaddleverageandcounterpartyrisk.

27

Lastyear,theECBandotherEuropeancountriesbeganchargingbanksfordeposits.The
DanishandSwissnowcharge75basispoints.Banksarebeginningtopassthenegative
ratesontocommercialcustomers.
Thereisalimittothis,ofcourse.Atsomepointbankswilldecideitscheapertohold
physicalcurrencyintheirvaultsthanitistomaintainexcessdepositsatcentralbanks.
Correspondingly,customerscandecidetheywouldratherholdcashthanpayforthe
privilegeofdepositingmoney.
Wearepayingattentiontoapossibletransitionfrombanksrejectingdepositorsto
depositorsrejectingbanks.
_____________
Source:GSGlobalMacroResearch,NegativeInterestRates:HelpfulorHarmful?,February27,2015.

28

SolvencyIIwasestablishedwiththegoalofrewardingfinancialinstitutionsforminimizing
risk.
Forinsurancecompanieswithlongtermliabilities,itmakessensetoownlongdated
assets,asmismatcheddurationisarealoperatingrisk.
Inanormalenvironment,lifeinsurersarewisetolockinlongtermcashflowssothatthey
willhaveincometopaydistantbenefits.

29

So,thedesignersofSolvencyIIgavegovernmentbondsthatreducedurationriskalower
capitalchargethancash.Thefirstcolumnisthestandalonemarketriskchargeforcertain
assets.Thesecondcolumnconsidersotherfactorsincludingdiversificationandduration
matching.Governmentdebtactuallyhasanegativecapitalcharge.ItappearsthatSolvency
IIdidnotanticipatenegativebondyields,asholdingdebtwithlockedinnegativeyields
cantpossiblybesaferthansellingandholdingcash.Underthenewrules,sellingthebonds
toholdcashwouldcreateacapitalcharge.Thatislikeusingbubblewrapfilledwitha
corrosivetohelpprotectapackage.
_____________
Source:
https://www.ageas.com/sites/default/files/Regulatory%20Impact%20on%20Banks%20and%20Insurers%20In
vestments%20%20final.pdf

30

Hereisanexample.Imagineaninsurerwhohasasimpleportfoliowith40billioneurosof
sovereigndebtand5billioneuroseachofrealestateandequities.
Ifthesovereigndebttradestoanegativeyield,itwouldbewisetosellittoholdcash.
Sellingthedebtwouldincreaseliquidity,raisetheportfoliosreturn,lowerdurationrisk,
reducemarketrisk,andevenreducecreditrisk,asgovernmentdebtcandefault.
Butletsseewhathappensiftheinsurerdoesthis.
_____________
Source:
https://www.ageas.com/sites/default/files/Regulatory%20Impact%20on%20Banks%20and%20Insurers%20In
vestments%20%20final.pdf

31

UnderSolvencyII,theimpactwouldbeanadditionalcapitalchargeofover1billioneuros.
Tocompensate,theinsurercouldsellotherriskierassets inthiscasealmostitsentire
equityportfolio oritcouldraisefreshequitybysellingstock.
YoucanseehowSolvencyIIpracticallyforcescompaniestoholdsovereigndebt.Wethink
thisisthebestexplanationforthepersistenceofnegativeinterestratesinbondswith
duration.
_____________
Source:
https://www.ageas.com/sites/default/files/Regulatory%20Impact%20on%20Banks%20and%20Insurers%20In
vestments%20%20final.pdf

32

WehavepassedthepointwhereJellyDonutpolicyismerelyslowingtherecovery.
Distortionsarenowaddingrisktothebankingandinsurancemarketsandleadingtopoor
incentivesforthelargestplayersinthefinancialsystem.
Monetarypolicyandregulationshavecombinedlikeafailedchemistryexperimentto
createapotentiallydestructiveforcethatshouldnotexistoutsideoffiction.Ithinkthis
addstotheultimateattractionofholdinggoldinsteadofgreen.

33

Letstalkaboutacoupleofstocks.

34

Arecessioniswhenyouhavetotightenyourbelt;depressioniswhenyouhavenobeltto
tighten.Whenyou'velostyourtrousers you'reintheairlinebusiness.
_____________
Source:http://www.economist.com/blogs/gulliver/2011/12/businessquotations

35

Airlineshavegeneratedtheworstreturnoncapitalofanyindustry.
Butifyouvealwaysdreamedofowninganairplane,thereisawaytoownhundredsof
themandgeneratearespectablereturn:Youcangointotheaircraftleasingbusiness.
_____________
Source:IATAEconomicsBriefing10,"ProfitabilityandtheAirTransportValueChain",June2013;Industry
MedianROICwithoutgoodwill,1965 2007,McKinsey&CompanyforIATA.

36

Thisishowitworks:
Youborrowmoneytobuyplanesfromthemanufacturersandleasethemtotheairlinesat
lockedinmonthlypayments,usuallyforaninitialperiodoftentotwelveyears.Youcan
alsodosale/leasebackdealswiththeairlinesthemselves.
Attheendofthelease,yougettheplanebackandreleaseitorsellit.

37

Today,40%oftheglobalairlinefleetisleasedcomparedtolessthan2%in1980.
Manyemergingmarketairlineslackgoodaccesstocapitalmarketsandbankfinancing.
Leasingallowsthemtofinancefleetgrowth.Otherairlinesleasetoaccessnewerplanes
withouttakingresidualvaluerisk.
_____________
Source:http://www.boeing.com/assets/images/bcc/images/Lessors/Slide2_900.png

38

OurlongideaisAerCapHoldingsN.V.,tickerAER.AerCapisthelargestand,inourview,the
bestmanagedindependentlessor.Inamarketwithfewbargains,webelievethatthestock
ischeapandoffersagoodriskrewardopportunity.
_____________
Source:BloombergL.P.,issuerfilings,managementpublicstatements,andGreenlightcalculationsderived
fromissuerfilingsandpublicstatements.Greenlightsadjustmentstofiguresinfilingsandpublicstatements
wereinthesolediscretionofGreenlight. AerCapstockpricethroughoutthepresentationistheclosing price
asofApril2,2015.

39

SeveralsmallerleasingcompaniesmergedtoformAerCap,whichthenpubliclylistedin
November2006.Sincethen,itsgrownbookvaluepershare19.6%ayear.
_____________
Source:BloombergL.P.,issuerfilings,managementpublicstatements,andGreenlightcalculationsderived
fromissuerfilingsandpublicstatements.Greenlightsadjustmentstofiguresinfilingsandpublicstatements
wereinthesolediscretionofGreenlight.

40

CEOGusKellyrunsthebusinessinadisciplined,shareholderfriendlyway.Withinthe
leasingindustry,AerCapstandsoutforitsrecordofexcellentriskadjustedreturnsand
opportunisticgrowth.
_____________
Source:BloombergL.P.,issuerfilings,managementpublicstatements,andGreenlightcalculationsderived
fromissuerfilingsandpublicstatements.Greenlightsadjustmentstofiguresinfilingsandpublicstatements
wereinthesolediscretionofGreenlight.

41

Herearethenumbers:
Leasepaymentsvarydependingontheplane.Widebodiesgeneratehigherupfrontlease
ratesbutbearmoreremarketingriskgivenasmallercustomerpool.AerCaptendstofocus
onlowerrisknarrowbodies.
Maintenancerevenuefundsaircraftoverhaulexpenses.
Depreciationisover25yearswitha15%residualorscrapvalue.
Pretaxreturnonassetsisalmost7%aftersubtractingleasingcosts,whichincludecredit
lossesandcorporateSG&A.
_____________
Source:Greenlightestimates.

42

AerCapdebtfinancesabout75%usingbothsecuredandunsecuredmostlyfixedratedebt,
whichcurrentlycostsunder4%.AerCapisdomiciledinIreland,sothetaxrateislow.
Altogether,AerCapearnsalowteensROEonanewleasingdealexcludinggainsorlosses
whentheleaseends.Thecompanybearscreditrisk,residualvalueriskandtheobvioustail
risk
_____________
Source:Greenlightestimates.

43

SnakesonaPlane

44

AerCapmanagescreditriskbyaggressivelymonitoringcustomercreditworthinessand
diversifyingitscustomerbase.
Between2007and2013,whichincludedthefinancialcrisisandsomeidiosyncraticairline
defaults,AerCapsannualdefaultswereapproximately2.5%.
Losseswerelow,averagingonly0.2%,becausearound80%ofthedefaultedplaneswere
repossessedandthenreleasedorsold,and20%ofthedefaultedplaneswentbacktothe
airlineunderarestructuredlease.
Despitethemacroeconomicturbulence,AerCapsaverageportfolioutilizationduringthis
periodhasbeenalmost99%.
_____________
Source:AERfilings,Greenlightcalculationsderivedfromissuerfilings,andGreenlightestimates.

45

Unlikeseveralofitsprivateandpubliclytradedpeers,AerCapdidnothavetotakelarge
assetvalueimpairmentsduringandafterthecrisis.Infact,AerCaphasusuallydisposedof
planesatapremiumtotheircarryingvalues.
_____________
Source:BloombergL.P.,issuerfilings,managementpublicstatements,andGreenlightcalculationsderived
fromissuerfilingsandpublicstatements.Greenlightsadjustmentstofiguresinfilingsandpublicstatements
wereinthesolediscretionofGreenlight.

46

AerCapfocusesitsportfolioonthemostwidelyusedcurrentgenerationaircraft,especially
narrowbodies.Whiletheseaircraftprovidelowerupfrontrentalyields,theyhaveheld
theirvaluebetterovertimeandthroughcycles.
Managementhasagoodtrackrecordofshowingdiscipline.Thecompanydidnotoverpay
fornewaircraftintheleaduptothecrisis,anditroutinelysellsolderaircraft,whichare
moresensitivetocyclicaldownturnsandtechnologicalobsolescence.
_____________
Source:AERfilings,Greenlightcalculationsderivedfromissuerfilings,andGreenlightestimates.

47

Oneofthefirstaircraftlessors,ILFCwasacquiredbyAIGin1990andwasthesecond
largestlessorintheindustrybehindGE.
Itranintotroubleduringtherecession.
AIGwasforcedtotake$5billionofassetimpairmentsbetween2010and2013duetoits
agingfleetwithtoomanywidebodies.
Notsurprisingly,AIGconcludedthatILFCwasanoncoreassetandlastyearsolditto
AerCap.
_____________
Source:Representsowned&managedfleet,FlightglobalInsight,andGreenlightcalculations.

48

AerCapboughtitatasizeablediscounttoitsalreadywrittendownbookvalue.
AerCappaid$3billionincashandissued97.6millionsharestoAIG.
Itwasabargain.AerCappaidonly84%ofILFCsappraisedfleetvalueandlessthanhalfits
adjustedbookvalue.
_____________
Source:BloombergL.P.,issuerfilings,managementpublicstatements,andGreenlightcalculationsderived
fromissuerfilingsandpublicstatements.Greenlightsadjustmentstofiguresinfilingsandpublicstatements
wereinthesolediscretionofGreenlight.

49

TheacquisitionsignificantlyincreasedAerCapssize,addingaround1,000ownedand
managedplanestoitsfleet.
AerCapisnowthelargestindependentlessorintheworld.AlongwithGE,theycontrolover
40%oftheleasingmarket.
_____________
Source:Representsowned&managedfleet,FlightglobalInsight,andGreenlightcalculations.

50

AerCapalsoobtainedILFCslarge,attractivelypricedorderbookofnextgenerationplanes,
whichisnowacouplebilliondollarsinthemoney.
AerCapisalsointheprocessofreducingcombinedSG&Aandloweringitstaxrateby
movingILFCsU.S.assetstoIreland,whereAerCapenjoysa12.5%taxrate.
_____________
Source:AERfilings,managementpublicstatements,andGreenlightcalculations.

51

AerCaphasalreadyexceededitsinitialproformaEPSguidance.
OncurrentconsensusEPSestimatesfor2015,AerCapsstocktradesatanattractive8.5x
earnings.
_____________
Source:BloombergL.P.andBloombergconsensusestimatesretrievedApril2015.

52

Whilethestockischeapon2015earnings,webelievethereismoretocome.
AerCap'sfleetwillgrow15%by2018asittakesdeliveryofnewplanes.
AsImentioned,SG&Aandthetaxratewillimprove.
Combinedwithbuybacksfundedbytheongoinggenerationofexcesscapital,webelieve
thatAerCapcangrowitsEPSbyaround10%annuallyoverthenextfewyears.
_____________
Source:Greenlightestimates.

53

Thecompanys7yearunsecuredbondyieldshavedeclinedtounder4%sincethedealwas
announced.Theyshoulddeclinefurtheroncethecompanyregainstheinvestmentgrade
creditratingitlostduetotheILFCtransaction.
Thoughthestockhasadvanced,theP/Emultiplehasbarelychangeddespitestrongpost
dealexecutionandimprovingearnings.
Wethinkthattheequitymarketwillfollowthecreditmarketandreratethecompany.
_____________
Source:BloombergL.P.;BloombergconsensusestimatesretrievedApril2015andGreenlightcalculations.

54

AerCapsmanagementteamdoesntjusttalkaboutmanagingthebusinessfor
shareholders.Inadditiontorunningthebusinesswell,AerCaphasbeenanaggressive
buyerofitsownstockatlowprices.During2011and2012,thecompanyrepurchased24%
ofitssharesoutstandingatanaverageoflessthan$12ashare.
Managementhasgoodincentivetocreateshareholdervalue.IntheILFCdeal,senior
managementwasawardedalargebatchofrestrictedstockunitsthatvestin2018and
2019,twothirdsofwhichdependonperformance.Alltold,inanexpensivemarket,this
appearstobeacheapstock.
_____________
Source:AERQ22014earningscallonAugust12,2014.

55

Wethinkathenahealthisashort.LastMay,attheSohnconference,Iexplainedwhywe
thoughtathenawasaverygoodexampleofthebubblegoingoninasegmentofthe
market.
Incaseyoumissedit,Iwillbrieflysummarizethethesisandthenbringeveryoneuptodate
onwhatshappenedsincethen.Forfurtherreference,thefullpresentationisonlineatour
website.

56

athenahealthhandlesthebillingforphysiciansthroughawebbasedplatform.The
companyalsoprovideselectronichealthrecordsandotherservices,andchargesa
percentageofcollectedbills.
Thecompanysbusinessisprimarilyintheoutsideofthehospital,orambulatorymarket.
_____________
Source:athenahealthwebsiteathttp://landing.athenahealth.com/g/improvecare,retrievedMay2014.

57

Atthetimeofourpresentation,athenawasbeginningtoentertheinpatientorhospital
market,throughanewservicewhichwouldtakeoverahospitalsadmissions,referrals,and
otheradministrativefunctions.
athenahadjustannounceditsfirsttwoalphacustomersinApril2014,longtimeathena
clientsStewardHealthCareandGriffinHospital.

58

Wecalledathenaabubblestockbecauseitsshareshadgoneparabolicevenasits
fundamentalsdeteriorated.AtthetimeofSohn,eventhoughthestockhadrolledover,it
stilltradedatmorethan100xforwardearningsthatareadjustedtoignorestock
compensationexpense.
_____________
Source:BloombergL.P.

59

Analystscomparedittocloudcompanies,socialmediacompaniesandSaaScompaniesand
appliedsimilarlyaggressivevaluations.
Butwhatwesawwasacompanythatusedawebsitetopartiallyautomateastillvery
paperandlaborintensivebackofficebillingcollectionprocess.
_____________
Source:PiperJaffray&Co.reportdatedOctober21,2013.

60

https://youtu.be/YEww0VOfbJI

Essentially,weseeitasabusinessprocessoutsourcer,withaverypromotionalCEO.
_____________
Source:Compilationcomprisedofexcerptsfromthefollowing,retrievedApril2014:
1) HealthDatapaloozaonJune3,2013(https://www.youtube.com/watch?v=Ka_gTyVRjSE).
2) athenahealth6thAnnualInvestorSummitonDecember12,2013
(http://investors.athenahealth.com/events.cfm).
3) EHRtvinterviewwithAnnandEricFishmanonOctober27,2010(http://www.ehrtv.com/athenahealth
jonathanbushnov2010/).
4) FOXNewsNetworkonMarch27,2012(http://video.foxbusiness.com/v/1532985902001/athenahealth
ceoonhealthcarelawcloudcomputing/#sp=showclips).
5) CableNewsNetworkonApril20,2011
(http://money.cnn.com/video/news/2011/04/18/n_athena_cloud.cnnmoney/).

61

Afewweeksbeforewepresented,MorganStanleyreleasedareportthatincludedaDCF.
MorganStanleyusedaseriesofwhatwethoughttobeexceedinglyaggressive
assumptionsthatIreviewedindetaillastyear.
Thepunchlinewasthatwhenwereplicatedtheirframeworkwithmorerealistic
assumptions,wecameupwithabasecaseDCFvalueof$50pershare.
_____________
Source:MorganStanley&Co.estimatesasprovidedtoGreenlightinApril2014andGreenlightcalculated
adjustmentstoMorganStanley&Co.estimates.GreenlightsadjustmentstoMorganStanleysmethods,
factors,andcalculationswereinthesolediscretionofGreenlight.

62

Wealsopresentedabearcasethathighlightedseverallargeheadwindsthatathenawould
havetocontendwiththatledtoaDCFvalueofjust$14pershare.
_____________
Source:MorganStanley&Co.estimatesasprovidedtoGreenlightinApril2014andGreenlightcalculated
adjustmentstoMorganStanley&Co.estimates.GreenlightsadjustmentstoMorganStanleysmethods,
factors,andcalculationswereinthesolediscretionofGreenlight.

63

Thebullcaseassumedthatathenawouldsuccessfullyexpandtobealeadingplayerinthe
inpatientmarket.
WeobservedthatEpicSystemswouldbeabigobstacletoathenassuccessthere,asit
wouldbedifficultforathenatodevelopaproductthatwoulddisplaceEpicsdominant
softwaresolutionforhospitals.
_____________
Source:TheVeronaPress,August9,2013,http://www.connectverona.com/articles/2013/08/09/epicwows
chambergroup.

64

Sowhatshappenedsince?
Thestockisprettymuchinthesameplace.
_____________
Source:BloombergL.P.

65

athenahasalonghistoryofdeterioratingearningsestimates.Overthelastyear,estimates
havecontinuedtodecline.ThisistrueforbothGAAPandadjustedearnings.OnaGAAP
basis,EPShasdeclinedoverthelastthreeyearsandthecompanycurrentlyoperatesata
loss.
NotethatthegapbetweenGAAPandnonGAAPearningsisnow$1.50pershare.In2010it
was$0.28pershareandhasgrowneveryyearsince.
Likemanycompanies,athenahaslearnedthatifWallStreetcountscashcompensationbut
notstockcomp,itmayaswellpayitspeopleinasmuchstockaspossible.
_____________
Source: AdjustedandGAAPEPSestimatesarehistoricalBloombergconsensusestimatesfornotedtime
periodsasretrievedfromBloomberginMarch2015.

66

Butlookatthisexcerptfromthecashflowstatement.
athenawantseveryonetobackoutthestockcompensationbecauseitsanoncash
expense.Yet,itpaysoutcashtaxesaspartofitsstockcompensationscheme.At$28
million,thatsmorethanthecompanysentirefreecashflow.
_____________
Source:ATHN2014Form10K

67

athenatellsinvestorstoignorecurrentprofitsbecauseitneedstoinvesttomaximizeits
growthopportunity.In2014,R&Dexpenseswereexpectedtogrowandpressureoperating
margins,butthisdidn'thappen.R&Dexpensesontheincomestatementactuallydeclined
asapercentageofsaleslastyear.
Wheredidathenainvest?
ItinvestedinCapEx,whichwentfrom6%ofsalesto10%.ItalsogrewtotalR&D
substantially.
But,itcapitalizedtheincreasingpart,withcapitalizedsoftwaregoingfrom4.9%to7.2%.
Marginsfell,onlyitwasn'tduetohigherinvestmentforgrowth,asthegrowthinvesting
wasmostlycapitalizedratherthanexpensed.
Andhaditnotcapitalizedalltheseexpenses,marginswouldhavefallenevenfurther.
_____________
Source:athenahealthsfilingsonForm10Kand10Q;andGreenlightcalculationsderivedfrom
athenahealthsfilings.

68

athenaslippedanaccountingchangeintoitsthirdquarter10Qtoacceleraterevenue
recognition.Whilethereisnodisclosureoftheimpact,inourexperiencethisisthesortof
thingcompaniesdowhentheyarestrainingtomeetexpectations.Notably,thatquarter,
athenaexceededconsensusrevenueestimatesby0.25%.

69

https://youtu.beSRdKgnCOxCU

Socomingbacktothebullcase,heresJonathaninOctoberoflastyearreminding
everyonethatthecompanysgoalistogrow30%ayear.
_____________
Source:http://video.cnbc.com/gallery/?video=3000319485

70

athenamissedthat30%goalin2014.
AccordingtoJonathanBush,despitemissingthistarget,itdidgreatandhuge,and
enterprise,whichisabouthalfitsbookings,justfellalittleshort.
_____________
Source:athenahealthwebsiteat
http://investor.athenahealth.com/phoenix.zhtml?c=213592&p=quarterlyearnings,retrievedMarch2015.

71

Ingeneral,athenaisfairlytransparentwithitsdisclosure,butitdoesntdiscloseits
bookings,presumablyforcompetitivereasons. However,thecompanyissuespressreleases
fornewclientswithover150physicians,knownastheenterprisegroup.
So,wecantabulatethepressreleasestoestimateenterprisebookings.Youmightnot
thinkthisqualifiesasdeepresearchbutnoneofthesellsideanalystshavewrittenabout
thisandtheresultsarerevealing.
Hereyouseeathenaannounced2,000newproviderwinsin2011.
In2012itannounced2,950newproviders.
In2013,youcanseeithadtwoenormouswins,whichdrovetheincreaseto7,350.
_____________
Source:Greenlightcalculationsfornewathenacollectorenterprisecustomersbasedonathenahealthpress
releasesat http://newsroom.athenahealth.com/phoenix.zhtml?c=253091&p=iroloverview.

72

Sowhathappenedin2014?
athenahadatargetof30%growth.
Jonathansaystheycameupalittleshort.
Thegreenlineisoursenseofwhatalittleshortmightmean.
Theysaidthirty,somaybetheyonlygrew25%,whichwouldbeabout9,200newproviders.
_____________
Source:Greenlightcalculationsfornewathenacollectorenterprisecustomersbasedonathenahealthpress
releasesat http://newsroom.athenahealth.com/phoenix.zhtml?c=253091&p=iroloverview.

73

So,howdidtheydo?
athenaannouncedafewsmallcontractstotalingonly1,246providers.
_________
Source:Greenlightcalculationsfornewathenacollectorenterprisecustomersbasedonathenahealthpress
releasesat http://newsroom.athenahealth.com/phoenix.zhtml?c=253091&p=iroloverview.

74

Youcanseethatannouncedenterprisebookingsfell83%.
_____________
Source:Greenlightcalculationsfornewathenacollectorenterprisecustomersbasedonathenahealthpress
releasesat http://newsroom.athenahealth.com/phoenix.zhtml?c=253091&p=iroloverview.

75

AttheanalystdayinDecember,thebullishhighlightwasthatbookingsgrowthwould
returnto30%in2015.
_____________
Source:athenahealthwebsiteat
http://investor.athenahealth.com/phoenix.zhtml?c=213592&p=quarterlyearnings,retrievedMarch2015.

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But,that30%isoffthenowlowerbase.Investorshavebeenledtobelievethat2014wasa
smallhiccupandthatathenasbookingsaretrackingtothegreenline.Wethinkthereality
isthatbookingsgrowthwillcomeoffasubstantiallylowerbaseandaremoreliketheblue
line.
athenamightcheer30%enterprisebookingsgrowth,butthatwonteventakeitbacktoits
2011level.
_____________
Source:Greenlightcalculationsfornewathenacollectorenterprisecustomersbasedonathenahealthpress
releasesat http://newsroom.athenahealth.com/phoenix.zhtml?c=253091&p=iroloverview.

77

Whatdoesthismeanforoverallbookings?
Weknowthatenterprisebookingswereslatedtobe50%oftotalbookingsin2014,soif
thesebookingsdeclined83%,overallbookingsweredownin2014versus2013.
Again,ifathenaresumes30%bookingsgrowthoffthelowerbase,itwontreturnto2013
levelsthisyear.
Evengrowing30%overlastyearsdepletedbasecouldbeachallengebecauseinthefirst
quarterathenaannouncedjustonesmallcontract.
_____________
Source:Greenlightcalculationsfornewathenacollectorenterprisecustomersbasedonathenahealthpress
releasesat http://newsroom.athenahealth.com/phoenix.zhtml?c=253091&p=iroloverview.

78

Bookingsarealeadingindicatorofinstallationsandinstallationsarealeadingindicatorof
revenue.So,thedeclineinbookingsprobablydidntaffect2014revenues,butwillprovide
aheadwindin2015andprobablyanevenbiggerheadwindin2016.Thestreetexpects
revenuestodeceleratefromthehistoricalrateofover30%to22%thisyearand21%next
year.
Managementinsiststhatthelongtermrevenuegrowthrateisstill30%.
_____________
Source:BloombergconsensusestimatesretrievedinMarch2015.

79

https://youtu.be/KHRuAUljSS8

Andincaseyourecuriousastowherethat30%targetcomesfrom.
_____________
Source:http://blogs.vmware.com/euc/2011/07/fortunebrainstormjaviersolteroonhowtheenterprise
caninnovate.html,retrievedApril2014.

80

LastMay,weidentifiedthesesixcustomersthatwebelievedathenamayloseinthe
comingyears.
WestPennAlleghenydidthefirstmajordeinstallationthisquarter.Obviously,athena
needstowinnewbusinessjusttoreplacelostcustomers.
Itseemslikelythatathenawillcontinuetoloseenterprisecustomers.
_____________
Source:Greenlightopinionbaseduponpublicstatements,newsarticles,announcementsforopen
employmentpositions,anddiscussionswithindustryparticipants.

81

Theenterprisebookinglosshasfolloweddeteriorationinitsbrandimage.
athenamisseditsclientsatisfactiontargetsforeveryquarterin2014,aftergenerally
beatingtheminprioryears.
InhealthcarevendorreviewerKLASsratings,athenasscoresdroppedforeveryproduct
andeverysizecustomer,anditsrankingsversusotherproviderseitherdeclinedorstayed
flat.ItalsolostthetitleofbestoverallsoftwarevendortoEpic.Itspossiblethatathenas
diminishedreputationhasimpacteditsabilitytowinnewbusiness.
_____________
Source: KLAS
http://www.epic.com/
http://hitconsultant.net/2015/02/02/indepth2014bestinklasawardsforsoftwareandprofessional
services/
http://investor.athenahealth.com/phoenix.zhtml?c=213592&p=irolcalendarpast

82

AfterSohn,JonathanBushwentonCNBCandexplainedthatwehadmisunderstoodthe
company.WhenaskedexplicitlyaboutEpic,hecalledthemthebestdarndinosaurofour
ageandsaidthefutureisthecloud.
Whenthehostfollowedupnotingthatathenawouldhavetospendbillionstobuilda
systemtocompetewithEpic,Jonathansaid,
Sothisisthekey.Werenotgoingtodevelopasystemtotakethemon.Wearebuildinga
network.
_____________
Source:http://video.cnbc.com/gallery/?video=3000273642

83

Lessthaneightmonthslaterathenaspent$80milliontodotwoacquisitionstoaccelerate
thebuildingofacompetitivesystem.
webOMRisBethIsraelsEHRplatformthatathenawillintegrateintoitsowninpatient
offering.
RazorInsightsisacloudbasedEHRforruralandcommunityhospitalswithunder50beds.
EventhoughRazorInsightshas25customers,athenaleftitsrevenueguidancesubstantially
unchanged.
_____________
Source:Greenlightcalculationsfornewathenacollectorenterprisecustomersbasedonathenahealthpress
releasesathttp://newsroom.athenahealth.com/phoenix.zhtml?c=253091&p=iroloverview.

84

https://youtu.be/oLJZVUPKvJw

HeresJonathanBushdescribingthevalueofacquisitions.
Wesuspectthatathenaisdoingjustthat usingtheseacquisitionstoimplicitlylower
guidancewithoutactuallyloweringguidance.
_____________
Source:http://video.mit.edu/watch/areyoureadyforipostrategiesandstepsforhowandwhentotake
yourcompanypublic9327/

85

AsforEpic,JonathanBushdedicatedawholechapterinhisbooktocriticizingthecompany
forbeingaclosedsystem.
_____________
Source:WhereDoesItHurt?AnEntrepreneursGuideToFixingHealthCare.JonathanBushandStephen
Baker,chapter9,page135.

86

WhenAppleannouncedHealthKitlastsummer,itskeypartneringivingpatientsaccessto
theirrecordsontheirmobiledeviceturnedouttobeEpic thedinosaurisnowinthe
cloud.
_____________
Source:http://www.modernhealthcare.com/article/20150205/NEWS/302059938

87

WhileEpicmovesintothecloud,athenasboardseemssomewhatmoregrounded,and
excludingBush havesold58%oftheirsharesinthelastyear.
_____________
Source:Greenlightcalculationsbasedonregulatoryfilings.

88

https://youtu.be/28cY08pxibw

AttheIraSohnconferencelastyear,weallowedrelativelygenerousassumptionsinthe
basecaseDCF,whichvaluedathenaat$50pershare.
Backthen,wewerentforecastingabigslowdowninenterprisebookings,massive
increasesincapitalizedresearchanddevelopmentproppinguptheincomestatement,or
Epicenteringthecloud.
Here,JonathanBushsuggeststhatitsuptomeandotherinvestorstodecidewhatathena
isworth.
Well,atleasthedidntgethispricetargetfromthesameplacehegothisgrowthrate.Asit
standsnow,wethinkathenasbusinessperformanceistrackingclosertoourbearcase
valuationof$14pershare.
Wecontinuetoexpecttheathenastockbubbletopop.
_____________
Source:http://www.bloomberg.com/news/videos/b/daa965b8068c48fab49f109565a96743

89