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In a steady-state environment, even with a slowing economy, the opportunity set for value+catalyst investing looks very good. The large backlog of overdue and necessary corporate activity we have expected has materialized, causing us to deem 2011 the ‘year of the break-up.’ For the first half we maintained a relatively fully-invested position. With conditions ripe for corporate change and activist shareholders, we carefully selected opportunities such as Williams Co. (WMB), El Paso Corp. (EP) and McGraw-Hill Companies (MHP), which were followed swiftly by value-unlocking split-up announcements.

However the rise of systemic risk over the summer has threatened to upset investors’ economic assumptions. We monitor three key global macro/policy issues. In Europe, the primary concern is whether any solution exists that can ‘ring-fence’ a Greek debt default so that capital market financing
remains available to Italy, Spain and a host of major banks. In the U.S., we fear the Super Committee will be unable to agree on $1.2 trillion of budget cuts, which could lead to a de-stabilizing budget impasse. Lastly, the rumored ‘hard landing’ in China could finally manifest, dragging down the commodity complex and export markets. While these issues are pending, we feel the uncertainty itself hinders global growth and we have begun to model our current and prospective investments on a 2012 recession-case basis.

Drawing upon the lessons of 2008, we have made the decision to run with considerably lower gross and net exposures for now. We feel it is a market to hold only what you truly believe in – offset by position specific and other portfolio hedges – and to go home with only a modest amount of net market exposure. That has been our posture since early August. Our exposure has ranged between 15-30% net long recently, versus 50-65% earlier in the year. It is also a time to actively build a buy list and look to opportunistically upgrade the portfolio when we come across unusual bargain entry points. We believe the
rewards of surviving such a time will justify the defensive posture at present.

Beyond the daily wrestle with highly volatile and macro-driven markets, JANA Partners continues to stride forward into its second decade in business. We have noteworthy progress to report with certain activist positions and we are pleased to have culminated a search for a Chief Administrative Officer with an excellent hire.

We are seeing large daily swings in the market on a regular basis. Against this backdrop of political uncertainty and high volatility, our bias is to keep net exposure low (in the 20-30% range) until we see more clarity. With a highly-liquid and adjustable short book, we expect our exposures to fluctuate against
a range-bound market (lower as the market moves higher and higher as the market moves lower). Sticking with what we love, our current activist positions are about 20% of the long book. Other hard catalyst special situations make up about 25%. The balance of our long positions are generally stable, defensive
businesses run by smart capital allocators with great franchises we are excited to own. Cash buying power currently represents 20%. We believe our best defense is staying liquid, focusing on highquality businesses, and
being very disciplined on price. The short side of the portfolio includes a combination of approximately 20% general market hedges, 10% sector-specific hedges and about 20% single-name or ‘alpha’ shorts. In this market we have been careful to be at least near fully-hedged in exposures to energy, cyclicals, consumer names and Europe. Several short themes resonate with our team, including the following:

• We believe there will be a slowdown in US advertising despite the bullish commentary of media executives. We are short advertising firms and advertising dependent media.
• We believe the Australian housing bubble is popping. We have targeted some banks and retailers.
• We expect luxury consumer goods to retrench after sharp stock market losses. We are short some high-end retailers.
• US grocers appear to be getting pinched by dollar stores and Walmart and will struggle to pass through food inflation.
• We expect budget austerity will affect a range of government-facing businesses, from defense to engineering and construction.
PORTFOLIO HIGHLIGHTS
After the public disclosure of our filing position and the subsequent announcement of the company’s breakup plans, we can unveil the mystery of Position A. Its story supports our belief that activist shareholders have a critical role in the current market and is another example that careful, disciplined target selection can often yield swift and favorable results.

McGraw-Hill Companies (MHP). On September 12th, McGraw-Hill announced a “Comprehensive Growth and Value Plan.” This plan involves separating the McGraw-Hill conglomerate into two public companies to be known as McGraw-Hill Markets and McGraw-Hill Education. The plan also includes commitments to significantly reduce overlapping corporate costs and to accelerate share repurchases toward a total of $1 billion in 2011. The announcement closely followed our 13D filing of August 1st in which we disclosed a more than 5% MHP ownership stake and alluded to ongoing talks between us and MHP management. These developments represent another significant catalyst brought about by JANA’s activist group in a situation bearing several similarities to the El Paso Corp. (EP) investment we discussed last quarter.

As with El Paso, we had followed McGraw-Hill for years before concluding that the time was right to invest. While a break-up liberating MHP’s Standard & Poor’s unit had long been debated, it was not until this year that we felt McGraw-Hill came to satisfy all of our “V3” requirements for success in active
shareholder engagement. To review, the elements of V3 are:
• Value – After multi-year underperformance somewhat traceable to its inefficient corporate structure, MHP traded at the valuation of its least desirable business (Education), representing a sizeable discount to sum-of-the-parts valuations and offering an attractive shareholder return irrespective of any event.
• Votes – We confirmed that shareholder interest in a break-up plan had shifted materially during the period of underperformance causing the MHP board to intensify its ongoing strategic review. If it were to come to a vote or proxy battle, we felt confident in the outcome.
• Variety of ways to win – Even in an environment that includes litigation and regulatory uncertainty over rating agencies, we saw many ways MHP could be restructured to unlock value short of the four-way break up we advocated initially. For instance, cost structure and balance sheet optimization can create significant value with or without a formal split.
The fund began establishing a position in February of this year. We presented our own comprehensive plan in person to CEO Harold “Terry” McGraw on August 22nd, and he welcomed the dialogue. Once
again, in addition to our funds’ investment, our position was bolstered by an additional investment from
the JANA Special Investment Fund and a co-investment from Ontario Teachers’ Pension Plan, lending
undeniable credence to the cause. Through our background work, we believe we discovered several value
drivers not widely appreciated by the market, including the extent of redundant costs in the inefficient
MHP structure that could be eliminated in a split. We also conducted a deep-dive analysis of potential
rating agency liabilities stemming from the financial crisis to gain better clarity on issues misunderstood
by many investors. Nevertheless, to protect against factors such as a decline in debt issuance and
potential sovereign retaliations, we initiated certain short positions against MHP which have so far added
to overall profits from the long position.

Since the September announcement we have continued a productive dialog with management over
specifics of the Growth and Value Plan. While we are pleased with the company’s announcements to date,
there are multiple additional levers to unlocking even greater value at the company’s disposal, and we will be
watching the company’s further comments and actions closely. Much more detail can be found in
following public documents:
• New York Times’ coverage of our 13D filing on August 1, 2011 is here.
• JANA’s public Presentation to McGraw-Hill of August 22, 2011 is here.
• McGraw-Hill’s September 11, 2011 announcement of the Growth and Value Plan is here.
• Absolute Return+Alpha Magazine, JANA’s Turn of the Screw, article reprint October 2011 is here.

Update – El Paso Corp. (EP). Major events unfolding during the writing of this letter have made necessary a further update regarding our El Paso investment (much to our delight). On October 16th, El Paso announced that, instead of pursuing the announced spin-off of its energy exploration portfolio, it would sell the entire company to Kinder Morgan Inc. (KMI), the largest pipeline and storage company in the U.S., in a $39 billion cash and stock transaction. The price of approximately $27 per EP share is very close to our medium-term fair value target for El Paso and over 90% higher than where EP shares began
this year. With anticipated cost synergies, KMI expects to raise both its dividend payout and target growth rate by over 20% after closing the deal. El Paso’s energy assets will be marketed for sale to help pay down transaction-related debt. The deal is expected to close in the second quarter of 2012.
JANA Partners applauds El Paso CEO Doug Foshee for astutely seeking the best results for shareholders.

The El Paso turnaround under his tenure is an unqualified success story. Needless to say, this development is helpful as we attempt to stage a performance comeback in the fourth quarter. We were initially attracted to El Paso because we appreciated the unique combination of steady growth and stable cash flow offered by pipeline general partnerships. Based on our initial review of the deal, we are keen to continue as owners of the combined pipeline pure-play run by the legendary Rich Kinder with a prospective 5%+ yield and a double-digit growth profile.
New Position Updates. We hold significant buying power as we navigate an environment loaded with crisis potential. We are mindful that times of stress can offer opportunities to upgrade one’s portfolio with higherquality
companies at valuations rarely seen. We are looking for low cash flow multiples on ‘recession-case’ 2012 earnings as we maintain a buy list and selectively engage the market. The steep crisis-driven recession of 2008-09 often serves as a useful guideline in constructing a recession case, though we do not expect the
current economic slowdown to be as severe.

Out-of-favor healthcare stocks are one emerging theme for us. Since this summer’s U.S. debt ceiling drama, we observed indiscriminate selling across the sector of the good with the bad. We have developed a view that
eventual details of the budget compromise are likely to spare essential service providers. We look for highquality
protected franchises with limited or quantifiable exposure to budget cuts at bargain entry points, such
as the following.
• HCA Holdings Inc. (HCA) is the largest hospital operator in the U.S. with the highest margins. A 2006 LBO, HCA re-entered the public markets with an IPO in March 2011 at $30 per share. HCA shares suffered a 45% decline in August in part due to budget fears. We view HCA as a business with irreplaceable assets and a wide moat – a clear leader among poorly-capitalized peers. In a stressed base-case that assumes heavy pressure on Medicare reimbursement, we
believe HCA can still earn over $3 per share. We were able to establish a position in the recent market turmoil at less than 7x our downside earnings estimates. We believe HCA management shares our views about the opportunity. They recently repurchased over 15% of the outstanding stock from Bank of America near the lows of the summer. In the recent pullback, many investors shed cyclical exposures with energy stocks, not surprisingly, coming under the most pressure. While we do not care to guess where volatile commodity prices will settle in turbulent times, we are starting to see some exciting value+catalyst opportunities that we can approach in a hedged manner.

• Anadarko Petroleum Corp. (APC) holds a unique energy production portfolio with major positions in each important U.S. shale basin and unique international exploration reserves. APC  has been trading at a wide discount to intrinsic value because of potential liabilities shared with British Petroleum for the 2010 Macondo disaster. While under the stigma of Macondo, we believe APC got little recognition for certain major exploration catalysts, such as a vast

Mozambique natural gas discovery, that substantiate APC’s net asset value. Management has articulated a compelling strategy focused on addressing the discounted valuation, starting with the pursuit of a settlement with BP. (Note: A $4 billion settlement was in fact announced on October 17, 2011, triggering a wave of analyst upgrades.) Thereafter, we expect a full review of strategic
options which could lead to a value-unlocking split into two companies or the sale of undervalued assets.

CONCLUSION
Though we have to play more defense than offense for the time being, our conviction in our team and our strategy is stronger than ever. The evolution of our investment process has definitely, in our view, resulted in a greater clarity of mission and crispness of decision-making. Our more concentrated portfolio is a result of a more focused and well-managed team that develops high conviction in differentiated ideas. We consider the JANA 2.0 transformation of our business a success in many respects, even though it may not yet be apparent in the numbers. As always, we appreciate our investors’ continued support and hope this finds you all in good health and spirits.
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