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EZJ

Implications of Mike Rake’s phoney calculation of ROCE on Directors Pay

27/01/2012 the issue of the phoney ROCE calculation at

EZJ 1

Basic accounting

• A company can use two types of capital to finance its assets : – Equity which belongs to the shareholders – Debt (including “off-balance-sheet” debt such as leases)

• Both equity and debt are on the liabilities side of the balance sheet and equal the assets

• Loading a company with debt increases the risk to the Equity so the ROE has to be higher than the return on debt to compensate for the higher risk

• Measuring Return on all capital employed is meant to manage that risk

•


EZJ 2

Basic accounting 2

Capital employed =

equity +

debt +

capitalised lease obligations


EZJ 3

Basic Accounting 3

• If you buy a house for £10

• You put in £3 of your own money

• You borrow £7 from the bank

• You sell the house for £12 one year later

• ROE = £2/£3 = 66%

• ROCE = £2/£10 = 20%

• If you borrow £9 from the bank your ROE would be £2/£1 = 200% but you risk loosing it all


EZJ 4

The history

• Bonuses were previously calculated on a 15% ROE target but Mike Rake changed this to a 12% ROCE target without shareholder approval.

• I assumed the target came down because the capital employed is a bigger number than the equity

• Then by using a phoney calculation they just made it a lot easier to earn huge bonuses


EZJ 5

Summary

• The Mike Rake regime is claiming that they have achieved a 12% return on capital employed in FY2011

• Their calculation is simply phoney and self serving • The true return on capital employed is c. 4% (nowhere

near the target of 12%, not even close ) • On the back of this phoney calculation they will pay

themselves c £8m in bonus shares • They will ignore again the shareholder vote at the AGM

for the 2nd year running • This year the EPS will be down c20% • To a shareholder it feels like daylight robbery


EZJ 6

The Mike Rake definition of ROCE

• It arrives at a number for capital employed which is less than the equity of the company by £30m

• It is not that clear where the £30m comes from?

• Guess: It uses the assets of the company (cash) to offset all the debt so they cancel each other out

• Moral hazard: This encourages excessive leverage and risk taking : deploying more capital does not cost them anything in this calculation – this is dangerous for shareholders


EZJ 7

EZJ Slide - ROCE


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ROCE Calculation is incorrect. Capital employed is less than Shareholders equity under Management’s definition.

Average Lease rent was £106, therefore capitalised leases should be £740 based on 7x operating lease rent convention.

• Mike Rake completely ignores the leased aircraft in the phoney calculation of ROCE

• The P+L shows lease payments of £106m last year (insert slide)

• They have to multiply this by 7 and add it to the capital employed


EZJ 9

EZJ Slide – Comment on ROCE Calculation

The EZJ ROCE calculation contains a number of moral hazards for shareholders:

• Incentivises airline towards Sale and leasebacks/ operating leases of fleet – 100% finance increases cash thereby thus decreasing the

capital employed (by the Rake definition) thus optically increasing ROCE

– Increases leverage of the company

– incentivises Management to hoard more cash than necessary whilst earning very poor returns on the cash

– Dis-incentivises payment of cash out as dividends


EZJ 10

EZJ Slide – Implication of EZJ ROCE Calculation

• Assume Aircraft cost is $35m

• Pre-delivery payments totalling $15m paid in prior years

• $20m due to Airbus on Delivery

• Aircraft sold to lessor on Delivery for $40m.

On Delivery:

• Airline receives $40 million and pays out $20m so has net increase of $20m in cash.

• No increase to liabilities (Borrowings) included in ROCE (as leases are ignored)

• Liabilities/Borrowings reduced by the $20m surplus cash

• Easier to meet the ROCE target


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Example: effect of Sale and lease back on EZJ ROCE Calculation

• ROCE targets should be used to improve the numerator i.e. Profit of the business whilst taking into account how much risk they are placing the equity under using leverage

• Management should not be manipulating the Denominator i.e. the true capital employed in the business (Equity, Debt, Capitalised leases) to achieve the ROCE target.


EZJ 12

ROCE Targets

• A business that deploys £5 billion in assets should be making profits of at least £600m to achieve a 12% return.

• The rest is creative accounting.


EZJ 13

The true picture

27/01/2012 Confidential - Shareholder Discussion Paper 14

Leases x7 to be used for ROCE

calculation

Profit & Loss Statement (Source: EZJ Results Statement FY2011)


EZJ 15

The true test of how management should be measured

Debt c. £1.2bn+ £1.6= £2.8

Capitalised Leases £0.7bn

+ c. £5 Billion =

Capital £5bn

Net profit £225m

= 4%

Equity £1.7bn

+

Remuneration


EZJ 16

As a result of Mike Rake’s phoney calculation of ROCE they will

unjustly reward 10 staff to the tune of almost £8m solely based on one year’s Long Term Investment Plan

Award

EZJ Directors latest share awards under the Long Term Investment Plan (“LTIP”)

Company easyJet PLC

TIDM EZJ

Headline Director/PDMR Shareholding

Released 07:00 05-Jan-2012

Number 0205V07

RNS Number : 0205V

easyJet PLC 04 January 2012

easyJet plc

Director/PDMRs shareholdings

04 January 2012

easyJet plc announces that the PDMRs below have been awarded the following shares under the

easyJet Long Term Incentive Plan ('LTIP'):

Preferred Name Surname

Award 1 Shares

Award 2 Shares

Matching Shares Total

Carolyn McCall 169,297 169,297 106,978 445,572

Chris Kennedy 101,832 101,832 32,174 235,838

Warwick Brady 92,922 92,922 15,405 201,249

Mike Campbell 69,488 69,488 5,091 144,067

Trevor Didcock 57,281 57,281 17,668 132,230

Peter Duffy 57,281 57,281

114,562

Cath Lynn 57,281 57,281 7,124 121,686

Giles Pemberton 57,281 57,281

114,562

Alita Benson 45,824 45,824

91,648

Paul Moore 45,824 45,824

91,648 These vest in three years time, subject to the performance conditions shown below and measure the

average Company's Return On Capital Employed for the financial years ending on 30 September

2012, 2013 and 2014.

Award 1

Threshold

(25% Vests)

Target

(50% Vests)

Maximum

(100% Vests)

Return On Capital

Employed (ROCE) 8.0% 10.0% 12.0%

Award 2

Award 2

Threshold

(25% Vests)

Target

(50% Vests)

Maximum

(100% Vests)

Return On Capital

Employed (ROCE) 11.5% 12.5% 13%

For further details, please contact:

Paul Moore, Corporate Communications 01582 525973

Rachel Kentleton, Investor Relations 01582 525258

Ed Simpkins, Finsbury 020 7251 3801

This information is provided by RNS

The company news service from the London Stock Exchange END

RDSKMGGMLDDGZZM


EZJ 17

Value of awards at today’s price

Preferred

NameSurname

Award 1

Shares

Award 2

Shares

Matching

SharesTotal

Value at

(p):404

Carolyn McCall 169,297 169,297 106,978 445,572 1,800,111

Chris Kennedy 101,832 101,832 32,174 235,838 952,786

Warwick Brady 92,922 92,922 15,405 201,249 813,046

Mike Campbell 69,488 69,488 5,091 144,067 582,031

Trevor Didcock 57,281 57,281 17,668 132,230 534,209

Peter Duffy 57,281 57,281 114,562 462,830

Cath Lynn 57,281 57,281 7,124 121,686 491,611

Giles Pemberton 57,281 57,281 114,562 462,830

Alita Benson 45,824 45,824 91,648 370,258

Paul Moore 45,824 45,824 91,648 370,258

Total 754,311 754,311 184,440 1,693,062 6,839,970


EZJ 18

The £8m excludes

• Further appreciation in the share price

• The cash bonuses each year

• Their salaries

• The fact that it has bullet vesting in 3 years whatever the ROCE is in the first two years


EZJ 19

The 10 year view

•More than 10% dilution of the shareholders by issuing £180 million of free shares to a handful of staff!!!


EZJ 20

Issue of new shares is out of control


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c. 41 million shares, or 10% of the Company, have been issued to Staff since IPO

@£4.5 per share = c.£180m

(by comparison M+G , the biggest shareholder after the founder holds only 28 million shares

Total Voting Rights Issued since IPO

Date Total Voting Rights

(m)

Rights Issues Placements

etc. (m)

Share Incentive Schemes

(m)

Agg. Share Incentive Schemes

(m)

2000 186.6 2001 260.4 72.5 1.3 1.3 2002 391.7 130.4 0.9 2.2 2003 394.0 2.3 4.5 2004 399.2 5.2 9.7 2005 400.4 1.2 10.9 2006 410.5 10.1 21.0 2007 419.1 8.6 29.6 2008 422.7 3.6 33.2 2009 424.9 2.2 35.4 2010 429.5 4.6 40.0 2011 430.4 0.9 40.9


EZJ 22

Almost 1m shares issued

in 2011 despite

promises by Rake that they will stop this

41m shares issued since

IPO, over two thirds of

which were issued

between 2006 and 2010

They have 17 million shares tacked away somewhere?

• Estimated that at least 17m shares are today held in staff and LTIP “trust” schemes making these schemes the 8th largest shareholder in the company.

• Presumably they use these votes to manipulate AGM voting?

• These shares should not be allowed to vote!


EZJ 23

Other risks to shareholders from the Mike Rake definition of ROCE

• The same phoney definition is used to manage profitability by route

• The next slide should be re-cast with the line being at 4.5% which means most routes are actually deeply loss making

• These guys refuse to accept that because they want to buy more Airbuses


EZJ 24

ROCE Of Routes (From Pre-close Presentation September 2011)

• .


EZJ 25

Contribution per block hour – takes no account of how much time the route takes, or how many months of the year the route is flown

High performing routes most likely summer only (many new/<3 years), being flown 2 – 3 months a year. Then where do aircraft get used?

Mike Rake has refused to publish ROCE by aircraft

– I emailed Rake with 6 of his biggest shareholders in copy asking for more information to assist shareholders in understanding the performance of their investment

– Airlines deploy capital in aircraft not routes

– ROCE by aircraft is a more relevant measure

– There is a concept of a “line of flying” which is what an aircraft does in a day

– ROCE by line of flying can be published using the same format as the routes slide, with giving competitors any valuable information

– Mike Rake continues to ignore these requests


EZJ 26

Airbus

• Mike Rake and his predecessors has spent US$8 billion with Airbus over 10 years for 265 aircraft

• The return on this invest is zero

• Rake will pay Airbus c. US$1.3bn in the next couple of years for more aircraft and the earnings of company are going down 20%

• Each new Aircraft is destroying value


EZJ 27

The SOLUTION

Shareholders need to exercise their legal rights at the

forthcoming AGM.


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