1 Baupost Limited Partnerships 2012 Year End

BAUPOST LIMITED PARTNERSHIPS 2012 YEAR END LETTER “In the end, more than freedom, they wanted security. They wanted a comfortable life, and they lost it all-security, comfort and freedom. When the Athenians finally wanted not to give to society but for society to give to them, when the freedom they wished for most was freedom from responsibility, then Athens ceased to be free and was never free again.” --Edward Gibbon (1737-1794), British historian and MP “A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largesse from the public treasury. From that the public treasury with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship. The average age of the world’s greatest civilizations has been 200 years.” --Attributed to Alexander Fraser Tytler (1747-1813) “I am more worried than I have ever been about the clouds gathering today…. I hope they pass without breaking, but I fear the defining feature of coming decades will be a great Disorder of the sort which has defined past epochs and scarred whole generations.” -Dylan Grice, Global Strategist, Societe Generale, October 2, 2012 The Baupost Group, L.L.C. 10 St. James Avenue, Suite 1700 • Boston, Massachusetts 02116 • Phone: 617-2108300 • Fax: 617-45-1-7333 January 18, 2013 Dear Limited Partner, We are pleased to report a gain for the year ended December 31. Various appendices and tables detailing a categorized breakdown of our investment returns, largest individual gains and losses, portfolio allocation, and ten largest positions at December 31 will be available in separate quarterly reports on our website in early February. Year in Review All things considered, 2012 was a profitable but frustrating period for Baupost®. For much of the year, it felt as if we were all dressed up with no place to go We had plenty of cash to deploy the strongest and deepest investment team we’ve ever had searching assiduously for opportunity, a well-considered plan as to where we might look, and an operations team ready to process and report on any investments we might make. But, for various reasons, potential sellers of securities and assets largely held back while buy-side competitors became increasingly aggressive. Bargains generated by the panic selling and forced liquidations of late 2008 and early 2009 were long gone, replaced by mostly higher prices amidst a grind-it- out environment of subdued economic conditions and festering problems. On the whole, though, given the less than robust opportunity set, we are quite pleased to have found sufficient new investments to keep most of our capital productively deployed. Much of our 1 success last year was the result of years of hard work analyzing complex and messy situations and building and strengthening relationships that underpinned our sourcing efforts. While our return for the year was not scintillating, we regard it as acceptable considering the limited risk incurred to achieve it, including the consistent maintenance of cash balances that hovered around 30% of capital all year before ending somewhat higher. While our investment approach is always bottom up, the prevailing market and economic environments inevitably influence the flow of opportunity. One likely scenario for 2013 is a reprise of 2012: extremely low interest rates increasingly pressuring yield-starved investors to throw caution to the wind while curtailing the opportunity set for bargain seekers. Indeed, during the first week of January 2013, the S&P 500 hit a five-year high while junk bond yields fell below 6% for the first time in history. Another plausible scenario would involve real progress on deficit reduction and entitlement spending, thereby encouraging legitimate optimism abut the future. But the odds of such a development seem discouragingly low at this time. Given the rancorous debate and partisanship that characterized the last-minute “fiscal cliff” deal, the real downside scenario—which concerns us greatly-involves the end of the “free lunch” of large deficits, zero interest rates, and relentless quantitative easing. This story line would take the form of a currency, sovereign, or economic crisis inciting panic throughout the financial markets. Our portfolio holdings are quite compelling as we enter 2013, and we believe we will achieve solid long-term returns with limited downside risk under any of the aforementioned scenarios. Indeed, because we never know what is going to happen, we always attempt to build an eclectic, diversified portfolio that should protect capital even in times of great adversity while also generating decent investment performance under virtually any market or economic environment. Meanwhile, we will remain disciplined, continue to choose capital preservation over speculation, and stay focused on achieving good absolute, not relative, returns. The success of an investment firm is necessarily dependent on the actions of others. The collective behavior of the entire community of investors determines market prices, and price fluctuations, in turn, drive investment opportunity. In other words, determined effort, deep analysis, strong processes, and good judgment are necessary but not sufficient for investment success. When buyers are numerous and sellers scarce, opportunity is bound to be limited. But when sellers are plentiful and highly motivated while potential buyers are reticent, great investment opportunities tend to surface. The actions of two powerful figures, Ben Bernanke and Mario Draghi, impacted us and other investors profoundly last year. Throughout 2012, the Fed chairman and his counterpart at the European Central Bank (ECB) were maestros whose monetary symphonies beguiled most investor. Their seductive melodies, consisting of the same flat notes of lenient policy actions and endlessly offbeat repetitions, had the effect of intensifying competition for investments by luring many into paying up for risky assets while dampening any urgency sellers may have had. Bernanke’s plan for quantitative easing (QE3), announced in September 2012, involved the Fed’s purchase of $40 billion of agency mortgage-backed securities (MBS) a month. Then, only three months later, he effectively doubled down with a plan to augment the MBS activity with monthly buybacks of $45 billion of long-term U.S. Treasury securities. Bernanke’s ongoing financial experiment (now in its fifth year and counting) is a real world test of his Ph.D. thesis on the proper response to a looming depression. In reaction to his efforts, investors belted out a resounding chorus of “risk on” for much of the year. 2 While economic conditions in the U.S. have moderated from crisis levels, Eurozone economies continue to struggle. Greece remains mired in economic depression; its GDP today is 19% below its level of four years earlier. Reported Spanish unemployment hit 25% recently, the highest since 1976. Mario Draghi’ s mid-year announcement to undertake Outright Monetary Transactions (OMTs), in which the ECB buys back shorter-term maturities-between one and three years-of peripheral European countries’ sovereign debt, calmed markets while provoking risk taking. Spain, Italy, and other countries have temporarily benefited from issuing debt at interest rates well below what the market would have otherwise demanded, while European banks purchase debt of their own sovereigns through collateralized borrowings in a new form of carry trade, Meanwhile, according to the international Monetary Fund (IMF), the underlying sovereign debt-to-GDP ratios of Portugal, Ireland, and Spain all continue to grow. According to the IMF, Germany and France- Europe’s core-now have debt to GDP ratios of 83% and 90%, respectively, a level considered dangerous for any country’s long-term fiscal soundness. The sovereign debt crisis and Eurozone fiscal imbalances remain grievous threats to the global economy, with Draghi effectively declaring a three-year truce between debtors and creditors at great expense to the healthier European economies. His actions are keeping market forces temporarily at bay, but when they re-emerge another day of reckoning will be at hand. Thanks to Bernanke’s and Draghi’s interventionist policies-and the markets’ belief that they will continue indefinitely-interest rates have plummeted. In the U.S., the ten-year Treasury bond yield bottomed at 1.43%, while the thirty-year yield hit an astonishingly low 2.46%. Triple-A-rated Microsoft recently issued five-year paper at less than one percent, while the five-year Treasury bond yielded as little as 0. 56%. Similarly in Europe, rates in most countries fell significantly while bond prices surged. Vanishing interest rates have combined with the pressures wrought by short-term, relative investment performance measurement to drive investors into riskier investments (i.e., “risk on”). Desperate for yield, investors poured money into high-yield bond fund; 2012 inflows more than doubled the previous yearly high set four years ago. As a result, junk-bond investors have posted huge gains as yield plummeted to all-time record lows in late 2012 and again in early 2013. Similarly, yields on commercial mortgage-backed securities hit their lowest level since the inception of the Barclays Capital U.S. CMBS Investment Grade Index in 1997, while leveraged loan issuance hit a five-year high. As perceived risk dropped and bond yields plummeted, most global equity markets surged in 2012 in an equally frenetic reach for return. Both the Russell Midcap Index and the Russell 2000 Index of small-cap stocks hit an all-time high just yesterday. When today’s aggressive policies finally end and market forces reassert themselves, those who grabbed desperately for return and bore excessive risk to do so will encounter substantial market value declines. If economics were a hard science like chemistry, you’d mix a little of this with a bit of that and the concoction would lead to strong economic growth, full employment, rising home prices, buoyant financial markets, and low inflation every time.

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