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Nick Sleep

Xerox
NASDAQ:XRX
2002-2005
Industry: Printer
Category: Stalwart, Despised, Accounting

Context
Xerox is the manufacturer of presses, copiers, printers
Revenue of 17b, niche in high end (100k+) printers at 70% market share

Why the Company is Mispriced
Management promised 15% per annum growth, but it's fundamentally only a 5% growth business
Management was poorly incentivized to play accounting games to exercise their bonuses by artificially pushing the stock price up
Management had began recognizing their contract revenue as sales-type leases instead of operating leases
Effectively, forward recognizing revenue
When the revenue eventually unravelled, it shocked the market

Alternative View
Despite the accounting game, the cash flow of the company, the intrinsic value of the company remains unchanged
Prices are depressed by temporary factors
At 6/sh, the company is trading at 4.5x FCF
Nomad values the shares at 14/sh

Result
Xerox shares nearly doubled over the next few years
I assumed a $20/sh cost basis in 2002, and a $35/sh exit in 2005 for a CAGR of 15%
Notably Xerox shares traded sideways for a long time, despite the deteriorating fundamentals