I’m a little overdue for a recap on Nexeo’s results. The company reported Q2’18 sales growth of 14% and EBITDA growth of 18%. Most of the growth was in its Chemicals segment, which showed top line growth of 17.5% (though 4.8% of that was from the Ultrachem acquisition) mainly due to higher prices. Plastics was also up 9.6% due to 14% price growth offset by 4% volume decline.
This was a really solid result and if you think about the balance of the year, the performance should continue. The company distributes chemicals and plastics, which in some sense are oil-linked derivatives. Since oil is up considerably year over year, the pricing gains should continue. Importantly, the company benefits most from this inflationary environment, as they buy inventory at a lower price and sell at a higher one.
Indeed, as the economy improves as well, volume growth should continue. I don’t model much in this regard, I’m only at 1-2% over the long term, and this will be upside to my estimates.
The stock is now at $9.13, which means it is only up 8% since I first wrote about it. However, I still think it is a bargain.
I now want to draw your attention to Nexeo’s warrants. In fairness of disclosure, I own a significant amount of these in my PA now, as these are high risk / high reward plays on Nexeo’s stock.
A warrant is essentially the same thing as a call option. I pay a price today to have the option to buy the underlying security in the future at a specified price. If the underlying security ends up being below the threshold at the end of the period, the option expires worthless.
Nexeo’s warrants (Ticker: NXEOW) are just like that. They give the buyer the right, but not the obligation, to buy 1/2 of Nexeo’s stock at a certain price (strike price). Nexeo’s warrants strike price is $11.50. That’s the price you’ll buy it at, plus you pay the price of the warrant for the option. Here is the language from their 10K on the subject.
“As of December 5, 2017, outstanding warrants to purchase an aggregate of 25,012,500 shares of our common stock became exercisable in accordance with the terms of the warrant agreement governing those securities. These warrants will expire at 5:00 p.m., New York time, on June 9, 2021 or earlier upon redemption or liquidation. The exercise price of these warrants is $5.75 per half share, or $11.50 per one full share, subject to certain adjustments.”
The math looks something like this. Let’s say Nexeo’s stock gets to $15. I then pay $11.50 to exercise the option. That should mean if the warrant gave me the right to buy 1 whole share, that the implied price of the warrant would be $3.50 ($15 – 11.50). Since Nexeo’s warrants give the right to buy 1/2 of a share, you need to divide that by 2, which gives you $1.75. However, if the warrant stays under $11.50, its implied worth is zero.
So, as if this needed to be stated, these are highly risky instruments and warrants can be highly volatile. What I like about them is that we have until June 2021 until they expire. That is a lot of time for Nexeo to build value.
The Company also noted that they would like to take out the warrants, as it makes the capital structure more complex and people worry about dilution (from day 1, I’ve included warrants in my share count using the treasury stock method and based on my target price). Here’s the CEO, David Bradley, on the subject:
“we’re in an active dialogue, have been for a while with our board about the complexity of our capital structure and getting it simplified. Clearly, there’s several opportunities, the primary one probably being the warrants that are outstanding. There’s a lot of those. We hear a lot from investors that, that’s quite a bit of overhang. So we would like to clean those up at some point.”
I think its a win / win. Either Nexeo tenders the warrants at a premium, or the stock goes up like I suspect and they realize value that way. The warrants are currently trading at less than 60 cents. My updated price target math looks like the below. Sure, in the short term maybe they don’t make as much sense as buying the stock outright. But as investors look out to 2019 and 2020, I think the warrants will be worth much much more.