Because there are now less moving pieces, we can clearly arrive at a price target for the warrants. Based on my previous posts, you know that my price target for Univar is ~$32/share in the next 12 months. I think I am being reasonable in this analysis (though I admit, Univar is hosting its 2019 outlook call next week which could change things).
(March 4 Update: UNVR released 2019 guide of ~$750MM of EBITDA, which reflect 10 months of Nexeo and expectations of flat industrial demand. Seems relatively conservative. They also expect to generate $275MM of FCF, which is still a 7% FCF yield. Not too bad, but not amazing either).
appointed Equiniti as the successor warrant agent pursuant to the Nexeo Warrant
Agreement. This means they will now
handle the warrants being exercised. Unfortunately, in the meantime, this means
the warrants will be pretty illiquid.
Following my last post on Univar’s acquisition of Nexeo, I wanted to provide a follow-up on the warrants. After confirming that the warrants will remain outstanding until June 9, 2021, I now think the warrants are even more compelling.
For one, we are much more tied to Univar, a larger more diversified company, given the take-out price of Nexeo is based on $3.29 of cash and .305 of UNVR stock. Just so everyone is on the same page, I’d like to provide a sensitivity below on what the outcome is for the Nexeo warrants (ticker NXEOW) based on different outcomes.
One factor to point out is that the cash portion of the deal moves as Univar’s stock moves below $25.34. The reduction is a maximum of $0.41. The reason for that is that Univar doesn’t want the cash portion of the deal to exceed 70% of the transaction consideration, as that would lower the strike price on the warrants.
Here’s an example:
Now that we have that moving mechanism established, we can sensitize what the intrinsic value of NXEOW is based on the movement in UNVR’s stock price. The instrinsic value should be derived by taking the total consideration for Nexeo and subtracting the strike price. The stock portion of UNVR is based on 0.305 * UNVR’s stock price, just as a reminder. We must then divide by 2, given each warrant is for one-half share.
The results are shown below:
The risk here is that UNVR trades to $26.5 or below, as the warrants would have an intrinsic value of zero…
But wait, aren’t we forgetting about time value??
Yes – that’s the factor not mentioned so far. Warrants are essentially long-dated call options and the cost of a call option is essentially the intrinsic value + time value remaining on the call. This is why further dated call options (typically only 6 months out) are more expensive than near dated ones — you need to account for additional time and, pardon the pun, optionality.
Let’s take a look at UNVR’s calls to get a better picture on what time value is embedded. The latest dated calls are March 15, 2019. The call with a strike price of $25 would currently have intrinsic value of $4.43, shown below. The call is trading for $5.90 however, which implies $1.07 of time value. That is time value for 177 days away! We have 994 days for the warrants!
I’m no expert in determining the remaining time value that should be built into the warrants, but I do know one thing… these warrants, even at $0.80, do not account for much time value.
In this post, I’ll go through what I think of the transaction, the mechanics as they are presented so far, and what to do with the stock and warrants.
The transaction is broken down into a cash and equity consideration, as shown below. Each holder of Nexeo’s common will get 0.305 of Univar’s shares (worth $8.36 based on Univar’s close price) and $3.29 in cash, representing a total value of $11.65. This represents 9.5x Nexeo’s LTM EBITDA.
I think is honestly too cheap to sell at, but the TPG and First Pacific own over 60% of the shares and voted in favor of the deal, so there’s not much investors can argue for here. Univar trades at 10x LTM EBITDA and Brenntag trades for ~12.5x. Considering the fundamentals were moving in the right direction and you can realize a signficant amount of synergies here (you don’t need 2 sales people in the same region, you can consolidate warehouses, etc.), I think the stock should have gone for a higher multiple. Univar is targeting $100MM of synergies, so in reality, you could view it as the company paid ~$2bn for $300MM of EBITDA, or 6.6x EBITDA.
Either way… I digress… and there’s no point complaining when it appears the deal is done. When you put two and two together, you actually arrive at a ~$940MM EBITDA company, as shown below. If you assume Univar is worth 10x EBITDA, where it has historically traded, I also show that I think Univar should trade up to $33 a share.
That foots to ~20% more upside in Univar’s stock based on the closing price today, accounting for the additional shares needed to be issued and the additional debt.
What should we do with Nexeo Stock and Warrants?
Well, as mentioned, I don’t think a higher price is coming for Nexeo and I would sell the common stock as it approaches $11.65. The transaction is expected to close in the 1H of 2019. I don’t think there will be much in the way of regulatory hurdles given how fragmented to chemical distribution space is.
Now to the meaty part. I recommended Nexeo’s warrants in this post, and they haven’t moved much since then. With a $11.65 take-out and a strike price of $11.50, that implies the value of the warrants is then $0.15… but it is more complicated than that.
All the press release says is, “Following the close, existing Nexeo equity warrants will be exercisable for the merger consideration in accordance with the terms of the warrant agreement.”
That is very vague. On the call, management only said that, “The structure of the transaction that we have presented today, addresses all of those equity features [meaning the warrants] in a complete way and a satisfactory way to all the holders of those investments.”
So what does satisfactory mean? Pretty vague.
That is because the value of the warrants are going to be tied to Univar until the transaction closes. Significantly. Here’s why:
When we bought the warrants, that gave us the right to acquire 1/2 share for $5.75 (or a whole one for $11.5 if you buy 2 warrants). That means we can exercise 2 warrants between now and the close and and buy the stock for $11.50. So if we exercise the stock , our total cost will be the cost to exercise + the cost of the warrants. I lay out an example below of what that means if you bought 1,000 warrants to keep it simple. This essentially means if you bought the warrants at $0.60, our new breakeven is $31.
As you can see, this is not the best outcome for the warrants, but hey, at least they are not worth zero…. They also shouldn’t trade down from $0.60 to $0.15, as that would present a major buying opportunity!
Plus, there is a decent amount of time until close (1H’19), which leaves time for both companies to increase earnings which may result in Univar’s stock appreciating above my $33 price target above. When looking at Univar’s call options, it’s March 2019 call options with a $28 strike price are trading at $4. Part of this is time value… Nexeo should also reflect time value.
Unfortunately, I did see some questions of whether the warrants will stay outstanding post-transaction. I’m still a little unclear on this and what ability Univar has to tender for the warrants, but the language in Section 4.4 of the Warrant Agreement does seem to imply that they will stay outstanding, meaning we should have some time value built into the warrants on what is arguably a better pro forma company.
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.
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.”
There has been precedent for tenders of warrants from SPACS, as shown here and here and here for premiums to where they were trading.
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.