Mix Shift At Nexeo Drives ~75% Upside

 Trades at a 30% discount to peers despite superior EBITDA growth trajectory

which instead warrants a premium.
 The market appears unaware of the mix shift to specialty products.
 Fair value of ~$15, or ~75% upside from current levels.
 Downside well-protected by increased supplier outsourcing during economic
downturns as well as a large discount to comps.

Nexeo Solutions (NXEO) (“Nexeo”, “NXEO” or “the Company”) goes for ~7.6x EV/'16E
EBITDA on the market. Relevant comps in the chemicals/plastics distribution space
which Nexeo appears undervalued against are Brenntag (BNTGF)(BNTGY) and Univar
(UNVR) who trade approximately 30% higher - both are priced at ~10x EV/'16E
EBITDA.

Why is this so?

The issue can’t be debt. Although Nexeo is levered at ~4.1x net debt/CY15 EBITDA,
relatively speaking, this is not concerning as peers Brenntag and Univar possess ~2x
net debt/CY15 EBITDA and ~6.4x net debt/CY15 EBITDA respectively. In particular,
UNVR does not appear to be punished by the market as a result of its high debt load.

On an absolute basis, such levels of leverage appears high at first sight, but is actually
not overly aggressive. This may seem counter-intuitive as NXEO is a chemicals and
plastics distributor; large chemical companies are struggling to grow sales and
earnings, a situation which might imply to the casual observer sales at NXEO should
decline on a forward-looking basis.

Commodity price declines and a strong dollar continued to pressure Dow in 1Q ‘16. The
pending Dow-DuPont merger can be seen as an implicit admission that earnings
growth through higher sales are unlikely. Instead, cost cuts and synergies will be the
main driver going forward. These troubles are not solely limited to Dow, but are also
experienced by firms such as Monsanto.

But such an assessment neglects to consider the nuances of the industry. Most
suppliers to distributors such as NXEO are highly concentrated – top 10 suppliers fulfil
~50% of total product procured at the firm. In contrast, the distributors’ customer
base is highly fragmented – the Company’s facilities serves >20,000 customers, with
none accounting for a material portion of sales. This introduces an interesting
dynamic.

In times of economic softness, end-users reduce purchases, making extensive

distribution infrastructure at firms like Dow hugely unappealing – high fixed costs on
declining sales is not a fun combination. Hence, companies like Dow are increasingly
turning to outsourcing product distribution to middlemen such as NXEO in order to
defend their margins in such environments as the Company can drive higher utilization
out of its infrastructure by spreading its footprint across thousands of customers. This
is exceptionally important in the current environment in order for suppliers to lower
capital spending as distribution is typically a non-core operation for them; after all,
Nexeo only exists today because Ashland sold its distribution business to TPG in the
earlier part of the decade.

This dynamic is precisely why I am confident top-line troubles at major

chemicals/plastics giants are actually a net positive for NXEO - it encourages suppliers
to outsource more work to distributors when times are hard. Notably, there does not
appear to be a symmetrical reaction on the opposite side – when times are good,
suppliers still outsource to distributors, likely because they have come to realize access
to distributors – especially large ones like Nexeo - gives them more revenue
opportunities.

It also explains why sales, gross profits, and EBITDA at Nexeo have been robust in
recent years despite significant commodity price declines and other headwinds
experienced by its suppliers and customers (as an example, ag has been very tough in
recent years due to low crop prices). The situation at UNVR further corroborates my
assertion - the firm is guiding for modestly lower EBITDA despite significant oil & gas
exposure; an uninformed observer would expect a larger decline.

It also doubles as downside protection during a recession along with the fact that NXEO
trades at a meaningful discount to peers. Note the Company has no raw material
exposure as a distributor due to pass-through pricing and thus has less earnings
volatility compared to suppliers.

So if it’s not leverage, what could explain the discount to peers?

Merging With A SPAC: Not Exactly Your Standard IPO

One potential reason for the opportunity could be due to the lack of coverage. This
should not be surprising. Most firms listed on the public markets got there through an
IPO, while Nexeo took the unconventional route by merging with a SPAC that was
sponsored by famed investor Wilbur Ross.

Investment banks typically distribute company information during the months leading
up to the IPO for book-building purposes and to ensure a smooth transition for its
client onto the public markets.

Unlike IPOs however, SPACs are not given the same degree of publicity due to their
lack of activity pre-deal; without an imminent acquisition, there is hardly anything for
the sell-side to write about.
As a result, significant mispricings can and do occur in the SPAC space, and this
absence of coverage on NXEO could be a reason why it trades at a discount to peers, in
my view.

Limited Market Awareness Regarding Mix Shift

The Company is guiding to (a) ~1% and ~6% sales growth and (b) ~10% and ~9% adj.
EBITDA growth in ’16 and ’17 respectively according to the April investor presentation.
In contrast, Brenntag’s EBITDA is expected to grow at ~4.5% and ~6% in ’16 and ’17
respectively while Univar is guiding for a decline in ’16 EBITDA.

From the above, it appears to me another potential reason for the mispricing is that
the market simply does not believe management’s estimates. If the market thought
NXEO could hit said estimates, the stock would probably trade in-line with peers, or
likely at a premium due to its stronger growth trajectory.

That said, the apparent market skepticism is not totally unfounded. After all, post-
merger, the Company has a limited public market history. Sure, Ross is a phenomenal
investor, but to the best of my knowledge, he has little documented experience in the
chemicals/plastics distribution space. Hence, it appears there is some justification for
treating Nexeo as a “show-me” story.

However, it is evident to me there is likely limited market awareness regarding NXEO’s

mix shift towards specialty products. Reason being – while the Company states that it
sells both commodity and specialty products, it does not disclose a breakdown of the
commodity/specialty mix, making it hard to decipher the mix shift. Thus, said shift is
unlikely to be noticed by most market participants. It can only be inferred through
close examination of the Company’s disclosures. This mix shift makes it highly likely
the Company will be able to hit management's estimates.

Commodity Versus Specialty: Explaining The Nuances

Back when Ashland sold Nexeo to TPG in early 2011, the Company was earning ~3%
EBITDA margins while peer Brenntag clocked ~7%. Both companies state that they
distribute commodity and specialty products but do not provide breakdowns. Judging
from their EBITDA margins however, it is clear that Brenntag's sales were weighted
more heavily towards specialty while Nexeo was more focused on commodity.

The distribution of commodity products is not complicated. This is because end-user

demands are fairly homogenous and hence end-products are standardized. One
example is titanium dioxide (TiO2). The fact that there are many uses for TiO2 – paper,
plastics, rubber, cosmetics are just a few specific applications – highlights the lack of
customization required by end-customers. In turn, this implies the distribution of
commodity chemicals does not require any special knowledge whatsoever. Customers
buy in bulk; business is thus more transactional and oriented for the short-term, and
purchase decisions are made almost solely based on price and on-time delivery.

On the other hand, the distribution of specialty products is highly complex. Unlike their
commodity counterparts, specialty products are sold in much smaller quantities and
require application-specific know-how as end-user needs often differ greatly.
Essentially, it requires one to have extensive knowledge and frequent interaction with
its customers to ascertain their often unique problems, and to come up with tailored
solutions.

While it is true that suppliers like Dow can skip the middleman and go direct, this is
often uneconomic because the end-user base is highly fragmented (think: millions of
small-time farmers). Hence, although customers are cumulatively large, they are
individually small. Ergo, it makes much more economic sense for the supplier to go
through an independent distributor; the independent distributor can do it more
cheaply because its position as the aggregator of demand from thousands of end-users
enables utilization rates to remain higher as compared to captive distributors (i.e.
distributors that exist within suppliers).

A good example of the intricacies of serving the specialty market is illustrated by an

Alent case study. A metal-finishing firm's "home-brew" plating process was hampering
its ability to meet growing OEM demand (i.e. a fairly unique problem) and also called
for additional equipment replacement due to looming environmental regulations.
Through understanding the customer's situation, Enthone, a subsidiary of Alent,
installed and introduced more efficient processes which also compiled with
regulations as evidenced by third-party validation (i.e. tailored a solution to fit unique
customer requirements).

This would only have been possible if one had the infrastructure, personnel, and
expertise in place to maintain an intimate relationship with the end-user. Apparently,
Nexeo did not possess such capabilities when it was a subsidiary of Ashland.

Subsequent to the buyout by TPG, the Company made the required technological
investments through the implementation of an ERP system and also spent significant
amounts on personnel to enhance its commercial capabilities. Nexeo also embarked on
inorganic initiatives such as the CSD and Archway acquisitions in order to expand its
capability in lab testing, formulation, and custom blending, hence obtaining the
expertise required to serve the specialty market.

As a result, the Company has morphed into a distributor capable of serving clients in
the specialty space. Indeed, this must have been the case considering NXEO only won
large deals with BASF, Solvay, and Royal DSM after it had achieved the aforementioned
requirements. While management does not quantify the details of these deals in their
respective press releases, it is likely that said deals makes management's guidance
highly achievable, in my view.

This is because all three deals were made with large firms with many billions in
revenue. Two of those deals (BASF and Solvay) were exclusive contracts, suggesting
the suppliers were heavily committed to making the partnership work. Furthermore,
the Company specifically acknowledges BASF as one of its largest suppliers.
Additionally, it appears to me the aforementioned deals would not have warranted
their individual press releases if they were not material to the Company.

Moreover, there is likely upside to management's guidance – specifically '16/'17 adj.

EBITDA estimates. As discussed, management is guiding ~10% and ~9% adj. EBITDA
growth for '16 and '17 respectively. This compares to ~13% CAGR adj. EBITDA growth
from 2012-2015. While this historical double-digit annual growth was likely boosted
by low-hanging fruit as TPG removed costs post-buyout, I still have a hard time
reconciling why the growth trajectory of adj. EBITDA would slow down.

This is especially so when one considers that management is guiding ~$15m-$24m in

cost savings going forward, which accounts for ~42%-67% of incremental adj. EBITDA
'17 number as compared to the '15 figure. Furthermore, we have already established
that revenue growth going forward is likely to be higher-margin due to the mix-shift
towards specialty. These incremental high-margin revenues are also turbo-charged by
significant operating leverage – after restructuring operations, management cites that
the Company has the "ability to increase volumes 50%-100% with [its] current asset
base".

The collective impact of these variables makes it highly probable that management is
low-balling guidance, in my view. '17 numbers are particularly intriguing, as while
management is forecasting an acceleration in sales growth (from ~1% to ~6%) it is
curiously projecting a deceleration in EBITDA growth (from ~10% to ~9%) in a
business which clearly possesses material operating leverage.

It is not difficult to deduce why management is likely low-balling guidance. Given the
Company's limited public market history post-deal, management likely wants to set a
conservative tone so as to not run the risk of over-promising and under-delivering.

This point is further supported by the fact the SPAC founders subordinated the entirety
of their promote – i.e. they restructured the 12.5m founder shares as an earn-out, with
50% realizable when shares trade to $12.50 (~45% upside) and the remainder
realizable when shares go for $15 (~75% upside). In my view, this not only hints at
the probability of guidance being conservative (if guidance is easily exceeded, the stock
would likely pop higher, and vice versa), but also aligns founders with minority
shareholders.

Why Did TPG Sell?

With such promising prospects, the debate inevitably turns to - why would TPG sell at
a discount? As a point of reference, management cited that NXEO was valued at 8.4x
EV/'16 adj. EBITDA while peers Univar, Brenntag, and IMCD were priced at 9.8x, 11.2x,
and 14.4x respectively at the time of the investor presentation, which serves to
highlight the extent of the discount.

In my view, merging with Ross's SPAC represented an opportunity to bring Nexeo onto
the public markets faster than a traditional IPO process would. The Company's investor
presentation highlighted the potential for Nexeo to roll up smaller peers due to the
highly fragmented nature of the distribution space. Being listed gives the Company
several advantages – chief of which is an additional currency (i.e. equity) that can be
issued to support inorganic growth initiatives. As discussed, NXEO also recently
completed the roll-out of its ERP system and has substantial operating leverage
waiting to be utilized, which bodes well from an M&A point of view.

In addition, TPG did not sell out entirely – the private equity firm still retains 35% of
the equity, with the potential to increase this to 38% with the aforementioned earn-
out. As a result, TPG still holds the potential to realize substantial upside if things go
well.

Valuation

Based on my suspicions that guidance is likely being low-balled, it may seem

appropriate to assume upside to management's '16 and '17 adj. EBITDA estimates – to
be conservative however, I will opt not to. Management is forecasting ~$213m in adj.
EBITDA in '17. Slapping a 12x EV/adj. EBITDA multiple on this figure works out to
~$2.56b in EV.

Such a multiple appears warranted due to the Company's growing specialty mix,
superior growth prospects relative to peers, and expected deleveraging. Indeed, the
wide disparity between NXEO's incremental EBITDA opportunity (~10% annually
through '17, likely more) as compared to peers (mid-single digits at Brenntag, modest
decline at Univar) should be adequate support for the ~2x turn premium to peers. Note
that IMCD is not a valid comp because of its sole focus on the specialty space – Nexeo,
Brenntag, and Univar are targeting a mix of commodity and specialty.

Free cash flow clocked in at ~$120m in 2015. Note that this differs from management's
free cash flow numbers as the Company defines FCF as adj. EBITDA – CapEx, net of
asset disposals, while I define it as cash from operations – CapEx. Comparing this to
2015 adj. EBITDA of $177m implies ~67% FCF conversion.

Given there are no major planned working capital investments/capital expenditures

that would depress FCF going forward (fixed asset additions, ERP implementation, and
IT investments were completed by '15), it seems fair to assume Nexeo would be able
to at least maintain current FCF conversion rates; actual conversion rates are likely to
be meaningfully higher given the mix shift to specialty (peers Brenntag and Univar
who possess a higher specialty mix enjoy higher conversion rates) and CapEx declining
from '15 levels to ~$25m annually (per management's guidance) as the aforementioned
growth CapEx rolls off.

Using the ~67% FCF conversion rate, NXEO should generate ~$273m in free cash flow
by year-end '17 (~$130m in '16, ~$143m in '17), which would reduce net debt (currently
~$760m) by a similar amount. As a result, equity value by year-end '17 is roughly
~$2.07b ($2.56b - ~$487m), implying a ~$18.10 stock on ~114.5m shares
outstanding (note the share count is adjusted to account for the earn-out at $12.50
and $15; 90.77m + 11.2m + 12.5m). Discounting this back to the current year at a
10% rate gets me to just south of ~$15 per share, or ~75% upside from current
levels.

Recommendation: Initiate a long position in Nexeo Solutions with a target price

of ~$15 per share and considerable downside protection.

Off the radar, armed with superior growth prospects as defined by EBITDA growth
(primarily due to mix shift and incremental cost cuts) relative to peers, along with
significant downside protection due to (1) increased outsourcing by suppliers in
difficult economic environments to reduce fixed costs and (2) a material discount to
peers, shares of NXEO represent an opportunity with asymmetric risk/reward, in my
view.

While the natural catalysts to close the price/value disparity would be improving
EBITDA and delevering the balance sheet in future years, it's my opinion that shares
could re-rate as soon as the 3Q '16 earnings call. I think management would likely
utilize their first post-merger quarterly earnings call to quantify and highlight the
opportunities covered in this article, which could lead to a repricing of shares. Other
catalysts include sell-side initiations – Lazard, Deustche, BoAML, and Credit Suisse
were the investment bankers running the deal - and the possibility of management
presenting at investment conferences.

The largest risk to my thesis would likely materialize in the form of a delay in mix
shift; said delay would probably be caused by a stalling in adoption rates. That said,
this risk appears well-mitigated by the fact that NXEO has already signed up many
large customers on an exclusive basis, which implies a proven product. Large suppliers
are capable of 'fishing around' for the best distribution deals and in all likelihood
would not have committed to exclusivity without being highly certain of long-term
payback. Hence, the fact that they committed to an exclusive distribution contract
materially de-risks Nexeo's growth outlook.