Sum of the parts
When one company runs businesses the market values differently, value each at its own peers' multiple, then ask why the market will not.
- Value a company segment by segment, net of head-office costs and debt
- Measure the market's discount to the sum of the parts
- Back out the multiple the market puts on one segment
- Show why leverage magnifies a conglomerate discount
The intuition
A shop sells designer handbags and discount socks under one roof. A buyer of the handbag business alone would pay a lot for its profits; a buyer of the sock business would pay much less. Value the whole shop at the sock multiple and you give the handbags away; value it at the handbag multiple and you overpay for the socks.
A sum of the parts (SOTP) values each segment at the multiple its own peers trade on, subtracts the head-office costs that belong to neither, and subtracts net debt. If the shares trade below that, the gap is the conglomerate discount.
Segment EV = segment EBITDA × peer multiple. Head-office drag = head-office costs × blended multiple. Gross SOTP = segment EVs − drag. Equity value = gross SOTP − net debt; divide by the shares for a value per share.
Why it works
- The conventions here: two segments, each at a peer EV/EBITDA multiple. Head-office costs are capitalized at the EBITDA-weighted blended multiple. A conglomerate discount applies to the gross SOTP, before net debt.
- Capitalize the head-office costs because they recur for as long as the businesses share a head office, and a buyer of the whole would inherit them.
- The discount to the equity is bigger than the discount to the whole. Net debt does not shrink, so a haircut to the gross SOTP comes entirely out of the equity.
- The market's discount has reasons: complexity, fewer natural buyers for the shares, the good business funding the bad one, and management that will not break the company up.
- Back out the implied multiple by taking one segment's peer value out of the market's enterprise value: what is left is what the market is paying for the other.
- An activist's pitch is usually a SOTP plus a catalyst: a spin-off, a sale or a new board that closes the gap. Without one, a discount can last for years.
| A: 200 × 12, and B: 300 × 6 | $2,400M and $1,800M |
| Blended multiple: 4,200 ÷ 500 | 8.4x |
| Head-office drag: 25 × 8.4 | $210M |
| Gross SOTP: 4,200 − 210 | $3,990M |
| Equity value: 3,990 − 1,000 | $2,990M, $29.90 a share |
| With a 20% conglomerate discount: 3,990 × 80% − 1,000 | $2,192M, $21.92 a share |
A 20% discount to the whole cuts value per share by 26.7%, because the $1,000M of net debt does not shrink.
The formulas
Each business at its own peers' price.
The EBITDA-weighted average.
Recurring costs, valued like the earnings.
Then divide by the shares.
What the market is not paying for.
Run it backwards.
Worked example
Value each segment, capitalize the head-office costs at the blended multiple, take off the drag and the net debt, then divide by the shares.
See it move
Same company and the same segment EBITDA. Change each segment's peer multiple, the head-office costs, leverage and the conglomerate discount a sceptic applies.
- Raise segment A's multiple. The gross SOTP and the value per share both rise.
- Raise the head-office costs. The drag grows and the gross SOTP falls.
- Raise net debt. Equity value falls; the dollar gap between the two per-share bars does not change, but it becomes a bigger share of a smaller number.
- Raise the conglomerate discount. Value per share falls by a bigger percentage than the discount itself.
Run it backwards
Same company, reversed: take segment A at its peers' multiple. What multiple is the market paying for segment B?
Start from enterprise value at the market price. Take out segment A at its peer value and add back the head-office drag, which the market price already carries. What is left is the market's value of B; divide by B's EBITDA.
If that multiple is well below B's peers, either B is worse than its peers, A deserves less than its peers too, or the whole company is mispriced: the classic 'you get B for almost nothing' pitch.
Traps
Say it in the interview
“How would you value a company with two very different businesses?”
Check yourself
4 fresh questions, with new numbers. Answer each one correctly to finish the chapter. Get one wrong and you will see the full working, then you can try it again with new numbers.
Answers within 1% are marked right. Type the number; $, %, x and M are fine. First tries count toward Learned: the topic is Learned once every chapter is done and 75% of first tries were right.
- Segment EV = EBITDA × peer multiple, segment by segment.
- Capitalize head-office costs at the blended multiple.
- Equity value = gross SOTP − net debt.
- Leverage makes the equity discount bigger than the discount to the whole.