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How do you do a sum-of-the-parts (SOTP) valuation?

A sum-of-the-parts adds segment values, but most of the work is in what comes after the addition. A three-segment worked example, and the two omissions that double the apparent discount.

Julian R. Sterling · from Business Valuation

A sum-of-the-parts (SOTP) valuation values each business segment on the multiple of its own peers, adds them, then deducts capitalised central costs, net debt, pension deficits and minority interests, and adds stakes the group does not consolidate. In the illustrative case below 650.0 million of segment value becomes 368.67 million of equity, 9.22 a share against an 8.00 share price: a 13.2 per cent conglomerate discount. Skip the central costs and the minority and the same group appears to trade 33.3 per cent below its parts.

Worked in full in Business Valuation by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →

When a SOTP is the right method

A single multiple on consolidated EBITDA assumes the group is one business with one risk and one growth rate. When it holds a slow industrial unit and a fast software unit, there is no peer set for the whole, and the blended multiple the market would pay is exactly the number you are trying to find. The SOTP answers it from the bottom: what would each unit fetch alone. It is the standard method for activist break-up cases, for spin-off and disposal decisions, and for any group with listed subsidiaries or associates.

The case

All figures in millions and illustrative. The segment multiples are assumed for the example, not taken from market data.

Segments and group items

Segment or item	EBITDA	Multiple	Group ownership
Industrial components	40.0	8.0x	100%
Software	15.0	14.0x	80%
Distribution	20.0	6.0x	100%
Unallocated central costs	−8.0

Net debt is 180.0, the pension deficit 20.0, and the group holds a 30.0 stake in an associate it accounts for by the equity method. There are 40.0 million shares, trading at 8.00. The software subsidiary carries no debt of its own.

Step 1: value each segment

Each multiple should come from the segment's own peer set, with its median and quartiles, as in mean or median multiple in a comparable company analysis.

Step 2: charge the central costs

Segment EBITDA is reported before the head office: board, group finance, listing costs, treasury. Those 8.0 do not disappear in a sum of the parts unless the group is actually broken up, so they are capitalised and deducted. The usual convention uses the blended segment multiple.

The check in the last line matters: the SOTP enterprise value divided by consolidated EBITDA gives the multiple your parts imply for the whole. If it is far above what any diversified peer trades on, the segment multiples are probably too generous.

Step 3: bridge to equity

From group EV to value per share

Item	Millions
Group enterprise value	580.67
Less net debt	−180.0
Less pension deficit	−20.0
Less minority interest, 20% of the software value	−42.0
Plus associate stake	30.0
Equity value	368.67
Per share, on 40.0 million shares	9.22

The minority is deducted because 100 per cent of the software EBITDA sits in the consolidated figures but only 80 per cent of its value belongs to the group's shareholders. The associate is added because its earnings are not in EBITDA at all. The full list of debt-like and cash-like items is in the enterprise value to equity value bridge.

Step 4: the discount

Sensitivity: the segment that drives the answer

The high-multiple segment dominates. Moving the software multiple also moves the blended multiple, the capitalised central costs and the minority, so the per-share value rises by less than the gross segment value suggests.

Software multiple against SOTP value per share and implied discount

Software multiple	Gross value	Central costs	Minority	Equity	Per share	Discount at 8.00
10.0x	590.0	62.93	30.0	327.07	8.18	2.2%
12.0x	620.0	66.13	36.0	347.87	8.70	8.0%
14.0x	650.0	69.33	42.0	368.67	9.22	13.2%
16.0x	680.0	72.53	48.0	389.47	9.74	17.8%
18.0x	710.0	75.73	54.0	410.27	10.26	22.0%

At 10.0x for software the discount nearly vanishes. An activist case for a break-up usually rests on one segment's multiple, and this table is where it should be challenged.

The common mistake

Adding segment values and subtracting net debt, and nothing else. Leave out the central costs and the equity is 438.00, 10.95 a share, 18.8 per cent too high. Leave out the minority as well and it is 480.00, or 12.00 a share, and the shares now seem to trade at a 33.3 per cent discount rather than 13.2. More than half of that headline discount is two lines of arithmetic, not market inefficiency.

Even a correct SOTP is a value the shareholders can only realise by separating the businesses. Separation has a cost: one-off fees, stranded costs, and tax on any disposal. An illustrative 25.0 of one-off separation cost alone is 0.63 a share, about half of the 1.22 gap between the SOTP and the price.

Takeaway

• Value each segment on its own peers, then capitalise and deduct the central costs that segment EBITDA leaves out.
• Deduct minorities in subsidiaries you consolidate in full, add stakes you do not consolidate.
• Divide the SOTP enterprise value by consolidated EBITDA as a sanity check on the multiples you chose.

The book is about why one company can carry three defensible values at once; the free workbooks for its case put the comparable set, the transaction set and the DCF side by side with the bridge to equity for each.

Questions readers ask

What is a conglomerate discount?

The gap between a group's share price and its sum-of-the-parts value per share, expressed as a share of the SOTP. In the worked case the parts are worth 9.22 a share and the shares trade at 8.00, a 13.2 per cent discount. Its size depends heavily on how carefully central costs and minorities are deducted.

How do you treat head office costs in a SOTP?

Capitalise them and deduct them, because segment EBITDA is stated before central costs that the group cannot avoid. A common convention is the blended segment multiple: 8.0 million of costs at 8.67x is 69.33 million, 1.73 a share in the worked case. Leaving them out overstates the equity by 18.8 per cent.

Should a SOTP use EV/EBITDA for every segment?

Use whatever metric the peers of each segment trade on, provided the result is an enterprise value. A software unit might be valued on revenue or EBITDA, a bank subsidiary on book value, which is already an equity value and must not have net debt deducted again. In the worked case all three segments use EV/EBITDA, at 8.0x, 14.0x and 6.0x.

Also on this site

• Mean or median multiple in a comparable company analysis?Use the median with its quartiles. In a five-peer set one outlier lifts the mean EV/EBITDA to 9.14x against an 8.20x median, adding 15.5% to the equity value.
• What goes in the bridge from enterprise value to equity value?Debt at repayment amount, free cash only, leases, pensions, deferred items, minorities. On 120.0 of EV, equity is 53.32, not the 80.00 loans less cash gives.
• How should corporate overhead be allocated to business segments?The base decides who looks unprofitable: an $18.0M pool on revenue gives Equipment a $2.00M loss, on gross profit a $1.07M profit. Group profit is $5.5M either way.
• How does the capitalization of earnings method value a business?Next year's normalised cash flow over the discount rate less growth: 1,236,000 over 15.0 per cent (18.0 less 3.0) gives a value of 8,240,000. Worked example.
• How does the excess earnings method value a business and its goodwill?Charge the tangibles a return, capitalise the rest: 692,000 of excess earnings at 22 per cent is 3,145,455 of goodwill and a value of 5,545,455.
• How much does the mid-year convention add to a DCF?The square root of (1 + WACC), minus one: 4.40 per cent at 9 per cent. Shifting only the forecast years adds 1.20 per cent; the perpetuity adds the rest.

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